Today, you will learn why bank reconciliation is important to the audit.
An audit engagement is not completed unless substantiation of cash is done. First, all Cash in the Bank balances should be reconciled with their corresponding bank statements. The accountant should prepare bank reconciliation reports for all bank accounts. Next, cash in the local treasury is also validated through surprise cash counts and other verifications. It is made to ensure that all cash collections are accounted for and deposited without delay. Also, the materiality of the errors affects the opinion of an auditor.
This post lists the most common reasons a bank reconciliation is important to the audit. For instance, it detects unauthorized disbursements. These are usually unrecorded check issuances and fund transfers. In addition, it helps auditors to correct mistakes in accounting entries. It is useful for financial transactions that were recorded in another bank account. Erroneous amounts of recording cash in the books are also detected. Furthermore, it calculates the total actual cash balance of an entity. This is important to show an organization’s available cash in the bank balance.
1. Reconcile an entity’s Cash in the Bank balance with corresponding depository bank records
A bank reconciliation statement reconciles the cash balance reported by accounting and the cash balance reported in a bank statement. First, it is done monthly to identify the reconciling items. Regular reconciliation allows early detection of errors and misstatements. Next, the reconciling items are listed in the reconciliation report. An auditor may use them to decide on what actions to make. Furthermore, examples of actions are usually correcting errors, recognizing unrecorded transactions in a book of accounts, and setting up cash and accounts payable in case of stale checks.
2. Identify unrecorded financial transactions
Frequent unrecorded transactions are interest income, bank charges, unknown deposits, and others. For instance, interests earned are usually recorded after receipt of bank statements. Earnings from time deposits are also recognized, the same as interest earned. In addition, bank charges are also taken on a book of accounts based on bank statements. Also, unknown cash and check deposits are the most tedious to reconcile. The process involves contacting banks and digging up documents to identify the depositors.
Accumulation of unrecorded transactions affects the reliability of financial statements. For instance, a significant amount of receipts are not yet recorded. It could mean that a cash balance in an accounting record is understated. Management could have spent the sum on its business operations. Also, unrecorded disbursements bring about cash overstatements of an entity. An entity may report huge amounts of cash on a balance sheet as the outcome. Furthermore, unfamiliar deposits in a bank are not recognized in the books of accounts. They are supposed to be recorded in a cash in the bank account and other payables. The payables are adjusted when the reason of the deposit is already identified.
3. Detect unauthorized payments of money
Validating disbursements is also the responsibility of an auditor. For instance, owners of an entity usually want information about unpermitted payments of money from funds. The sooner they are aware, the sooner they can act. Also, the unauthorized releases of cash usually increase the losses of an organization, which is most probably unrecorded. The owners should be informed when detected by an auditor. Of course, an auditor could not review each disbursement. The audit can use sample testings to form an opinion, especially with many transactions.
4. Calculate the existing cash balance of an entity (Adjusted Method)
The *adjusted balance method of bank reconciliation calculates the existing cash bank of an organization. For instance, unknown deposits are added to the cash balance, while unrecorded disbursements are taken away from a book balance. Also, accounting errors increase or decrease the book balance. Conversely, deposits in transit are added to a bank statement balance. In addition, outstanding checks are deducted from a bank statement balance. Similarly, bank errors are plus or minus to a bank balance. Thus, a book and a bank balance are adjusted to calculate the actual cash balance.
* Adjusted Book Balance = Unadjusted Cash in Bank Balance + (-) book reconciling items
* Adjusted Bank Balance= Unadjusted Bank Balance + Deposits in transits – Outstanding Checks + (-) Bank reconciling items.
Note: Both Adjusted Book Balance and Adjusted Bank Balance should balance after the bank reconciliation.
5. Recognize stale checks in the Accounts Payable
Stale bank checks understate cash balances and accounts payables. For instance, outstanding checks become stale when they are six months old. There are several reasons payees did not deposit the checks, though. In addition, when the checks are stale, banks normally would not allow cash outs anymore.They would refuse posting the amount to the depositors’ account. However, although the checks are now invalid, they are still payable to the payees. Check replacements should be made through contacting the check drawer. Hence, the amounts should be debited to Cash in the Bank account and credited to accounts payable.
6. Correct erroneous accounting entries
Bank reconciliation statements can identify various accounting errors. For instance, a check issuance is recorded in another bank account. It is a common error which can be addressed through reconciliation of bank accounts. In addition, errors in recording on the books of accounts are also detected. Amounts in accounting entries are sometimes overstated or understated because of errors. Hence, when errors are known, adjusting entries can be made.
Bank reconciliation statements are part of the working papers prepared by an auditor. In fact, the reconciliation statements are used to support the opinion of an auditor. The report of an auditor is usually based on an actual review. Also, when there are no bank reconciliations, the auditor may prepare the reports from the beginning. Some auditors usually prepare their own reconciliations for selected bank accounts. Thus, a bank reconciliation statement is a requirement during an audit.