Cash Control: Bank Reconciliation: The process of comparing a company's records of its cash balance in a bank with a bank's records of the company's cash and accounting for any differences is called a bank reconciliation. Preparing a bank reconciliation helps control cash because the bank's records provide the company with an independent record of the company's cash transactions.

To understand the bank reconciliation process, assume the Lowell Corporation opens a checking account at the Lawrence National Bank. At the beginning of July, the bank had a cash balance of $960,000 and other resources of over $9 billion. $825,000 of the bank's resources had been obtained from companies who deposited cash in the bank in return for checking privileges. In its general ledger, in addition to all its other assets, liabilities, and stockholders' equity accounts, the bank would show a $960,000 cash asset and an $825,000 customer deposits liability, as shown below. The customer deposits account is a liability because the bank owes its customers the $825,000 they deposited in the bank. The bank has more than $825,000 cash because the bank obtains cash from additional sources than customer deposits.
 

Lawrence National Bank's General Ledger

Cash (asset)

 

Customer Deposits (liability)

7/1  $960,000

 

 

 

$825,000   7/1

 

In addition to maintaining general ledgers, banks and other companies also keep detailed records called subsidiary ledgers. Subsidiary ledgers are similar to general ledgers in that they include much information. However, each subsidiary ledger differs from a general ledger in that all the information a subsidiary ledger relates to one specific general ledger account. For example, while the general ledger includes information about cash, accounts receivable, accounts payable, common stock, fees revenue, etc., the subsidiary ledger for customer deposits includes information only about the customer deposits liability account. The customer deposits subsidiary ledger does not include information about accounts payable, common stock, fees revenue, or any account other than customer deposits.

Banks maintain customer deposits subsidiary ledgers in order to provide them with information about each customer. For example, the Lawrence National Bank's general ledger customer deposits account shows the bank owes its customers $825,000. This means the bank's customers may write checks and withdraw up to $825,000 from the bank. But which specific customers may write the checks? May any one customer withdraw the $825,000? Without detailed information about its customers, the bank would be unable to tell which customers have enough cash in the bank to cover checks they write.

From its simplified customer deposits subsidiary ledger shown below, the Lawrence National Bank can see that on July 1 it owes the Chelmsford Corporation $22,000, the Haverhill Company $3,600, and the Medford Corporation $7,400. All the bank's other customers, whose individual accounts are not shown below, are owed $792,000. This information enables the bank to allow the Chelmsford Corporation to write checks of up to $22,000. The Haverhill Company may write checks of up to $3,600 and the Medford Corporation may write checks for up to $7,400. The bank's other customers may write checks for up to $792,000. The Lowell Corporation cannot write any checks on the Lawrence National Bank because the Lowell Corporation has not deposited any cash in the bank as of July 1.
 

Lawrence National Bank's Customer Deposits Subsidiary Ledger

Chelmsford Corporation

 

Haverhill Company

 

$22,000   7/1

 

 

$3,600   7/1


 

Medford Corporation

 

All other customers

 

$7,400   7/1

 

 

$792,000   7/1

 

Building on this basic foundation of banks' general ledgers and customer deposits subsidiary ledgers, the following sections examine the effects of several cash transactions on the accounting records of both the Lowell Corporation and its bank, the Lawrence National Bank.

Assume that on July 2, the Lowell Corporation was formed when its owner opened a checking account by depositing $6,000 in the Lawrence National Bank at 10:00 AM. How would this transaction affect the Lowell Corporation's general ledger?

When the Lowell Corporation receives the $6,000 from its owner, it would increase its cash asset and its stockholders' equity account, common stock. The resulting journal entry would be a $6,000 cash debit and a $6,000 common stock credit. (Remember assets increase with debits?) When the journal entry is posted, part of the company's general ledger would appear as follows.

Lowell Corporation's General Ledger

Cash

 

All other accounts

7/2   $6,000

 

 

 

$6,000   7/2

 

The Lowell Corporation's general ledger shows that the company has $6,000 cash on July 2. Since cash is an asset, the $6,000 cash appears as a debit balance. Because this chapter focuses on cash, the above general ledger combines in one account the effects on all accounts other than cash. Thus, the $6,000 credit to common stock appears in "All other accounts." Of course, in the Lowell Corporationís actual general ledger, the $6,000 credit would appear in the common stock account.

How would the Lawrence National Bank's receipt of $6,000 from the Lowell Corporation affect the bank's general ledger?

When the bank receives the $6,000 from the Lowell Corporation, it would increase the bank's cash asset and its customer deposits liability. The resulting journal entry would be a $6,000 cash debit and a $6,000 customer deposits credit. When the journal entry is posted, part of the bank's general ledger would appear as follows.

Lawrence National Bank's General Ledger

Cash

 

Customer Deposits

7/1   $960,000

 

 

 

$825,000   7/1

7/2       $6,000

 

 

 

$6,000   7/2

7/2    $966,000

 

 

 

$831,000   7/2

 

When the bank receives the $6,000 deposit from the Lowell Corporation, how would this transaction affect the bank's customer deposits subsidiary ledger?

The bank's $6,000 receipt from the Lowell Corporation means that the bank now owes the Lowell Corporation $6,000. Thus, the bank's liability to the Lowell Corporation increases from $0 to $6,000. The bank's subsidiary ledger would show an increase in its liability to the Lowell Corporation as a credit to the Lowell Corporation account, as shown below. (Remember liabilities increase with credits?)

