You’ve deposited a customer's check, recorded the payment, and your books show a healthy cash balance. But then you get your bank statement, and something's wrong. The bank has deducted the amount of that check from your account. This is likely due to non-sufficient funds, or an NSF check.

An NSF check, commonly known as a bounced check, occurs when the person or company who wrote the check doesn't have enough money in their account to cover it. The bank initially credits your account, assuming the check is good. When they try to pull the funds and fail, they reverse the credit and usually charge you a fee for the trouble.

On your bank statement, you'll see a debit for the check amount and often a separate debit for the bank's service fee. This means the cash you thought you had isn't there. Your books are now out of sync with reality, and you need to make an adjusting entry to fix them.

Fixing an NSF check involves two main steps: reversing the original payment entry and recording the bank fee. Since the customer's payment didn't actually go through, they still owe you the money. You need to put that debt back on your books.

First, you must move the amount from your Cash account back into Accounts Receivable. This re-establishes the customer's outstanding balance. You're essentially saying, "Never mind, that payment didn't happen. You still owe us."

Second, the bank fee is a business expense. You need to record it as such. This fee reduces your cash and increases your expenses for the period.

Let's say a customer's check for $100 bounces, and the bank charges you a $5 fee. Your cash account didn't increase by $100; it actually decreased by $5. The customer's debt of $100 is back on the books.

To get your accounts in order, you'll make a journal entry. This single entry accomplishes both tasks: it re-establishes the customer's debt and records the bank fee. The total credit to your Cash account will be the sum of the bounced check and the fee.

Here’s what the journal entry looks like for our $100 bounced check with a $5 fee.

Notice how the debits ($100 + $5) equal the credit ($105), keeping the accounting equation in balance. After making this entry, your Cash account will accurately reflect its true balance, and your Accounts Receivable will show that the customer still needs to pay.

It's also common practice for a business to charge the customer a fee for the inconvenience of the bounced check, on top of the original amount owed. This would be handled as a separate transaction when you bill the customer.

Now, let's test your understanding of how to handle these adjustments.

Properly accounting for NSF checks is a key part of maintaining accurate financial records. It ensures your cash balance is correct and that you follow up on money you're rightfully owed.