Want to learn why outstanding checks are deducted from the bank balance?
Outstanding checks are subtracted from the bank statement balance to calculate the adjusted bank balance. The deduction is made in order to reduce the bank balance since they are previously issued checks. Those previously issued checks are actually authorized disbursements. Hence, outstanding checks should be deducted from the bank balance.
This post discusses further why outstanding checks are deducted from the bank balance so the readers may understand its significance.
But before that, one should understand the importance of a bank reconciliation statement.
Why is a bank reconciliation statement important?
Non-preparation of bank reconciliation reports leads to the issuance of unreliable financial statements. For instance, the cash balance on a balance sheet is not regularly verified with its supporting documents. In addition, the cash balance may be significantly misstated. Hence, not preparing a bank reconciliation makes the financial reports unreliable.
A bank reconciliation statement shows the remaining cash balance of an entity. After considering all the reconciling items, the adjusted book and bank balance are calculated. All outstanding checks are listed and subtracted from the bank statement balance. Deposit in transits is added to the bank reconciliation report. Now, a bank recon calculates the available cash balance at the end of the month.
The reconciliation report lists all the identified outstanding checks every month. First, they are identified by matching all checks issued and recorded by the depositor with cleared checks in a bank statement. Next, all uncleared checks are the outstanding checks to be reflected regularly in the report. So, the report shows the outstanding checks at the end of each month.
The adjusted cash balance is used by management for planning. For instance, they can limit their total disbursements when the balance is low. Investments should also increase if there are excess funds. Thus, the adjusted cash balance is needed for the ensuing month’s plan.
There are five reasons outstanding checks are subtracted from the bank balance.
1. Outstanding checks are deposited by payees within a few days
Outstanding checks are deposited by payees in a bank within a few days or weeks. They can be deposited the day after receipt or soon. Unless they are misplaced, lost, or become stale, they remain outstanding in a bank reconciliation statement. Of course, suppliers and contractors want to deposit their collections immediately. Hence, all outstanding checks are deposited immediately after a few days of receipt.
Because outstanding checks are converted to cash immediately, they are valid deductions to the bank statement balance. The issued and approved checks are obligations to pay the payees effective immediately for goods and services rendered. Hence, outstanding checks are deducted from the bank statement balance.
2. Released checks are already disbursed by the issuer
Issued checks still outstanding are already disbursed by the issuer. Money has already been left and should be deducted from the cash balance of the payor. Outstanding checks should also be subtracted from the bank balance unless there are errors and stale checks. Other than the exceptions, outstanding checks are already dispensed in favor of the payees.
3. They overstate the balance of the bank statement
Issuing a check reduces the book balance, which should also reduce the bank balance. It does not matter when the check is exchanged by the recipient in a bank. What matters is the issuance to the payees. Hence, the book and bank balance should be equal.
However, bank statement balances are overstated because of undeposited and uncleared checks. The undeposited checks are still unknown to the bank until they have received them. So, they are not subtracted yet to the bank balance overstating the bank balance.
4. They prevent the issuance of NSF checks
The subtraction of outstanding checks to the bank balance helps prevent the issuance of NSF checks. For instance, the bank account is already insufficient when the adjusted bank balance is negative. It means a bank overdraft has occurred in an entity at the end of the month. When subtracting outstanding checks, the bank balance can be determined anytime. Hence, deducting the outstanding checks from the bank statement balance protects the management against issuing NSF checks.
5. Calculate the correct adjusted bank balance
The adjusted bank balance is calculated by subtracting outstanding checks from the bank balance. It is to be used for planning to fund the obligations in the ensuing months.