What is a bank reconciliation, who prepares it, and how do I tie the books to the bank (with a worked example)?

What does a completed bank reconciliation prove, and what does it leave unproven?

A bank reconciliation compares the ending cash balance on the bank's records with the ending cash balance in your general ledger, to verify that both are accurate. Done properly, it leaves your books reflecting every bank charge and the correct balance of the account. That is the assurance you are buying: the cash figure on your balance sheet is the money actually in the bank, adjusted only for items you can name and support.

A completed reconciliation evidences three things about the cash account for the period:

• The ledger balance and the bank balance agree once identified items are applied.
• Every item that separates them is listed and supported.
• Anything the books had wrong has been corrected in the ledger.

It does not prove that every payment was legitimate or went to the right expense account. A payment coded to the wrong category still reconciles, and so does a fraudulent transfer you recorded without question. Reconciling the numbers is not enough on its own: read the statement and understand the activity on it as part of the review. Deciding which other accounts need the same treatment is a separate question.

Who should prepare the reconciliation, and who should review it?

The preparer is normally the person who keeps the books: an in-house bookkeeper, an outside bookkeeper, or the owner. The preparer is accountable for starting from the right balances, identifying and classifying every difference, posting the corrections, and producing a schedule someone else can check.

The reviewer should be someone other than the person who records transactions and moves money. Duties should be assigned so that whoever reconciles the account cannot commit a fraud and hide it. Applying that rule in a small business, the reviewer is the owner when someone else keeps the books, and an outside accountant when the owner does.

The review adds what preparation cannot: an independent look at the source. The reviewer should read a bank statement they obtained directly from the bank, not a copy handed over by the preparer, and compare it with the statement used in the reconciliation. Where recording, payment and reconciliation are fully separated, the reviewer can limit the rest of the review to spot-checking key items on the completed reconciliation and confirming it was finished on time; where they are not, see below. A reviewer who only initials a summary adds nothing.

When one person records, pays and reconciles. In a very small business the same person may record the transactions, make the payments and do the reconciliation. The loss is specific: no one else ever compares the ledger with the bank, so an error or a misappropriation by that person can be carried and concealed indefinitely. If that person is an employee or an outside bookkeeper, the owner can at a minimum obtain the statement straight from the bank and review each month's reconciliation against it. If the owner is that person, reviewing their own work restores nothing; consider outsourcing the bank reconciliation to someone else, such as a contracted accountant. Designing a fuller set of compensating controls is its own topic.

What do you need in place before you start?

Assemble four inputs before you open the reconciliation:

1. The bank statement for a defined period, with its ending balance and date.
2. Books posted through the same date. Record transactions as they happen, from the source records: invoices, receipts, deposit slips, payment approvals. Before you start, post everything dated on or before the statement date: deposits, checks, card and ACH payments, and transfers. A reconciliation run against half-posted books can appear to agree by coincidence, or produce a long list of "differences" that are really just unposted work.
3. Last period's completed reconciliation. Its list of outstanding checks and deposits in transit is where this period's matching starts. Once you account for every check the bank has returned, the checks that remain unmarked are your outstanding checks. You can only tell that from an accurate starting list.
4. Support for anything unusual. Deposit slips, check copies, loan or merchant statements, and any correspondence with the bank.

If last period was never reconciled, stop here. Catching up unreconciled periods is a separate job, and a reconciliation built on an unreconciled start cannot be relied on.

How do you tie the books to the bank?

Work the two sides separately, then compare.

1. Take both balances as of the same date. The statement's ending balance, and the general ledger cash balance at that date.
2. Match activity. Tick each deposit and payment on the statement against the ledger, and each ledger entry for the period against the statement. Carry last period's open items into this matching.
3. List what is on the ledger but not the bank. These are usually deposits in transit and outstanding checks.
4. List what is on the bank but not the ledger, and anything on both sides at different amounts.
5. Adjust the bank balance for the items the bank has not yet processed: add deposits in transit and subtract outstanding checks. The result is the adjusted bank balance.
6. Adjust the book balance for the items the books are missing or have wrong: bank charges, interest, and errors. Each of these becomes a journal entry, not just a line on the schedule.
7. Compare the adjusted balances. If they agree, post the book-side entries and complete the documentation. If they do not, keep looking (see below).

