Outstanding checks

What Is Outstanding Checks?

An outstanding check is a check that a company or individual has written and recorded in their own accounting records but that has not yet been presented to or cleared by the bank. In the realm of financial accounting, outstanding checks represent a common timing difference between a company's cash balance, as reflected in its general ledger, and the cash balance shown on its bank statement. These checks are considered a current liability for the issuer because the funds have been committed but have not yet left the bank account. Understanding outstanding checks is crucial for accurate bank reconciliation, a process within cash management that ensures the cash balance in a company's books matches the balance reported by its bank.

History and Origin

The concept of a check, which forms the basis of an outstanding check, has ancient roots, with early forms of written payment instructions appearing in the Eastern Mediterranean during the first millennium. These early instruments, such as the sakk used by merchants in Basra, allowed for payments to be made from a depositor's account without the physical transfer of cash. The versatility of checks significantly evolved with the development of negotiability in 16th-century Europe, and their use was further promoted in 18th-century England through the suppression of banknotes.¹⁶

In the United States, legislation in the 19th century helped establish a nationwide check payment system. The early 20th century saw the Federal Reserve's establishment, partly to create a more efficient national check clearing system, which further solidified checks as a dominant payment method.¹⁵,¹⁴ Even with advancements, the time lag inherent in the physical processing and clearing of checks created the phenomenon of outstanding checks, a consistent element in financial record-keeping for centuries.

Key Takeaways

• An outstanding check is a payment issued by a company or individual that has not yet been cashed or deposited by the recipient.
• The amount of an outstanding check is deducted from the cash balance in the issuer's internal accounting records but still appears in the bank's records until it clears.
• Identifying outstanding checks is a key step in performing a bank reconciliation to align a company's cash balance with its bank statement.
• They represent a short-term commitment of funds that still reside in the bank account, impacting the true available cash flow.
• Companies must monitor outstanding checks to prevent overdrafts and maintain accurate financial reporting.

Formula and Calculation

Outstanding checks are a common reconciling item in the process of a bank reconciliation. When preparing a bank reconciliation, outstanding checks are subtracted from the bank statement balance to arrive at the true, or "adjusted," cash balance. This adjustment accounts for checks that have been written and recorded by the company but have not yet been processed by the bank.

The basic formula for adjusting the bank balance in a reconciliation, incorporating outstanding checks, is:

$\text{Adjusted Bank Balance} = \text{Bank Statement Balance} - \text{Outstanding Checks} + \text{Deposits in Transit}$

Where:

• Bank Statement Balance: The ending cash balance shown on the bank statement.
• Outstanding Checks: Checks issued by the company that have not yet cleared the bank.
• Deposits in Transit: Deposits made by the company but not yet recorded by the bank.

This formula helps to derive a cash balance that can then be compared to the company's book balance after it has been adjusted for items like bank fees or interest earned.¹³,¹²,¹¹

Interpreting the Outstanding Checks

Interpreting outstanding checks involves understanding their impact on a company's immediate liquidity and the accuracy of its financial records. While the bank statement shows a higher balance because the checks haven't cleared, the company's general ledger already reflects the reduced cash amount. This difference means the business cannot spend the money allocated to these outstanding checks, even if it appears available in the bank's records.

A significant volume or value of outstanding checks can indicate that recipients are slow to deposit payments, or it might suggest a timing issue around an accounting period end. Regularly monitoring outstanding checks ensures that the business has a clear picture of its truly available cash. Proper tracking helps prevent scenarios where a company might mistakenly believe it has more funds than are actually available, potentially leading to overdrafts or poor cash management decisions.

Hypothetical Example

Consider "Green Garden Supplies," a small business that uses checks to pay its vendors. At the end of May, Green Garden Supplies' internal cash account in its general ledger shows a balance of $12,500. However, the bank statement received for May shows an ending balance of $15,000.

To reconcile this difference, the bookkeeper identifies the following outstanding checks that were written and recorded by Green Garden Supplies in May but have not yet cleared the bank:

• Check #101 to "Flower Power Nursery" for $1,000
• Check #102 to "Soil & Seed Distributors" for $800
• Check #103 to "Tool Time Inc." for $700

The total value of outstanding checks is $1,000 + $800 + $700 = $2,500.

To adjust the bank statement balance, the bookkeeper would subtract these outstanding checks:

Bank Statement Balance: $15,000
Less: Outstanding Checks: $2,500
Adjusted Bank Balance: $12,500

After accounting for these outstanding checks (and assuming no other discrepancies like deposits in transit or bank charges), the adjusted bank balance of $12,500 now matches Green Garden Supplies' cash balance in its accounting records. This bank reconciliation confirms the accuracy of the company's cash position.

