Read Along With the VideoTranscript
Let's talk about bank reconciliations again. In the last video, we talked about the why. Why do we do a bank reconciliation? In this video, we're gonna talk about how do you do a bank reconciliation. If you didn't watch the why video, why do we do bank reconciliations, I recommend you go back and watch it. But the main takeaway was bank reconciliations solve for one problem, and that problem is incomplete knowledge.
We're trying to take two points of view, trying to take the books' point of view and the bank's point of view, and distill that into one truth of how much cash do we have. There's only one answer. There's only one truth. But the books have one concept, and the bank has one concept. But through a bank reconciliation, we can get down to the one true answer. Here is a problem. This is the problem we're gonna spend the next couple of minutes going through. Now, the problem says, "Prepare a bank reconciliation for July 31," given all of this information. Now, this may look overwhelming at first, but it's a puzzle, and it's very straightforward, and we're gonna solve the whole thing by asking the single question: Who doesn't know?
Because the answer to the question, who doesn't know, is going to tell us what side we should record it on. I told you, bank reconciliations are simply solving for incomplete knowledge. So the actionable question that we're gonna try to answer is: Who doesn't know?
And here's how you should start. You're always gonna have the balance per the bank statement is something, and the balance per the books is something. So right away, you need to write books, beginning balance, $3,900. Bank, beginning balance, $4,610. So what's happening here is the bank has sent us a bank statement as of July 31, and on that bank statement, they say, "Hey, guys, you've got $4,610 in cash." But on our books as of July 31, we say, "Uh-oh, we've got $3,900 in cash." So this is July 31, and we're saying, "Great. We got 39." They're saying, "Great. You got 46."
There's only one truth, and neither of these are it. So what we're gonna do now is we're gonna reconcile what the bank says with what the books say, and that's why it's called a bank reconciliation, because they gave us a statement on July 31 that said $4,610. Now, we're gonna go through and try to reconcile those differences, this, you know, $710 difference. We're gonna try to reconcile it to get to one true cash number. So we're gonna be making some pluses and minuses on our side, and we're gonna be making some pluses and minuses on the bank side. Now, you should know that we're not actually adjusting the bank's books at all.
We are the company, so we'll adjust our own books. But on the bank side, we're not actually gonna go in and change the numbers that the bank has for us because we can't do that. The bank is the bank. We're not the bank. But what we can do is we can say, "Well, the bank didn't know about certain things." So when the bank finds out, they're gonna add some money, or when the bank finds out, they're gonna take some money away. Now, we don't actually do that. We're just saying, "I know that when it happens, the bank is gonna do that." And so to get down to our one true number, we're gonna go ahead and do that now.
Blah, blah, blah. Let's actually just work on it. Enough theory. Let's just work through it. So you started by writing down the beginning balances. I'm just gonna get rid of all this. You started by writing down the beginning balances for the book and for the bank. We said book, $3,900; bank, $4,610. Now let's work through these transactions. Deposits in transit not recorded by the bank, $445. Now, for each transaction, I want you to use your brain and think about what is the real-life scenario. So this is words on a piece of paper, deposits in transit not recorded by the bank, but those words represent something that really happened.
We have checks, and we sent those checks to the bank. Now, at July 31, they may not have gotten there yet. They may arrive on August 5. But because we're doing it on July 31, those checks haven't reached their destination yet. So if you can, try to think about the real-world scenario that this sentence is describing. Deposits in transit. Checks were on their way, but they hadn't gotten to the bank yet. So let's ask our question. Who doesn't know? Who doesn't know that there are checks? Who doesn't know that we have an additional $445 in deposits? Well, we know about it because we were the ones that received the checks and sent them to the bank.
The bank, on the other hand, doesn't know. We're sitting right here. The checks are somewhere in the mail, but they haven't gotten there yet, so the bank has no idea that these checks are coming. So like I said, when the checks get there, the bank is going to add $445 because they're deposits that just, well, they just simply haven't arrived yet. So on our reconciliation, we say, "Hmm, well, when it happens, the bank is gonna add $445." So the process that we just went through is we just completed a bit of knowledge for the bank. The bank had incomplete knowledge, and we said, "Hmm, let's adjust that statement," because when the bank gets complete knowledge, they're gonna add $445.
So let's call this one deposits in transit. Now let's look at the next one. Okay, the next one says, uh-oh, says, "Bank error. A check written by another company was debited to your account for $20." So let's think about the real-world scenario. Somebody wrote a check, and it was taken out of our account instead of being taken out of their account. So the bank took $20 out of our account when they really shouldn't have. Now, you gotta think this one all the way through. The bank is gonna send us a statement, and it's gonna say, "Hey, we took $20 out of your account for that check you wrote."
