Bank Reconciliation Step by Step: Deposits in Transit, Outstanding Checks, and Adjusting Entries
A complete walkthrough of monthly bank reconciliation — book side adjustments, bank side adjustments, two-column layout, and the journal entries that follow. With worked examples covering NSF checks, bank service charges, errors, and EFT timing.
A complete walkthrough of monthly bank reconciliation — book side adjustments, bank side adjustments, two-column layout, and the journal entries that follow. With worked examples covering NSF checks, bank service charges, errors, and EFT timing.
Learning Objectives
- ✓Categorize timing differences (book side vs bank side) correctly.
- ✓Complete the two-column reconciliation that arrives at the true cash balance.
- ✓Record adjusting journal entries that bring the general ledger in line with the bank.
1. Direct Answer: Why Bank Balance and Book Balance Rarely Match
A monthly bank reconciliation explains the difference between the company's general ledger cash balance and the bank statement balance as of the same date. The difference is never zero in practice because of timing differences (deposits in transit, outstanding checks) and items only one side knows about until the statement arrives (bank service charges, NSF chargebacks, EFT receipts, errors). A proper reconciliation adjusts BOTH sides to the same final number — called the "true cash balance" or "adjusted cash balance" — and then the book side adjustments become journal entries. Bank side adjustments do not need journal entries because the bank already reflects them on its statement. The reconciliation is the primary internal control over cash and is a focus of every external audit.
Key Points
- •Reconciliation reconciles the bank balance and book balance to a single true cash balance.
- •Book-side adjustments become journal entries; bank-side adjustments do not.
- •Required monthly as an internal control and audit focus area.
2. Categorizing Adjustments: Bank Side vs Book Side
Bank-side adjustments are items the company already knows about but the bank does not yet show on its statement. Add deposits in transit (cash received and recorded by the company but not yet credited by the bank). Subtract outstanding checks (checks the company wrote and recorded but the payee has not yet cashed). Adjust for bank errors. Book-side adjustments are items the bank already shows but the company has not yet recorded. Add EFT receipts (customer deposits that hit the bank directly), interest earned, notes collected by the bank on the company's behalf, error corrections. Subtract bank service charges, NSF customer checks (deposits that bounced), monthly fees, error corrections that decrease the book balance. The mnemonic "DIBS - DUNS" helps: Deposits In transit and Bank errors on the bank side; Dues (charges) Unknown on the book side, NSF, Service charges.
Key Points
- •Bank side: deposits in transit, outstanding checks, bank errors.
- •Book side: bank charges, NSF chargebacks, EFT receipts, interest, errors.
- •After reconciliation, both sides equal the true cash balance.
3. Worked Example: Standard Monthly Reconciliation
Company books show cash balance of $12,450 on March 31. Bank statement shows $14,860. Items: deposits in transit $1,800; outstanding checks $3,910; bank service charge $25; NSF customer check $450; interest earned $125; an unrecorded customer EFT deposit of $650. Bank side: $14,860 + $1,800 - $3,910 = $12,750. Book side: $12,450 - $25 (charge) - $450 (NSF) + $125 (interest) + $650 (EFT) = $12,750. Both sides agree — true cash balance is $12,750. Journal entries (book side only): Dr Cash 650, Cr AR 650 (EFT). Dr Cash 125, Cr Interest Income 125. Dr Service Charge Expense 25, Cr Cash 25. Dr AR 450, Cr Cash 450 (NSF — reinstate the receivable). Net cash change in books: -25 - 450 + 125 + 650 = +$300. Pre-adjustment book balance $12,450 + $300 = $12,750 ✓.
Key Points
- •The reconciliation reveals unrecorded items; journal entries record them.
- •NSF checks reinstate the customer receivable and reverse cash.
- •After the journal entries, the GL cash balance equals the true cash balance.
4. Detecting a Recording Error
Books show $25,000; bank shows $22,360. Deposits in transit $4,000; outstanding checks $1,500. Service charge $40. Bank side adjusted: $22,360 + $4,000 - $1,500 = $24,860. Book side adjusted: $25,000 - $40 = $24,960. Difference = $100. The reconciliation does not balance. A $100 difference often signals a recording error — typically a transposition. Search the cash journal for an entry that, if reduced by $100, would resolve the difference. Suppose a customer payment of $1,260 was recorded as $1,360 on the books — the books are $100 too high. Correct by debiting accounts receivable $100 and crediting cash $100. After correction, book side = $24,960 - $100 = $24,860. Both sides now agree. The lesson: unreconciled differences are diagnostic, not just cosmetic. Always find them.
Key Points
- •An unbalanced reconciliation indicates an error or missed item.
- •Common errors: digit transpositions, missed entries, duplicates.
- •Always find and correct the cause; do not "plug" to balance.
