Accounting Reconciliation
What is Reconciliation in Accounting?
Working with the former accountants now working at FloQast, we decided to take a look at some of the pillars of the accounting professions.
Reconciliation in accounting is the most important part of making sure the numbers in your financial records are right. But here’s the thing: The reconciliation process isn’t something that’s really taught in accounting classes. Most people learn it on the job — if they learn it at all. It’s quite possible to have a very successful career as an accountant and never perform a single reconciliation, or even participate in a financial close.
What is Account Reconciliation?
According to Investopedia, the definition of account reconciliation is “an accounting process that compares two sets of records to check that figures are correct and in agreement. Account reconciliation also confirms that accounts in the general ledger are consistent, accurate, and complete.” Reconciliation provides a check on the completeness of your financial data.
Now, comparing two sets of records may not sound like an exciting task. But it’s a key step of the closing process, and vital for ensuring the integrity of a company’s financial statements. For companies that outsource their accounting, reconciliation is an essential part of quality bookkeeping.
The very basis of double-entry accounting is itself an internal reconciliation. Each entry must have debits and credits that equal. Transactions that impact a company’s bottom line — net income — are split between accounts on the balance sheet and the income statement. This means that journal entries that hit balance sheet accounts can cause something on the income statement to shift. When all the balance sheet accounts are reconciled, you’ve nailed net income.
Fortunately, today’s accountants have the advantage of automation and reconciliation tools like account reconciliation software that can make short work of the time-consuming chore of transaction matching. Most accounting systems and ERPs have built-in modules that can import bank transactions and compare them to the transactions in the system.
Why Do We Need to Reconcile Accounts?
It may seem obvious, but this is essential for making sure the accounting records are right. Reconciling accounts is central to the month-end close process. That’s how we know the financials are accurate — or at least materially correct — every month. Balance sheet reconciliation ensures that net income is correct.
Since 2006, when Sarbanes-Oxley became effective, public companies have been required to have internal controls that are adequate to prevent material misstatement. Performing regular balance sheet account reconciliations and reviewing those reconciliations is one form of internal control. Auditors will always include reconciliation reports as part of their PBC requests.
But even if you’re not subject to Sarbanes-Oxley, reconciling accounts — especially cash accounts— on a timely basis can help prevent fraud. We’ve all heard of small businesses that lose tens of thousands, even hundreds of thousands, to embezzlement. Many of those thefts could have been halted in their tracks immediately if the bank accounts had been reconciled regularly.
What Causes Reconciliation Discrepancies?
There are four main reasons that account balances don’t match the underlying documentation: Timing differences, mistakes, missing transactions, and fraud. Let’s go through these.
Timing differences. Sometimes a deposit or a payment recorded in your accounting software isn’t on the monthly bank statement. When paper checks were the main way that vendors and employees were paid, this was a much bigger problem. But today, nearly instantaneous communication of financial transactions means the delay between the money leaving one account and reaching another one may be measured in minutes or hours, not days or weeks.
Mistakes. Have you ever transposed digits, or fat-fingered a number? Everyone does. Or maybe the transaction hit the wrong account. Perhaps the Excel spreadsheet you used to calculate the journal entry has a formula error. Or it could be a bank error. Some or all of these will happen at some point in the life of every business. But if you don’t reconcile your accounts regularly, you might not catch mistakes as they arise.
Missing transactions. No matter how diligent the accounting team is, sometimes a transaction just slips through the cracks. Reconciliation helps to catch those.
Fraud. This is the one that keeps business owners and finance and accounting professionals up at night. While some fraudsters exhibit a true evil genius in covering their tracks, most thieves aren’t that clever. Careful attention to details and review of reconciliations by someone who doesn’t work with that account can help catch many instances of fraud.
Bank Reconciliations Can Prevent Overdrafts
Let’s say you’ve been drooling over the latest model widget polisher for your business. The local dealer offers you a special price, and you can get this deluxe $12,000 machine for just $8,000 today. According to your online bank balance (which you rely on to monitor your cashflow because your accounting software never seems to be quite up to date), you have $10,000 in the bank. Woo-hoo! You sign on the dotted line, and waltz out with your new widget polisher.
Later that day, you get an urgent text from your bank that your account is overdrawn by $5,000. Wait, what? Then you remember the check you wrote to a vendor last month for $7,000. If you had performed regular bank reconciliations, you would have known about that check and to keep your eyes peeled for it. Reconciliation can help you monitor your cashflow so you have enough to cover your business needs.
How to Do Account Reconciliation
Before we get into the account reconciliation process, let’s back up and think about the who, what, and when of the reconciliation workflow.
