Lecture: Cash and the Bank Reconciliation
Lecture script · about 15–20 minutes spoken · Week 9
Opening
Picture three places at closing time. At a farmers' market stall, two people count the cash box together. At a dog-grooming service, the owner checks the card deposits against the day's sales. And at our bicycle shop, a founder holds two numbers that should match and don't. The bank statement says the account holds $8,450. The shop's own Cash account says $8,851. Both can't be the shop's cash. This lecture is about guarding cash and finding the one true balance.
Let me remind you where we are. In Week 3 you learned to journalize and post with debits and credits. In Week 4 you adjusted the books at the month's end, and you learned that those adjustments never touch Cash. In Week 5 you built the balance sheet. And in Week 8 you met internal control and its five components: the control environment, risk assessment, control activities, information and communication, and monitoring.
Here's the plan. We'll take the third component, control activities, and point it at cash. We'll look hard at splitting duties, then at cash coming in, cash going out, and the petty cash fund. Then we'll read the bank statement and reconcile it, side by side, until both sides agree. We'll record only the entries the reconciliation needs, and we'll finish on the balance sheet. Next week, in Receivables, you'll move on to the money customers owe.
1. Six kinds of control over cash
Start with a coffee shop you know. The person at the register has a drawer nobody else uses. The safe in back is locked. Someone counts the drawer at closing. None of that feels like accounting, but every one of those habits protects cash.
Those habits are control activities: the actions a business builds into its policies and daily procedures to meet its control goals, such as limiting access to cash, splitting duties, and reconciling records.
The GAO, the Government Accountability Office, publishes a guide called the Green Book. In paragraph 10.04, Table 1, it lists common categories of control activities, and it says plainly that its list is not all inclusive. This course teaches six of them, each with a shop example. Access restrictions and accountability: each clerk uses a separate cash drawer and register login. Segregation of duties: the person who opens the mail and lists the checks is not the person who records receivables. Control over information processing: prenumbered repair tickets, every number accounted for. Physical control over vulnerable assets: a locked stockroom for bicycles and a safe for cash. Control over complete, accurate, and timely recording: a monthly bank reconciliation by someone who doesn't handle cash. And management of human capital: background checks before hiring, plus training and supervision for anyone who handles cash.
Pause and try this. A ticket number is missing from the stack. Which of the six categories caught it?
Run the list again in your head.
Here's the answer. It's control over information processing, the prenumbered repair tickets. Because every number has to be accounted for, a missing ticket makes someone ask where its cash went.
2. Splitting the duties, and the limit
Think about a student club with one treasurer who collects the dues, deposits them, writes the checks, and keeps the only record. If a payment vanished, who would notice? Only the one person who lost it.
That's the problem segregation of duties solves. It divides the work on an asset among different people, so that no one person both handles the asset and keeps its records. At the shop, one person opens the mail and lists each customer's check. A different person records the payment in Accounts Receivable. At the month's end, whoever reconciles the bank account compares that list with the bank's deposits. The check passes through three pairs of hands, and nobody can hide it without the others seeing a gap.
Now the honest limit. Internal control gives reasonable, not absolute, assurance. People make mistakes, and two employees can collude to defeat segregation of duties. If the person at the mail and the person at the receivables agree to hide a check together, splitting the work won't catch it.
And one wrong turn to cure. Splitting duties isn't a sign that the owners distrust their people. When a drawer comes up short, a second person's count can show the shortage wasn't the clerk's. It protects the employees as well as the cash.
Pause and try this. Can segregation of duties stop two employees who work together to hide a check?
Think about who would be left to notice.
Here's the answer. No. Collusion defeats it, because the two people who would catch each other are on the same side. That's why internal control promises reasonable assurance, never absolute assurance.
3. Cash coming in and going out
Cash moves in two directions, and each direction gets its own guard. The controls over cash include prompt deposits, payment by check or electronic transfer with approval, a petty cash fund with receipts, and a monthly bank reconciliation by someone who doesn't handle cash.