Practical Applications

Outstanding checks are a practical reality in business operations and are primarily managed through diligent bank reconciliation. Businesses, regardless of size, must regularly perform this process to maintain accurate financial records and ensure their internal cash balances align with their bank accounts. This includes monitoring payments made via paper checks that have not yet been presented for payment.

For accounting departments, keeping track of outstanding checks is vital for managing accounts payable and projecting future cash flow. The funds for these checks are still technically in the bank account, but they are effectively committed and cannot be used for other purposes. Companies implement strong internal controls, such as segregating duties for check writing and reconciliation, to prevent errors and mitigate the risk of fraud.¹⁰

Furthermore, accurate record-keeping of all financial transactions, including outstanding checks, is a requirement for businesses by tax authorities. For instance, the U.S. Internal Revenue Service (IRS) requires businesses to keep records that support income and deductions for a minimum of three years, and sometimes longer, depending on the specifics of the tax return.⁹,⁸ This emphasizes the importance of meticulously tracking all checks issued until they clear.

Limitations and Criticisms

While essential for accurate financial management, managing outstanding checks comes with certain limitations and potential criticisms. The primary drawback is the timing difference itself, which necessitates the ongoing reconciliation process. This manual or semi-manual process can be time-consuming, especially for businesses with a high volume of check transactions. The delay between issuing a check and its clearing creates a period of uncertainty regarding the exact cash balance available.

Another criticism relates to check fraud. Although outstanding checks are legitimate, the existence of paper checks in circulation creates opportunities for fraudulent activities such as check washing (altering the payee or amount) or counterfeit checks. Criminals can exploit the time lag for checks to clear.⁷,⁶ Even with modern banking systems and fraud prevention services like "Positive Pay," which matches issued check details with those presented for payment, the risk is not entirely eliminated.⁵ The declining use of paper checks in favor of electronic payments, while reducing the volume of outstanding checks, highlights the inherent inefficiencies and risks associated with physical checks.

Furthermore, a very old outstanding check that is never cashed can present an administrative burden. Businesses often need to track these indefinitely, as the funds are still legally owed to the payee until the liability can be properly removed, often through escheatment laws which vary by state.

Outstanding Checks vs. Deposits in Transit

Outstanding checks and deposits in transit are both common reconciling items encountered during a bank reconciliation, but they represent opposite sides of a timing difference between a company's books and its bank statement.

The core confusion between the two often stems from their shared characteristic as timing differences. Both items cause the company's cash balance in its internal general ledger to differ from the balance shown on the bank statement. However, outstanding checks account for money that has left the company's perception of cash but not the bank's, while deposits in transit account for money that has entered the company's perception of cash but not the bank's. Accurately identifying and adjusting for both ensures a true reflection of the cash position.

FAQs

How long does a check remain outstanding?

A check remains outstanding until the payee cashes or deposits it, and the funds are debited from the issuer's bank account. While checks generally have a "void after" date (often 90 or 180 days), banks may still honor older checks. However, after six months, banks are typically not obligated to pay a check, and it would then be considered stale-dated.

Why are outstanding checks important for bank reconciliation?

Outstanding checks are crucial for bank reconciliation because they represent a temporary discrepancy between a company's cash balance in its internal records and the bank's records. By accounting for these checks, a business can accurately determine its true available cash balance, helping to prevent overdrafts and ensuring that its financial records align with its banking activity.

Can outstanding checks lead to issues?

Yes, outstanding checks can lead to issues if not properly managed. If a business loses track of them, it might mistakenly believe it has more available cash than it does, potentially leading to overdrafts. Additionally, very old outstanding checks that are never cashed require administrative effort to track and eventually remove from the liabilities through specific accounting adjustments or compliance with escheatment laws.

Are outstanding checks a liability or an asset?

For the issuer, outstanding checks are considered a current liability. Although the cash still resides in the bank account, the funds are committed to a payment and are no longer genuinely available for other uses. The business has an obligation to pay that has not yet been fulfilled by the bank.

How do electronic payments reduce outstanding checks?

Electronic payment methods, such as ACH transfers or wire transfers, reduce the occurrence of outstanding checks because funds are typically transferred and settled much faster, often within one to two business days or even instantly. This eliminates or significantly shortens the time lag that creates outstanding checks with paper checks, streamlining cash flow management and bank reconciliation processes.