Carrying each side to its own adjusted balance keeps the two kinds of adjustment apart. Bank-side items need no entry because the bank will catch up. Book-side items need one once they are identified; an item under query with the bank stays listed until the bank answers.

What kinds of difference will you find, and what happens to each?

Every unmatched item falls into one of four classes.

Items the bank has not yet processed. The statement will not include deposits made after the statement date, or checks that had not cleared by then.

• Deposits in transit are money you received that the bank's records do not yet show, for example a deposit made on the last day of the month.
• Outstanding checks are payments you made that vendors or employees have not yet cashed or deposited, so the bank has not yet taken the money out.

These are listed on the bank side and need no entry.

Items the bank has processed that the books have not. The statement may include bank charges you have not entered in your books. Interest earned works the same way in the other direction. These go on the book side and are recorded in the ledger.

Errors in the books. A deposit keyed at the wrong amount, a payment entered twice, or a transaction never entered. These go on the book side and are corrected by a journal entry.

Items on the bank statement you do not recognise. An unfamiliar ACH debit, a transfer to an account you do not know, or a deposit you cannot trace. These do not go into the books yet. Raise a query with the bank at once, because your account agreement sets how quickly you must report fraud or errors. Until the bank answers, list the item on the schedule as a reconciling item under query, with the query correspondence as its support, and state in the result that it is open. How long an outstanding reconciling item may stay open is a timeframe for your reconciliation policy to address. Once the bank answers, the item becomes a book entry or a bank correction. The reconciliation is where you find and fix errors in the bank statement as well as in your books.

How do you tell a timing difference from something the books have wrong?

Ask one question of each item: will it disappear by itself on the next statement, without anyone touching the books?

• Yes: it is a timing item. The transaction is recorded correctly on your side, and the bank has simply not processed it yet. List it on the bank side and expect it to clear. Deposits in transit should show up as actual deposits next month, and most outstanding checks should clear next month too.
• No: it is a defect, or a bank item the books lack. A missing fee, a wrong amount or a duplicate will sit there forever unless you post an entry. Correct it in the ledger.
• You cannot tell: treat it as unrecognised. Query the bank, and do not guess an entry.

Apply a time test too. A deposit in transit should appear in the bank within a few days, and anything longer points to potential theft. A check outstanding for many months also needs investigating, not relisting out of habit. Every reconciling item needs support; apart from bank fees and interest, which the statement itself supports, each one also needs to be evaluated carefully.

Why must corrections be posted, and in which period?

A correction that exists only on the reconciliation schedule leaves the ledger wrong. The reconciliation looks finished while the balance sheet still shows the wrong cash figure, and next month the same item turns up again, one period older and harder to trace. Carrying an unexplained or uncorrected difference forward as an accepted "reconciling item" is the most common way a reconciliation looks complete while controlling nothing.

Post each correction in the period being reconciled, dated within it, because that is the period the item belongs to. A bank fee or interest posted by the bank on the last day of the month, and not yet in your ledger, relates to that month and is posted back to it. If that period is already closed, follow your normal procedure for adjusting a closed period rather than leaving the correction on the schedule.

What does a worked tie-out look like?

Facts (invented for illustration). A business reconciles its operating account for March. The statement ends on March 31, the same date as the period end.

• Bank statement ending balance, March 31: 18,420.00
• General ledger cash balance, March 31: 19,020.00
• From last month's list, check 1041 (410.00) cleared in March. Nothing else carried over.
• A deposit of 2,150.00 made after banking hours on March 31 is in the ledger but not on the statement.
• Checks 1047 (640.00) and 1049 (1,215.00) are in the ledger but have not cleared.
• The statement shows a 35.00 monthly service fee that is not in the ledger.
• A customer check deposited on March 12 cleared the bank at 1,250.00. The bookkeeper recorded the receipt at 1,520.00, a transposition that overstates the books by 270.00.

