Last week we produced an accounting tutorial setting out how to prepare a bank reconciliation. And we touched on some of the reasons why this is an important control for a business, and for personal finance. However this week we wanted to go a little further into these reasons. In particular if you have assignment or test question looking at internal controls, of which the reconciliation is a cornerstone of, this article might be useful for ideas.
Key Internal Control
The bank reconciliation plays such a central part in a business’ internal control system because of the nature of cash and the bank account. As you will see the bank account is the central record of the inflows and outflows of the business. Setting aside non-cash items, for example depreciation, the bank account reflects the vast majority of the economic benefits that flow between the business and third parties.
For example, when a sale is made to a customer this is reflected in the bank account when the customer pays; which might be at the time of sale or at a feature date. When the business pays for cleaning services, again when that account is paid the outflow of money is reflected in the bank account.
The second reason why the bank reconciliation is so critical is because of the nature of cash itself. Because money is so versatile in its use as a medium of exchange, is portable, generally holds value and widely accepted within an economy, it can be a great temptation for people to further their own economic prospects at the expense to the business. The more robust the controls around this area the less of a temptation it can be.
Practical Book Keeping
In addition to the internal control framework of a business bank reconciliations provide a very practical book keeping function. These activities include:
- a means to compare the business’ records with those of an independent third party, the bank, to ensure the entries made are correct and any errors can be identified and adjusted where required;
- a tool for the business to use to ensure the bank is correctly recording the flow of transactions through its system and properly accounting for the money the business has entrusted with them;
- ensuring the general ledger and therefore the trial balance and financial statements are disclosing the correct bank account figure, an important asset (or liability) of the business; and
- providing the business with a practical tool to monitor such mattes as unpresented cheques, a reducing issue due to the general decline in their use, but still important to monitor to ensure the settle of accounts is carried out in a timely manner.