Take cash coming in first. At the farmers' market stall, two people count the cash box at closing and both sign the count slip. One of them deposits the cash the next morning. Later, someone who didn't count it compares the slip with the bank's record of the deposit. The cash spent the night locked up, two people counted it, and it reached the bank fast.
A card business needs the same habit. At the dog-grooming service, card sales reach the bank as deposits. The owner, who doesn't take payments at the front desk, compares those deposits with the day's sales records. A sale that never reached the bank shows up as a gap.
Then cash going out. The bicycle shop pays its bills by check or electronic transfer, never from the cash drawer, and a founder approves each payment. An approved payment leaves a record, and a record can be checked.
Pause and try this. Does a business that takes only cards still need someone to compare deposits with sales?
Picture the grooming service's front desk.
Here's the answer. Yes. A card deposit can still be missed, counted twice, or recorded at the wrong amount. The control is the second person's comparison, and it works the same way for cards as for bills and coins.
4. The petty cash fund
Every business has tiny payments: postage for one package, a tip for a delivery driver. Writing a check for each one would be slow, so a business keeps a small box of cash.
That box is a petty cash fund: a small, fixed amount of cash held by one custodian for payments too small for a check, with a receipt for every payment. Its one rule is that the receipts plus the cash left always add back to the fund's set amount. If they don't, something is missing, and the custodian answers for it.
The fund has two entries. To set it up, the business writes a check for the set amount, and it debits Petty Cash and credits Cash. Then the custodian pays small bills and keeps receipts, with no entry yet. When the box runs low, the custodian hands in the receipts, and a check brings the cash back to the set amount. That refill debits the expenses the receipts show, like Postage Expense, and credits Cash.
Pause and try this. When the fund is refilled, is Petty Cash debited?
Think about what the receipts are telling you.
Here's the answer. No. The refill only brings the box back to its set amount, so Petty Cash doesn't change. The receipts show where the money went, so the refill debits those expenses.
5. Reading the bank statement
Every month the bank sends the shop a bank statement: the bank's own record of the account, listing deposits, checks and transfers paid, fees, interest, and the ending balance.
Here's the key idea of the whole week. The bank and the shop record the same cash at different moments. The shop records a check the day it writes it. The bank records it the day the check arrives. So at the month's end the two balances differ even when nobody has made a mistake.
That's why the shop prepares a bank reconciliation: a schedule that explains every difference between the balance on the bank statement and the balance in the Cash account, adjusting each side until both reach the same true cash balance.
One caution about words. A bank often calls your deposit a credit, because to the bank your deposit is money it owes you. That's the bank's books. In the shop's books, a deposit is still a debit to Cash.
At the end of Month 3, the shop's gap is $8,851 on the books against $8,450 at the bank, which is $401. Our job is to explain every dollar of it.
Pause and try this. Which starting balance is the shop's true cash, the bank's or the books'?
Don't pick too fast.
Here's the answer. Neither one yet. The bank doesn't know about checks the shop wrote recently, and the shop doesn't know about the fee the bank took. Both sides need adjusting before either shows the true cash.
6. The bank side
Start with what the bank doesn't know yet. A deposit in transit is cash the business has recorded and deposited that the bank had not yet added when it prepared the statement, so you add it to the bank side. An outstanding check is a check the business has written and recorded that the bank had not yet paid, so you subtract it on the bank side.
Let's run the shop's bank side. Begin at $8,450. Add the deposit in transit of $1,200, and you're at $9,650. Now subtract the two outstanding checks: check No. 211 for $400 and check No. 214 for $750, together $1,150. That leaves $8,500, the adjusted balance on the bank side. An adjusted balance is the cash balance each side of a bank reconciliation reaches after its reconciling items, and the two sides' adjusted balances must be equal.
Pause and try this. Should the outstanding checks go on the book side, since they are the shop's own checks?
Ask yourself what the shop's books already show.
Here's the answer. No. They belong on the bank side. The shop subtracted the $400 and the $750 from Cash the day it wrote the checks, so the books already know. Only the bank hasn't caught up.