Classify. The deposit and the two checks are timing items: recorded correctly, and they will clear next month. The fee is a bank item the books lack. The 270.00 is a defect in the books.

The tie-out:

Difference: 0.00. The two sides agree at 18,715.00, which is the true cash position at March 31.

Turning the book-side items into entries. Both are dated March 31 and posted in March.

Entry 1, the service fee:

Entry 2, the over-recorded deposit:

The second entry reverses the excess receipt and restores 270.00 to the customer's balance; whether anything is still owed is a collection question, not a cash one.

The reconciliation after posting. The ledger cash balance is now 19,020.00 − 305.00 = 18,715.00, so no book-side adjustments remain. The finished schedule shows the statement balance of 18,420.00, plus the 2,150.00 deposit in transit, less 1,855.00 of outstanding checks, giving 18,715.00, which equals the ledger. The deposit and the two checks carry forward as April's opening list and should clear on April's statement.

What if a difference remains after every item is applied?

If the adjusted balances still differ after you have applied every identified item, the reconciliation has not agreed. Do not force it. Posting an entry for the exact difference to "miscellaneous" or "suspense" makes the two sides meet, but it buries the evidence the reconciliation exists to produce and turns an unexplained difference into a meaningless entry in the books.

Instead, record the residual amount on the schedule, what you have checked so far, and that the reconciliation is not agreed. Hand it to the reviewer on that basis. Only an agreed reconciliation is signed off as agreed. Tracking down a difference that will not clear is a diagnostic job of its own.

What if the bank statement does not end on your period end?

Both balances must be taken as of the same moment. If your statement runs from the 15th to the 14th and your books close on the last day of the month, you cannot set the statement's closing balance against your month-end ledger balance. Either reconcile at the statement date against the ledger balance on that same date, or obtain from the bank a balance and the activity cut at your period end and reconcile at month end. Whichever you choose, use the same date on both sides every period.

How often should you reconcile, and why does each month depend on the last?

Reconcile every time a statement arrives: when you receive it, make sure the statement and your books agree. For most small businesses that means monthly, and more often where the risk is higher. Set the frequency by risk. An account used for ACH payments and wire transfers carries more risk than a quiet savings account and justifies closer watching.

Each period builds on the one before. This month's starting list of open items is last month's closing list, and each item on it should clear or be explained, which is why an item that simply rolls forward month after month is a warning sign. If you run several bank and card accounts, reconcile each one every period and keep a list so none gets skipped. Reconciling a credit card to its statement follows the same logic, with its own details.

What makes a reconciliation complete and ready for sign-off?

A bank reconciliation is complete when:

• The result is stated. The adjusted balances agree, or a residual is documented as not agreed.
• A schedule exists showing the bank and general ledger cash balances, how they compare, and every reconciling item, in enough detail and clarity for someone else to follow it without redoing the work.
• Every reconciling item has support. Deposit slips, check registers, bank notices, query correspondence.
• Every book-side item is posted in the ledger, so the ledger balance equals the adjusted bank balance.
• The preparer's sign-off follows your policy. Whether the preparer signs and dates the reconciliation on completion is a policy point for you to decide, and signing and dating is the recommended practice.
• The reviewer has documented their approval after comparing it with a statement obtained directly from the bank.

Ticking items off is not the same as reconciling. If you tick transactions in software, or put checkmarks on printouts, but never compare the resulting balance with the statement's ending figure, you have not performed the control, and no one can verify it afterwards. Automated reconciliation is its own topic; if you use it, verify periodically that it works as expected, especially after any system updates.

Keep the signed reconciliation with its support as part of your business records. The IRS requires you to keep records for as long as they may be needed to administer any provision of the Internal Revenue Code. Generally, this means you must keep records that support an item of income or deduction on a return until the period of limitations for that return runs out.