Every month, preparing bank reconciliation statements is required to validate the cash balance in a balance sheet. In the balance sheet, the cash balance often differs from the total amount of all bank statement balances because of reconciling items such as outstanding deposits and outstanding checks. For example, outstanding checks are identified every month to get the total amount and to understand its impact on the balance sheet. How does one account for them on the balance sheet?
To account for outstanding checks on a balance sheet, monitor them every month to assess their validity. For example, they should be reviewed regularly to see whether they are recorded in the right bank account. The recording of check issuance may be erroneously recorded in another bank account. It can be corrected by reviewing the check numbers, whether it belongs to the series. In addition, they should not be already stale to be valid. Stale checks are reverted to accounts payable and added back to the cash balance.
This post will show the accounting for outstanding checks on the balance sheet. Then, it will show why adjustments are not needed because outstanding checks usually appear in a bank reconciliation statement. Moreover, adjustments are only done when there are errors in recording check issuances and stale checks.
Basics of a Balance Sheet
To assist the reader, we need to understand what is a balance sheet. A balance sheet is an example of a financial statement. First, it includes an entity’s assets, liabilities, and equities. Second, the total assets should equal the total liabilities and equities. Third, the total assets include the cash balance of an entity. The cash balance is calculated through the addition of cash collections and subtraction of disbursements to the beginning cash balance.
Disbursements usually include issuances of checks. As a matter of fact, their amounts can total to about 80% of the total disbursements of an entity. Entities use checks to enforce strong internal control policies. Also, disbursements can remain outstanding at the end of the month. These can be outstanding checks that are identified in the bank reconciliation statement.
What is a Balance sheet?
Based at Harvard Business School, a balance sheet shows the book value of an entity. The Book Value is derived by subtracting liabilities and equity from the total assets. The assets have two classes, current and Non-Current assets.
This post interest is in the total current assets only because it includes the cash balance which relates to outstanding checks. Also, non-current assets are outside of this scope. They are not related to cash in the banks.
Outstanding checks are part of the reasons the cash balance in the balance sheet of an entity differs from the total balance of the bank statements. First of all, outstanding checks are allowed for disbursements but have not yet been cleared in the bank. They are still undeposited by payees as of the bank reconciliation date.
For non-accountants, seeing a bank reconciliation statement may appear confusing. For starters, it includes the total amount of outstanding checks. They are checks issued that have not been deposited in the bank. Also, they appear as a deduction from the bank statement balance in the reconciliation. What are they?
So let’s break them down first.
According to Investopedia, an outstanding check is a check issued by a payor but still not encased or deposited. In addition, it may still be under the clearing cycle. The clearing cycle usually takes at least three banking days. Similarly, an outstanding check may be an unreleased check, although already approved.
The payor is still liable to the payee until the check is cleared in the bank. Hence, this poses a problem of whether an entry should be made after a bank reconciliation statement preparation.
An entry is not usually required for outstanding checks. First, they clear in a Bank, eventually. They are revenue to the payees which would be deposited immediately. Next, they are valid and allowed for disbursements. The management had already allowed the payment, though not yet deducted from the bank balance.
The bank statement balance differs from the cash balance on the balance sheet
Generally, the cash balance in a balance sheet usually differs from the total bank statement balances at the end of the month. First of all, there are still uncleared checks. They are checks paid to suppliers or payees yet still undeposited. In addition, there are many reconciling items that need attention. They can be unrecorded deposits and disbursements.
Bank Reconciliation: What to do about outstanding checks?
Outstanding checks are normally deducted from the bank statement balance every month to calculate the correct balance sheet‘ cash balance. In this case, they are still valid and recorded in the right account in the cash record. No accounting errors are found at the end of the month. That is to say, they are normally cleared within a few banking days.
Outstanding Checks Accounting
Conversely, outstanding checks are usually adjusted in the accounting records quickly when there are accounting errors. For example, they become stale and lost by payees. Stale checks are uncashed checks that are already six months old. They are usually adjusted, deducted from the cash balance, and credited to accounts payable. In addition, some outstanding checks were inadvertently recorded to another bank account instead of the right account. These are corrected by reclassifying them in the right bank account.
Uncashed checks and uncleared checks
Outstanding checks appear in a bank reconciliation statement because of many reasons. For instance, the payees have not deposited the checks. They may have forgotten about the checks or they have not scheduled when to deposit their collections. Notably, the checks may have been lost by the suppliers. Also, the checks become stale. The checks were lost and maybe forgotten.
There are two probable reasons for a stale check. First, the checks have been lost and forgotten. Those are common to entities that do not have monthly Bank Reconciliation Reports. Second, outstanding checks were cleared in the bank, but for some unknown causes, a bank made several errors. These errors are not common since bank employees are well trained.
Stale checks accounting
Stale checks are often listed in the bank reconciliation statement as part of its accounting. For instance, the outstanding checks includes stale checks. All checks that have not yet cleared in the bank are listed in the report. If unadjusted, those checks are easy to spot in the reconciliation. The check release dates of outstanding checks can be sorted for accounting. Hence, stale checks in accounting are debited to Cash in Bank Account and Credited to Accounts payable.