5. Notes Collected by Bank and Other Multi-Item Activity
When a bank collects a customer note on behalf of the company, the company learns about the collection only via the bank statement. Suppose the bank collected a $5,000 note with $200 interest and charged a $25 collection fee, crediting the company $5,175 net. The journal entry: Dr Cash 5,175, Dr Collection Fee Expense 25, Cr Notes Receivable 5,000, Cr Interest Income 200. The cash impact on the book side of the reconciliation is the net $5,175 (not the $5,000 face value). Similarly for direct deposit payroll where the bank disburses funds the company has not recorded: identify the gross amount, taxes withheld, and net cash impact before crafting the entry. Multi-item reconciliations are error-prone; large companies use software like BlackLine or FloQast to manage them.
Key Points
- •Note collection net cash = principal + interest - collection fee.
- •Match the book-side cash impact to the actual cash effect of the entry.
- •Large companies use reconciliation software for material accounts.
6. Connection to Adjusting Entries and Financial Statements
The bank reconciliation produces a list of adjusting journal entries that should be recorded BEFORE the trial balance is finalized. If the bank reconciliation reveals a $5,000 NSF check, that customer receivable should be reinstated and cash reduced before the balance sheet is published — otherwise AR is understated and cash is overstated. Bank reconciliation is one of the first procedures auditors test because cash is the most liquid asset and the easiest to misappropriate. Auditors trace deposits in transit forward to the next month's bank statement and outstanding checks forward to confirm they cleared. A "stale" outstanding check (over 6 months old) requires investigation and possibly escheatment to the state under unclaimed property laws.
Key Points
- •Reconciliation adjustments precede trial balance finalization.
- •Auditors trace deposits in transit and outstanding checks to next period.
- •Stale checks may require escheatment to the state.
7. Using AccountingIQ for Bank Reconciliation
Snap a photo of the bank statement and your cash ledger and AccountingIQ produces the two-column reconciliation, identifies which items are bank-side vs book-side, computes the adjusted cash balance, and generates every journal entry needed. The app flags common errors like missed outstanding checks, transpositions in the cash journal, and improperly categorized adjustments.
Key Points
- •Automated categorization of bank-side vs book-side adjustments.
- •Journal entry generation for all book-side items.
- •Error detection for transpositions and miscategorized items.
High-Yield Facts
- ★Bank reconciliation reconciles book and bank balances to a single true cash balance.
- ★Bank-side adjustments: deposits in transit, outstanding checks, bank errors. No journal entries.
- ★Book-side adjustments: bank charges, NSF, EFT, interest, errors. Require journal entries.
- ★NSF entry: Dr AR, Cr Cash (reinstates the receivable).
- ★Stale outstanding checks may trigger state escheatment.
Practice Questions
1. Books $40,000, bank $42,500. Deposits in transit $3,000, outstanding checks $4,200, service charge $50, interest $250. A $1,100 customer EFT hit the bank but is not on books. Reconcile.
2. Which side does a $300 deposit recorded twice in the books belong on?
3. A check for $750 cleared the bank but is not in the outstanding check list. The bank shows a debit memo of $750. What does this mean?
FAQs
Common questions about this topic
Monthly at minimum, immediately after the bank statement is available. Best practice for material accounts is weekly or even daily for high-volume operating accounts. The SEC requires public companies to perform monthly reconciliations of all material cash accounts as part of SOX internal controls. The faster you reconcile, the faster you catch errors and fraud.
A segregation-of-duties principle requires that the person reconciling the bank account NOT be the same person who records cash receipts, cash disbursements, or has access to signing checks. Otherwise the reconciler can hide misappropriation by manipulating reconciliation items. In small companies where strict segregation is impossible, an owner or board member should review and sign off on reconciliations independently.
After 6 months, contact the payee to confirm whether they intend to cash the check. If not, void the check on the books (Dr Cash, Cr the original expense or AP account) and remove it from outstanding checks. Funds that cannot be returned to payees may need to be escheated to the state under unclaimed property laws (typically after 1-3 years depending on the state and check type). Maintain documentation of all efforts to contact the payee.
Positive pay (a bank service where the company sends a list of issued checks to the bank, and the bank only honors checks on the list) reduces fraud risk and the volume of unexpected items on the bank statement. Reconciliation is faster because the bank essentially pre-validates checks. The reconciliation steps do not change, but the population of unexpected debits shrinks significantly.
Most banks offer statement cut-off date selection — pick the calendar month-end to align with your books. If alignment is not possible (some banks cut off mid-month), reconcile to the bank cut-off date and reconcile a separate calculation to the book period. The "true cash balance" still must agree to the general ledger as of a specific date for financial statement purposes.
Snap a photo of your bank statement and cash ledger. AccountingIQ produces the two-column reconciliation, identifies each item's correct side, computes the adjusted cash balance, and generates all required journal entries. The app catches common errors like duplicate recordings, transpositions, and items posted to the wrong side.