Bank Reconciliation: How to Prepare One, Reconciling Items and the Red Flags Auditors Look For

A bank reconciliation agrees the cash balance in the general ledger to the balance on the bank statement at the same date and explains every difference. It is the most basic control over cash, and one of the first documents an auditor asks for. Done monthly and reviewed by someone independent of cash handling, it catches errors, bank charges no one recorded and, sometimes, theft. Done badly, with a plug labeled "unreconciled difference," it hides all three.

This guide covers how to prepare a reconciliation, the common reconciling items, a worked example, the proof of cash, and the red flags auditors look for. A ready-made workbook is available in the bank reconciliation template.

Why the bank and the books differ

The bank and the company record the same transactions at different times and with different information. Differences fall into two groups:

• Timing differences: items the company has recorded that the bank has not yet processed, such as checks written but not yet cashed.
• Items the company has not yet recorded: activity the bank processed that the company learns about only from the statement, such as bank fees, interest, returned checks and automatic debits.

Errors on either side are a third category, and finding them is part of the point.

The two sides of a reconciliation

A standard reconciliation adjusts each side to a common figure, the adjusted (true) cash balance.

Bank side

Start with the balance per bank statement and adjust for items the bank has not recorded yet:

• add deposits in transit: receipts recorded in the books and deposited, but not yet credited by the bank at the statement date
• deduct outstanding checks: checks issued and recorded but not yet presented to the bank
• add or deduct bank errors, such as a deposit credited to the wrong account

Book side

Start with the balance per general ledger and adjust for items the company has not recorded yet:

• add interest earned and collections made by the bank on the company's behalf
• deduct bank service charges and fees
• deduct NSF (nonsufficient funds) checks: customer checks deposited and later returned unpaid
• deduct automatic payments not yet recorded, such as loan payments or merchant fees
• add or deduct book errors, such as a check recorded at the wrong amount

When both sides agree, the reconciliation is complete. Every book-side item requires a journal entry. Bank-side items do not, because they will clear on their own; they need follow-up only if they do not.

How to prepare a bank reconciliation, step by step

1. Get the statement and the ledger. Use the bank statement for the period and the general ledger detail for the cash account through the same date.
2. Start from last month's reconciliation. Check that last month's deposits in transit and outstanding checks cleared on this month's statement. Anything still uncleared carries forward.
3. Match deposits. Tick each deposit on the statement against the ledger. Ledger deposits not on the statement are deposits in transit.
4. Match disbursements. Tick each cleared check and electronic payment against the ledger. Ledger disbursements not on the statement are outstanding checks.
5. Identify unrecorded bank activity. Statement items not in the ledger, such as fees, interest, NSF items and automatic debits, are book-side adjustments.
6. Look for errors. Transposed numbers, duplicates and amounts posted to the wrong account. A difference divisible by nine often points to a transposition.
7. Prepare the reconciliation with both sides and confirm they agree to the cent.
8. Record the book-side journal entries and confirm that the adjusted ledger balance equals the adjusted balance on the reconciliation.
9. Review and sign. A person who does not handle cash or record cash transactions reviews the reconciliation, the supporting listings and the bank statement, and signs and dates it.

Worked example (illustrative)

At March 31 the bank statement shows a balance of 48,200 and the general ledger cash account shows 46,715. Matching the statement to the ledger identifies:

• a deposit of 6,500 recorded on March 31 and credited by the bank on April 1
• outstanding checks totaling 9,800 (checks 1041, 1043 and 1046)
• a bank service charge of 45, not recorded in the books
• an NSF customer check of 1,200, returned by the bank on March 28
• interest earned of 60, not recorded in the books
• check 1038 for supplies, recorded as 1,290 but correctly cleared by the bank at 1,920, so the books understate the payment by 630

Both sides agree at 44,900, which is the cash balance that should appear on the balance sheet. The book-side items need journal entries: debit cash for the interest and credit interest income; debit bank charges for the fee; debit accounts receivable for the NSF check, because the customer still owes the money; and debit supplies expense for the 630 correction. After posting, the ledger shows 44,900.