This is really a mistake, isn't it? We know that it's a mistake. We know that we never wrote that $20 check. Now, who doesn't know? The bank, they're the one that made the mistake. And what's gonna happen when the bank does finally get complete knowledge? When we call back and say, "Hey, bank, you took $20 out. That was a mistake," what is the bank going to do? They're going to say, "You're right. That was a bank error. We should have not done that. We're gonna add the $20 back." So the bank's real issue was they didn't know they made a mistake. They had incomplete knowledge.
We knew right away when it said Company B instead of Company A. We called and said, "You took $20 out of the wrong account." At that point, the bank has full and complete knowledge. "You're right. We made a mistake. We'll add $20 back." Okay, so we're working through these relatively easily. Now let's look at this next one. A note was collected by the bank for $1,025. Okay, let's ask the question: Who doesn't know that the note was collected by the bank?
Well, the bank knows. The bank was the one that collected it. So in the real world, what happened was there was a note outstanding, somebody owed us money, and the bank collected it for us. So the bank collected the $1,025 for us, so the bank clearly knew about it 'cause they were the ones doing the work. Now, when the statement comes, the statement arrives on... You know, we're doing this July 31, so we'll say the statement arrives on July 31, and we see they added $1,025 to our account. We didn't know that. We didn't know that the bank collected that for us. We didn't know until the statement arrived.
So when the statement arrived, we say, "Thank you, bank. Thank you for collecting that $1,025 for us. We need to adjust our cash balance because we were unaware that you did that." So we'll say that we add $1,025 to our books because the bank did something for us. Let's look at this next one: a debit memo for $10 for bank charges. This debit memo right here, this could be debit memo, credit memo, and there is a way to remember that, and I'll show you in a separate video how to remember debit memo versus credit memo. But for now, oddly, I want you to just ignore it because the answer is right here: bank charges.
The bank charged us $10, presumably just because they're a bank. Banks like to charge us money. So who knew about the bank charge? Well, the person perpetrating the charge, the bank. The bank knew that there was $10 they took out of our account. We don't know until the statement arrives, right? So we were unaware of this bank charge until the statement arrives, so there is no way that we could have included it on our books because we had no idea. So the question, who doesn't know? We didn't know. It was a bank charge. We didn't know about it. Now that we do know about it, we need to correct our balance because truly, the money is gone.
We just didn't know about it. So this one is bank charge. We need to correct our books to properly reflect the fact that this $10 is gone now. We just didn't know about it until the statement came. Okay, the next one says, "An NSF check was returned by the bank, $35." NSF stands for non-sufficient funds. That just means a bounced check.
Somebody wrote a check for $35. They only had $20 in their account, so the bank said, "Sorry, not enough money. Bounce it." Now, let's think about this one. What is the real-world scenario? The real-world scenario is probably something like this. We made a sale. We increased our cash by $35. We increased our revenue by $35. So we thought, "Okay, we made a sale of $35. They wrote us a check of $35, so we're gonna increase our cash." Then we sent the check off to the bank. The bank said, "Hey, there's not enough money there. I'm not gonna deposit that." They tried to pull the $35 out of the customer's account.
They tried to pull it out and put it into our account. But the customer didn't have $35, so no money ended up in our account. So really, this isn't the case. We didn't actually increase cash by $35. So when the bank sends us the statement that says that check was returned, "Here's the copy of the check. You can go after the customer if you want." We didn't know that the check had bounced. The bank knew because when they tried to pull it out, the bank realized, well, there's no money there. We're not gonna do it. We're not gonna give you $35 if we can't get $35 from this other bank account.
So the bank, in the statement, sends us the fact that that check bounced, and so really, we shouldn't have ever done this in the first place because there was no cash there. So what we need to do is we need to decrease our cash by $35 for non-sufficient funds. Basically, we're saying, "Oh, man, that check bounced. We didn't get the money. We need to take that out of our balance."
Okay, let's look at another one. The next one says, "Accountants credited cash for $175 instead of $100." Okay, let's get rid of all this mess. So up here, we had a bank error. The bank made a mistake. They did something wrong, whatever. Down here, we have a book error. Our accountants did something rather than doing something else. Let's first determine the size of the error. They credited cash for $175 instead of $100. So the size of the error is it's a $75 mistake. It should have been $100. We wrote down $175. The difference between those two is $75.