Lawrence National Bank's Customer Deposits Subsidiary Ledger

All companies other than the Lowell Corporation

 

Lowell Corporation

 

$825,000   7/1

 

 

$6,000   7/2

 

The Lawrence National Bank's customer deposits subsidiary ledger shows that as of July 2 the Lowell Corporation may write checks of up to $6,000, while all the bank's other customers may write checks of up to $825,000. In total, the bank owes its customer $831,000 ($825,000 + $6,000). This $831,000 total of all accounts in the subsidiary ledger equals the July 2 balance in the bank's customer deposits general ledger account. This is one of the important points about the relationship between a general ledger and a subsidiary ledger: the total of all accounts in a subsidiary ledger should always equal the specific account's total in the general ledger. As we proceed through other chapters, you will learn about additional subsidiary ledgers.

July 2 bank reconciliation: Suppose the Lowell Corporation wanted to compare its records of cash with the Lawrence National Bank's records of the Lowell Corporation's cash in the bank. This comparison would be called a bank reconciliation. It would involve comparing the Lowell Corporation's cash asset balance (which is a $6,000 debit balance on July 2) with the Lawrence National Bank's subsidiary ledger balance in the Lowell Corporation's liability account (which is a $6,000 credit balance on July 2). In very simple form, the July 2 bank reconciliation would appear as follows.

Balance per Lawrence National Bank, July 2

$6,000

 

 

Balance per Lowell Corporation checkbook, July 2

$6,000

 

The bank reconciliation shows that the company's record of a $6,000 cash balance is reasonable. The bank's records confirm the company does have cash of $6,000 it can use on July 2. The company may write up to $6,000 of checks if it so desires.

Outstanding deposit: Assume that on July 5 the Lowell Corporation received an $800 check for services provided to K. Berger Engineering on July 5. The Lowell Corporation deposited the check in the Lawrence National Bank at 4:30 on July 5. On July 6, the Lawrence National Bank processed the check. How would this transaction affect the Lowell Corporation's general ledger?

When the Lowell Corporation received the $800 for services provided to K. Berger Engineering, it would increase its cash asset and increase its stockholders' equity account, fees revenue. The resulting journal entry would be an $800 cash debit and an $800 fees revenue credit. When the journal entry is posted, part of the company's general ledger would appear as follows. Note in this illustration the fees revenue credit appears in "All other accounts."

Lowell Corporation's General Ledger

Cash

 

All other accounts

7/2  $6,000

 

 

 

$6,000   7/2

7/5    $800

 

 

 

$800   7/5

7/5  $6,800

 

 

 

$6,800   7/5

 

As a result of its transactions, the Lowell Corporation's records show it has $6,800 cash available to use on July 5.

The Lowell Corporation deposited the $800 check at 4:30 P.M. in the Lawrence National Bank. How would this transaction affect the bank's general ledger and its customer deposits subsidiary ledger?

Lawrence National Bank's General Ledger

Cash

 

Customer Deposits

7/1   $960,000

 

 

 

$825,000   7/1

7/2       $6,000

 

 

 

$6,000   7/2

7/6         $800

 

 

 

$800   7/6

7/6   $966,800

 

 

 

$831,800   7/6

 

According to the bank's records, the Lowell Corporation's $800 deposit did not increase the bank's cash asset or its customer deposits liability until July 6, even though the bank received the deposit on July 5. Because of the high volume of deposits and checks processed by banks, it is common for them to stop processing deposits after a certain time each day. For example, many banks will accept deposits from 8:00 A.M. through 5:00 P.M. but will stop updating their accounting records for deposits after 2:30 P.M. Such a policy can result in companies making deposits on one day that will not appear in the bank's records until the following day. Such was the case with the $800 deposit of the Lowell Corporation: it was deposited too late on July 5 to be recorded in the bank's records on July 5. Instead, the $800 deposit appeared in the bank's records as if it were made on July 6. In its general ledger on July 6, the Lawrence National Bank's cash asset increased by $800. Since the Lowell Corporation had $800 more cash in the bank, the bank's customer deposits liability also increased by $800. In its customer deposits subsidiary ledger, the bank would increase the Lowell Corporation's account by $800, as shown below.

 

Lawrence National Bank's Customer Deposits Subsidiary Ledger

All companies other than the Lowell Corporation

 

Lowell Corporation

 

$825,000   7/1

 

 

$6,000   7/2

 

 

 

 

$800   7/6

 

 

 

 

$6,800   7/6

 

July 5 bank reconciliation: Suppose the Lowell Corporation wanted to compare its records of cash with the Lawrence National Bank's records of the Lowell Corporation's cash in the bank as of July 5. According to its records, the Lowell Corporation's cash asset balance is a $6,800 debit balance on July 5. The Lawrence National Bank's customer deposits subsidiary ledger balance in the Lowell Corporation's account is a $6,000 credit balance on July 5. The $800 difference between the company's cash balance and the bank's records is because the bank did not process the $800 deposit until July 6. In business terms, a deposit made by a company but not processed by its bank is called an outstanding deposit. The outstanding deposit would appear on the company's July 5 bank reconciliation as follows.

 

Balance per Lawrence National Bank, July 5

$6,000

Add: Outstanding deposits

$800

Adjusted bank balance, July 5

$6,800

 

 

Balance per Lowell Corporation checkbook, July 5

$6,800

 

The bank reconciliation shows that the company's record of a $6,800 cash balance is reasonable. The bank's records confirm that the company does have cash of $6,800 that it can use on July 5. The company may write up to $6,800 of checks if it so desires. It is important to note that the outstanding deposit was added to the bank's balance because that is exactly what the bank will do when it processes the deposit. The bank will increase its liability to the Lowell Corporation and, thus, the Lowell Corporation will have $800 more cash in the bank.

** You now have the background to do text exercise 6.8.

 

 

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