Bank Reconciliations

Not fun, but critically important to good financial management

bank reconciliations

Bank reconciliations should be done for every account, every month, and reviewed by a responsible owner/manager, who doesn't actually prepare them. Fun? Hardly! But very important.

Background

Your business keeps accounting records so it can report and monitor its financial position. Most transactions involve receiving and disbursing cash through one or more bank accounts.

The bank receives and disperses the business's cash and reports on the transactions it processed for the business, typically in a monthly "bank statement."

The importance of bank reconciliations is to cross check or reconcile the information from the bank with the business' books and records. Many bookkeepers and owner/manager's lose sight at this point and tend to accept the bank statement as accurate.

A Huge Bank Error

During my career as a financial professional I saw very few instances of a bank actually making an error in the amount of a transaction. More often they were errors of transactions being posted to the wrong account. But one error was spectacular! A check for $27,000 was cleared for $270,000... a simple clerical error by a keypunch operator adding an extra zero. Of course, $243,000 too much was taken out of the account. My predecessor CFO had let the bank reconciliations fall behind during a time of staff shortage and change. The company had a line of credit but sufficient cash resources so that the LOC wasn't triggered despite the huge extra amount withdrawn.

The bank itself picked up the error when it obviously reviewed transactions at month end. It issued a credit for $243,000 the following month to reinstate the missing funds to the Company's bank account and sent a transaction notice to the company. The company's accounting clerk duly recorded the "deposit" based on the bank's "credit" slip.

Classic Reconciliation Error

Although bank reconciliations weren't being properly completed, the reconciliation process was partially in operation. When she saw the $270,000 bank statement entry that did not match the $27,000 cash disbursement, the clerk made a classic error that happens too often by those who lose sight of the reconciliation process. She requested a journal entry to "correct" the books, based on the bank information.

Company Books of Account

So at this point the books of account are wrong - they have both a $27,000 withdrawl (correct ). and a $243,000 deposit (error). Then a $243,000 journal entry, bringing the cash account to the correct balance. But still leaving offsetting $243,000 errors in other accounts.

Error Compounded

There was another classic error/problem inherent in the company's accounting practices, which further complicated the bank reconciliations. We've fully written it up in Bank Sweep Accounts but in summary here's what was happening.

The company was really a group of six separate entities: C Corporation; S Corporation; Woman's Minority Corporation; Black Minority Corporation; Management Corporation; Facilities Management Partnership. Each separate legal entity had two bank accounts - operating and payroll.

The bank offered the "group" a fairly common service. It used its computer system and a central sweep account. Each night it "swept" the cash from individual accounts in to the central sweep account and passed necessary funds out to those the accounts on which checks had been written. The net position in the central sweep account was thus the net cash position of the group. a positive balance (cash on hand) earned interest. A negative balance (overdraft) was "covered" by an automatic advance from the line of credit, which, of course, resulted in interest being charged. Naturally, the bank duly reported its daily "sweeping" activity with transaction slips mailed to the company.

"Bank Sweep Accounts" will discuss the pros and cons of various ways to handle this situation. But the bottom-line conclusion is that most of the transaction data relating to the sweep activity should not be recorded in the books of each entity. In particular, there should not be an account set up for the bank sweep account.

However, I inherited a situation where the clerk was posting all the sweep activity into the individual entity accounts and had set up another account in the main company for the sweep balance. And, of course, since the "balances" had to follow a route between the main company's sweep account and the other entity accounts, "inter company" accounts were needed in each entity. Suffice it to say that tracing the $243,000 journal entry to "correct" for the initial bank error, the $243,000 correcting transaction when the bank found the error in the following month, and the "correcting journal entry" to fix the initial error between the entity bank account on which the cash was written, through both entity's intercompany accounts and into the sweep account was a nightmare! it's no wonder that with all this erroneous and confusing data being entered in the accounting records that the clerk didn't have time to keep up with the bank reconciliations!

So, the handling of the bank error was wrong... compounded by an erroneous system that recorded things that should never have been recorded.

Let's go back and see what a proper bank reconciliation process would have shown us.

Correct Bank Reconciliation Procedure

At the end of the month, when the bank error was discovered during the process of reconciling our books of account ($27,000 check) to the bank statement ($270,000 item cleared) we'd check out the transaction.

Either...

The returned check might show that we wrote it for $270,000 in which case we would need to get the $243,000 excess back from our subcontractor (who would probably have contacted us anyway to inquire about the sudden windfall!)

Or...

As was the case, we'd find that the bank made an error and we would contact them to initiate a correction. Since it was not our error, no adjustment would be made to our books of account, which are correct. We simply show an item on the bank reconciliation form and note that the bank had been notified and were investigating or had already agreed to correct the error. The next month, when the bank correction for $243,000 showed up on the bank statement, again no entry is appropriate in our books. Simply a note on the bank reconciliation that the previous month's error was corrected.

Of course, while the bank did correct the erroneous transaction, they neglected to deal with the fact that the sweep account had been missing $243,000 for several days. This amount should have earned daily interest, so we also had to have the bank pay appropriate interest into the sweep account-- well over $2000 in our case.

Lessons for the Family Business Owner/Manager

  1. Ensure that your staff are performing bank reconciliations every month as soon as the bank statements arrive. Actually look at the bank reconciliations and ask questions. Staff should be able to explain the process and any unusual transactions that are discovered. Fun work? Hardly! But it is important for your staff to know that you care and are watching.
  2. Look at your detailed accounting records periodically. You don't need accounting training to know that you have two bank accounts (you are one, if not the only one, signing officer) and that if there are more then something unusual is going on.
  3. Don't assume that just because accountants and bookkeepers talk in a mumble-jumble of debits and credits and double entry that they know what they are doing. Competent ones will be able to describe to you what is going on in accurate and non-jargon terms. Same for banks. Although I've found it rare, they do make mistakes.
  4. Simple observation. If your staff appear harried overworked, or aren't getting things done on time, it might be workload. Or, they could be "in over their head". Or doing things that don't need to be done.
  5. Ask to review the journal entries. When you go to the doctor, they first check your blood pressure, pulse rate, temperature and do a general observation. It's amazing what abnormalities this can alert them to.

    In accounting, most transactions are recorded in special books or journals -- cash receipts, cash disbursements, payroll etc..

    Journal entries are used for everything else. Some are routine: allocating the annual insurance premium payment to the 12 monthly accounting periods, instead of recording all the expense in the one month when the premium was actually paid; recording depreciation for your plant and equipment. The rest deal with errors, problems, corrections. Like a doctor looking for abnormal patterns, review the journal entries to get a good reading on the health of your business and how well it is being accounted for.

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