So we know that either way, we need to write $75 somewhere because that was the size of the mistake, that was the magnitude of the error that we made. Now, let's use our brains and see if we can figure out what actually happened versus what should have happened and determine the answer to the question, who doesn't know about this error? So accountants credited cash for $175, which means they took cash down on our side by $175. What they really should have done is taken cash down by $100. So they took cash down too far. So to correct for that, we need to bring cash up by $75 because they took it down too far when really they should have only taken it down $100.
They took it down $175. So to offset that mistake, we add $75 back. Now, the question is, who didn't know about that? Well, we're the ones that made the mistake, and we didn't know, obviously, because if we knew, we wouldn't have done it. So when the bank tells us, "Hey, guys, I took out the $100 that you told me to take out when you wrote that $100 check," we look back and say, "Huh, we wrote down $175. That was a mistake. We didn't know about that until you sent us this bank statement." So when you send us this bank statement that says $100, what we're gonna do is say, "Oh, shoot, I made a mistake.
I need to add back that $75 mistake." We would have had no way of knowing that or of catching that until the bank sent us this statement that said, "Great, that check was for $100," and we look back and say, "Oh, we wrote $175." So we didn't know about it.
We didn't know that we had made a mistake. So because we didn't know, we need to make the adjustment when the bank statement comes in. Okay, one more. Let's get rid of all of this and do the very last one.
The last one says, "Outstanding checks of $120." Now, this is somewhat similar to deposits in transit, right? Deposits in transit, we said, we got some deposits, put 'em in the mail, and then they arrive at the bank. But they hadn't arrived yet, right? This one is no different. This was just deposits. Now we're saying, we wrote some checks. Some people are gonna cash 'em, but they haven't cashed 'em yet. The only difference is this one is minuses. So with deposits, we're gonna add money. With outstanding checks, we're gonna lose money. The question about knowledge is, we wrote these checks. We're fully aware that when they hit the bank, we're gonna lose $120 because we wrote checks for $120.
The bank doesn't know because they haven't gotten to the bank yet, 'cause we're sitting here July 31 and saying, "Well, they haven't gotten there yet, but they will." So what we do is we say, when the bank realizes what's happened, when the bank realizes we've written $120 in checks, our balance is gonna go down. So let's go ahead and decrease that balance so that we don't think that we actually have more money.
This is basically what you do when you balance a checkbook. You say, "I just wrote $120 in checks, so I'm gonna go into my ledger, take out $120 so I don't accidentally overspend." Now we've reached the bottom. We've run out of scenarios. So hopefully, if we add all of these up, we come up to the same amount, and we have reconciled the amount of cash that we have.
Let's see if that's the case. Starting on the book side, we have $3,900 plus the $1,025 that the bank collected for us, minus the $10 the bank charged us, minus the $35 that the bank said, "Hey, sorry, that customer didn't have any money, so we didn't deposit your check," plus the $75 where the bank says, "We took out $100," and we thought, "Oh, that should have been $100, not $175." So if you add all that up, we get $4,955.
Okay, now hopefully, the bank will add to the same thing. So we started with $4,610 on the bank side. We said, "Hey guys, $445 is coming in the mail, I promise." Then there's this $20 bank error where they took $20 out of our account instead of someone else's account, and we tell 'em, "No, that was the wrong account." And once they figure that out, they'll say, "You're correct. Here's the $20 back." And then the $120 that we're gonna take out is because we've got $120 worth of checks that are outstanding that could be cashed at any point, and when the bank figures out that they've been cashed, they're gonna decrease our account by $120.
So fortunately, we ended up at $4,955. You'll know you've done a bank reconciliation right if the amounts reconcile. Obviously, the goal of a reconciliation is to get the amounts to reconcile. So this amount here, this $4,955, this is our true cash balance. This is the one true number. So you can see there are some things that we didn't know about. There were also some things that the bank didn't know about. Once we adjusted for all the things we didn't know about, and once we adjusted for all the things that the bank didn't know about yet, we came out to this one true number of $4,955.
If we had known about everything and the bank had known about everything, we would both have this same number. So each of these entries is adjusting for some lack of knowledge, some misunderstanding about the true nature of the world, some incomplete representation about reality.
So as you're going through all of these statements here, all of these, "This thing happened, that thing happened, such and such happened," you need to think about the true representation of the world and think about which of these entities, whether it's our company or whether it's the bank, which of these entities is not aware of the true representation of the world? Which of these entities has incomplete knowledge about the events that have transpired? If the note was collected by the bank, the bank knew about it. We didn't know about it. But just because we didn't know about it didn't make it untrue.
The bank collected that note for us, and therefore, we need to adjust our books to reflect reality. Reality is the note was collected. Our books just don't reflect that reality yet, and so we add this adjustment.