If the two sides had not agreed, the next step would be to re-match the statement line by line, not to adjust totals. A remaining difference usually turns out to be an item listed on the wrong side, a deposit split across two statement lines, or a transaction recorded twice.

The proof of cash

A standard reconciliation checks balances at one date. A proof of cash, also called a four-column reconciliation, reconciles the beginning balance, receipts, disbursements and ending balance per bank to the same four figures per books. It detects problems a single-date reconciliation can miss, such as receipts and disbursements that are both overstated by the same amount, or an unrecorded disbursement offset by an unrecorded receipt. Auditors use it when there is a fraud risk over cash, and quality of earnings providers use it to test reported revenue against deposits. See quality of earnings report.

Red flags auditors look for

Cash is a common target for misappropriation, and AU-C 240 directs auditors to consider fraud risk factors. On a bank reconciliation, the warning signs include:

• Unexplained or plugged differences, especially if carried forward month to month.
• Stale outstanding checks: checks outstanding for several months may be lost, voided without being recorded, or never mailed. They may also be subject to state unclaimed property (escheat) laws, which vary by state.
• Old deposits in transit: a deposit in transit should clear within a few business days. One that clears weeks later, or never, suggests a fictitious receipt or a lapping scheme.
• Kiting: writing a check on one account and depositing it in another, so that the same money appears in both accounts at year end. The signal is an interbank transfer recorded as a deposit in the receiving account before year end and as a disbursement in the paying account after year end. Auditors test this with a schedule of interbank transfers around year end.
• Reconciling items without support, or round-number items.
• Altered or incomplete bank statements. Obtain statements directly from the bank or online banking access where possible, rather than from the person who prepares the reconciliation.
• Lack of segregation of duties: the same person receives cash, records it and reconciles the account. See the segregation of duties conflict matrix.
• Late preparation: reconciliations done months after period end, or all done at year end for the auditors.

How auditors test the bank reconciliation

At year end, the auditor typically:

1. obtains the client's reconciliation and agrees the book balance to the general ledger and the bank balance to the bank statement or a bank confirmation; see the bank confirmation letter template and audit confirmations
2. foots the reconciliation and the listings of outstanding checks and deposits in transit
3. traces outstanding checks and deposits in transit to the subsequent month's statement (or a cutoff statement obtained directly from the bank), checking dates and amounts
4. investigates outstanding checks that do not clear and deposits in transit that clear late
5. vouches book-side reconciling items and confirms they were recorded
6. reviews the interbank transfer schedule for kiting
7. reads the statements for unusual items, such as large round transfers or payments to unfamiliar parties

Record the procedures, results and conclusion clearly, as described in audit working papers.

Frequently asked questions

What is a bank reconciliation?

A bank reconciliation is a schedule that agrees the cash balance in the general ledger to the bank statement balance at the same date and explains every difference, such as deposits in transit, outstanding checks, bank fees and errors.

Which reconciling items need journal entries?

Only book-side items, such as bank fees, interest, NSF checks, automatic debits and book errors. Bank-side items, such as deposits in transit and outstanding checks, clear on their own and need follow-up only if they do not.

How often should a bank reconciliation be prepared?

At least monthly, promptly after the statement is available, and reviewed by someone independent of cash receipts and disbursements. Companies with high transaction volume or fraud risk often reconcile more frequently.

What is check kiting?

Kiting is using the time it takes a check to clear to make the same funds appear in two accounts. Auditors look for interbank transfers recorded as receipts before year end and as disbursements after year end.

What should happen to old outstanding checks?

Investigate them. They may need to be voided and reissued, written back to cash, or reported and remitted to the state under unclaimed property laws, which vary by state.

Sources

• AICPA, AU-C Section 240, Consideration of Fraud in a Financial Statement Audit
• AICPA, AU-C Section 505, External Confirmations (bank confirmations)
• AICPA, AU-C Section 230, Audit Documentation

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error