7. The book side, and the swapped digits
Now turn to what the shop doesn't know yet. A bank service charge is a fee the bank takes directly from the account, so you subtract it. An NSF check is a customer's check that the customer's bank refused to pay because the account did not have sufficient funds. The shop added it to Cash when it deposited it, so you subtract it, and the customer owes the shop again. Interest the bank pays raises cash, so you add it. And the shop's own mistakes get fixed here too.
One mistake has a shape worth knowing. A transposition error is a recording mistake in which two digits of a number are swapped. The difference between the right and the recorded amounts is always evenly divisible by 9.
Here's the shop's book side. Begin at $8,851. Take off the $25 service charge and the $300 NSF check, and add the $10 of interest. Then the error: check No. 209 was written for $95 but recorded as $59, so the books took out $36 too little. Take that $36 off, and the book side lands on $8,500. It matches the bank side.
Pause and try this. The error was $36. Is that evenly divisible by 9?
Do the division in your head.
Here's the answer. Yes. 36 divided by 9 is 4, a whole number, which is the sign of two swapped digits. Nine and five became five and nine.
8. Only the book side gets entries
The reconciliation is a schedule, not a journal entry. So which items reach the journal? Journal entries are needed only for the book-side items. The bank-side items are already in the shop's books, and they'll clear the bank next month without help.
That gives the shop four entries. For the service charge, debit Bank Service Charge Expense $25 and credit Cash $25. For the NSF check, debit Accounts Receivable $300 and credit Cash $300, because the customer owes it again. For the interest, debit Cash $10 and credit Interest Revenue $10. And for check No. 209, which paid a supplier on account, debit Accounts Payable $36 and credit Cash $36. Each entry balances, and together the debits and the credits each come to $371.
Post those to Cash, and the shop's $8,851 drops by a net $351 to $8,500.
You might remember from Week 4 that adjusting entries never touch Cash. That rule still holds. These four entries aren't accruals or deferrals. They're corrections to Cash, catching the books up with what already happened at the bank.
Pause and try this. Does the $1,200 deposit in transit need a journal entry?
Ask whether the shop's Cash account already knows about it.
Here's the answer. No. The shop recorded that deposit when it made it. Only the bank is behind, so the bank side waits and the book side gets the entries.
9. Cash and cash equivalents
The reconciliation's last job is handing the balance sheet a number it can trust. Some businesses park spare cash in very safe, very short investments. Those are cash equivalents: short-term, highly liquid investments so near to maturity that their value is unlikely to change. They're reported together with cash on one line, cash and cash equivalents.
For the shop, the bank said $8,450 and the books said $8,851. The reconciled $8,500 is the shop's Cash at the end of Month 3, and it's the figure a lender would read.
One caveat. A reconciliation proves two records agree at one moment. It doesn't prove every sale was recorded in the first place, which is why it works alongside the other five controls.
Pause and try this. Which figure belongs on the shop's balance sheet for Cash at the end of Month 3?
Pick from the three you've heard.
Here's the answer. The reconciled $8,500. The bank's $8,450 is missing a deposit and includes checks it hasn't paid, and the books' $8,851 is missing the bank's items and the shop's own error.
Closing
Let me pull it together in the order we built it. Control activities are the everyday actions that guard cash, and this course teaches six of the Green Book's categories. Segregation of duties splits handling an asset from keeping its records, though collusion can defeat it. Cash coming in is counted and deposited promptly, cash going out is approved, and a petty cash fund covers small bills with a receipt for each. The bank statement is the bank's record, and the reconciliation explains every difference. Deposits in transit and outstanding checks adjust the bank side. Service charges, NSF checks, interest, and the shop's own errors adjust the book side. A transposition error leaves a gap divisible by 9. Only the book side gets entries, and the shop's true cash is $8,500.
Next in this module, read the Readings & Resources page, then work the lecture tutorial and the practice set before the quiz, the discussion, and the assignment. Next week, in Receivables, you'll measure what customers owe and estimate how much of it they won't pay.
Built with The Course Maker · samples.thecoursemaker.com