The Bank Reconciliation: A Key Internal Control in Financial Management
What if I said there’s a process that, when regularly performed, provides the following benefits: (1) increased accuracy in financial reporting, (2) early fraud detection, and (3) less time spent preparing for the annual financial audit—would you believe me? It probably sounds too good to be true. But, luckily, it’s not. Such a process exists—it is the bank reconciliation process.
What is a bank reconciliation?
A bank reconciliation is the process of comparing the activity listed in the local government’s bank statement to supporting transactions reflected in the general ledger. This process is a key internal control that helps ensure the proper stewardship of public monies. The bank reconciliation process is most beneficial when regularly performed—usually monthly is sufficient, although local governments with many transactions may consider reconciling accounts more frequently, perhaps on a weekly or bi-weekly basis.
Who performs the bank reconciliation?
In deciding who should perform the bank reconciliation, local governments should consider how duties have been segregated within the finance department. The reconciliation function must be segregated from the record-keeping function. It is far too easy for mistakes or potential acts of fraud to occur when the same person is responsible for recording financial transactions and then reconciling those same accounting records. Therefore, the bank reconciliation should be performed by an employee who does not have record-keeping responsibilities, such as recording cash receipts, handling disbursements, or regularly making journal entries.
In small local governments with limited finance staff, the employee with the least responsibility for financial record keeping should perform the bank reconciliation. Regardless of a unit’s size, it is best practice to have another person review and approve (by signing off on) the bank reconciliation. This secondary review and approval can be performed by a governing board member in small units with limited staff.
Why is a bank reconciliation necessary?
Each month a local government should receive a bank statement that reflects an ending account balance and lists the various deposits and withdrawals for the period. The same transactions shown on the bank statement should also be accounted for in the general ledger. As such, the bank statement balance and general ledger balance (i.e., “book balance”) should theoretically match at the end of the same reporting period. In practice, however, the ending bank statement balance and book balance generally do not match until the accounts are “adjusted” to reflect all transactions. This is why reconciliation is necessary—to ensure that the bank statement and general ledger reflect an accurate ending balance at the end of each period.
There are several reasons that may cause the bank statement and general ledger balances to differ. For example, timing differences are often a contributing factor—a deposit in transit may not have cleared the bank prior to the statement being issued. The following list highlights some common reasons that lead to discrepancies between the ending bank statement and general ledger balances:
- Deposits in transit that do not clear before the bank statement is issued;
- Outstanding checks (checks not yet cashed by the payee);
- Direct deposits not yet been recorded in the general ledger (e.g., state distribution of sales tax directly deposited to the bank account but not recorded to the ledger);
- Bank interest earned but not recorded in the general ledger;
- Bank fees charged by the bank but not recorded in the general ledger; and
- Recording errors or missing transactions (human error).
After adjustments are made, the bank and ledger balances should match, leaving an unreconciled amount of $0.00 (meaning that all money has been fully accounted for). In some instances, the ending balances will not match exactly, but the goal is to at least understand the reason for the discrepancy.
How is a bank reconciliation performed?
The person performing the reconciliation must “adjust” the ending balances of the bank statement and general ledger by adding and/or deducting the amount of any unrecorded transactions. The bank reconciliation process can be divided into six steps, as follows:
- Identify the unadjusted balance for both the bank statement and general ledger (these are the sums reflected before any adjustments have been made).
- Identify the “cleared” transactions—those that are recorded in both the bank statement and the general ledger. (Certain accounting software automatically performs this step.)
- Adjust the bank statement balance by (1) adding deposits in transit and (2) deducting outstanding checks not cashed by contractors/vendors.
- Adjust the general ledger balance by (1) adding direct deposits not reflected in the general ledger, (2) adding bank interest, (3) deducting bank fees, and (4) deducting bounced checks.
- After performing steps 3 and 4, the ending balances should match, leaving an unreconciled amount of $0. If this is not the case, the person reconciling must determine the reason for the discrepancy. Transposition errors, where two numbers are reversed in an amount, are common. It is also helpful to double check whether all the transactions listed on the bank statement have in fact been posted to the general ledger.
- Have a second person review and approve/sign off on the reconciliation. And maintain financial records that evidence the performance of the reconciliation process.
Key takeaways
The importance of regularly reconciling accounting records cannot be overlooked. The reconciliation process is a means to detect accounting errors sooner than they may otherwise be discovered if reconciliation is not regularly performed. The reconciliation process also helps to detect fraud and ensures the timely creation of accurate financial records. By adopting a month-end review process that includes bank reconciliation, the local government is emphasizing the importance of fiscal responsibility throughout the organization.
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