Who: The best person is someone who’s familiar with the kinds of transactions that flow through an account, but not the one who records those transactions. Besides the internal control aspect of segregating the duties of recording and reconciling, a fresh set of eyes is the best way to find mistakes. However, in very small organizations, that might not be possible.
What: In general, any balance sheet account with a material balance should be reconciled regularly. Account reconciliation software like AutoRec makes reconciliation easy enough that every single account can be reconciled in a snap — and some of that can be done automatically. But at the very least, cash, bank loan, and credit card accounts should be reconciled regularly. Companies with multiple entities will need to reconcile intercompany transactions as part of the consolidation process.
When: Depending on the transaction volume, reconciliation may need to be done monthly, weekly, or even daily. Frequent reconciliations in big accounts makes transaction matching easier and helps keep account balances updated in almost real time. Monthly reconciliations should be performed as soon as possible after the closing date.
The Four Basic Methods for Account Reconciliation
Did you know there’s more than one way to reconcile your accounting records? The best method depends on the type of account you’re reconciling. But for all methods, if you’re not using reconciliation software, the first step will likely be importing account transactions from your ERP or accounting software into an Excel spreadsheet.
Reconcile to a Bank Statement, Credit Card Statement, or Loan Statement
This is how the account balances for these kinds of accounts are reconciled. A bank reconciliation Excel template can help you make short work of this process. The starting point is always the ending point of the last reconciliation. Always check to make sure the previous reconciliation still ties out. If it doesn’t, you’ll have to go back in time or check the audit trail to find the transaction or transactions that changed.
Once you have a solid starting point, look at the reconciling items in last period’s ending balances. Are there outstanding payments or charges that cleared this month? Check those off on both sides.
Next, match the entries in the general ledger with transactions on the statement. Amounts, dates, and descriptions will help guide you. Check off items as you match them up. Adding to the challenge, sometimes an entry in the general ledger may correspond to two or more entries in a bank statement, or vice versa. These may pop out at the end, when everything else has been checked off.
Finally, look for the transactions that are in the general ledger, but not on the statement, and vice versa. Are they correct? Is this a timing difference? Do you need to record the bank fees or credit card interest in the general ledger? Add and subtract these as appropriate until you can get both sides to match.
Reconcile to Account Activity
Accounts like prepaid expenses, accrued revenues, accrued liabilities, and some receivables are reconciled by verifying the items that make up the balance. This may be done by comparing a spreadsheet calculation to the balance in the general ledger account.
A common example we should all remember from our accounting classes is prepaid insurance. Let’s say the annual insurance premium of $6,000 is paid on January 1. That means that $6,000/12 = $500 of that balance is expensed every month. Then we would expect that the balance on April 30 would be $6,000 – (4 x $500) = $4,000. If that’s the amount in the prepaid insurance account, then you’re done. If not, you may need to post an adjusting journal entry to get to the right balance.
Reconcile to Subledger Activity
Accounts receivable, accounts payable, inventory, and fixed assets may be tracked in separate subledgers or schedules. Some systems record all transactions involving cash in a ledger called a cashbook. Reconciling these accounts is usually a simple matter of making sure that the balance in the relevant subledger or schedule matches the balance in the general ledger.
Reconcile With a Rollforward
Equity accounts are usually reconciled by performing a rollforward. Starting with the ending balance of the prior period, you add all the increases and subtract all the decreases to get to the ending balance.
Mastering Reconciliation
Reconciliation is definitely not one of the most exciting tasks around, but there’s no thrill quite like spending hours — or even days — reconciling a beast of an account and getting the numbers to tie out perfectly. The key role that reconciliation plays in making sure your numbers are right means that anyone who works with financials needs to master the reconciliation process.
For a small business or an account with very few transactions, reconciliation may not be a challenge. But for high-volume accounts — like cash in a busy organization— you may be looking at thousands of transactions. Doing that work manually is tedious and time-consuming to say the least, and it’s easy to make mistakes. Adding to the challenge, some transactions may be split on one side but not the other.
AutoRec to the Rescue
Instead of spending days each month reconciling accounts, FloQast AutoRec can do that in minutes. AutoRec leverages AI to reconcile transactions, whether those are one-to-one, one-to-many, or many-to-many. Unlike other reconciliation systems, AutoRec doesn’t require users to create or maintain rules. You can literally get it set up in minutes and be off and running. Plus, you can set accuracy thresholds to determine whether transactions need to match to the penny, or if being off by say 5% is close enough. Give it a spin, and see how much time you can save every month.
