What is Account Reconciliation?

You’ve likely heard the phrase, “measure twice, cut once.” Reconciling your balance sheet follows the same logic, but in reverse – spend once, check twice. Double-entry bookkeeping is built on a foundation of checks and balances, requiring the assets side to match the liabilities and shareholder’s equity side. Account reconciliation is one of many methods accountants and bookkeepers use in double-entry accounting to keep financials straight. 

Proper reconcile accounting facilitates a host of financial requirements, not the least of which is shielding your business from audit or even prosecution for financial mismanagement. Despite its importance, though, many managers and executives think proper reconciliation is best left to the accounting department worker bees – but this isn’t the case.  

What is Account Reconciliation?

Reconciliation in accounting is when you formally compare figures on both sides of the balance sheet to one another to ensure they match as part of double-entry bookkeeping. For example, if you bought $10,000 worth of inventory during the financial period on credit, you’ll ensure that both your inventory amount (assets) and your accounts payable (liabilities) increased by $10,000.

Other forms of account reconciliation include validating cash balances against banking transactions. This is often an ongoing process rather than a recurring but (somewhat) infrequent formal account reconciliation as part of double-entry bookkeeping. If you own a business and close each Friday by counting your cash, you’ll be checking the balance in your safe against deposits and withdrawals made during the week – that’s a form of account reconciliation too.

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When Do We Reconcile Accounts?

Depending on the type of account and reconciliation method (more on that shortly), when and how often to reconcile accounts varies. At a minimum, you’ll reconcile major accounts like those on a balance sheet at the end of each month, quarterly, and annually to ensure everything is copacetic across periods. Other accounts, like checking petty cash against withdrawals or money in the register against daily sales, happen on an ad hoc or more frequent basis.

Ultimately, how often you formally reconcile major accounts outside of mandatory reporting periods – monthly, quarterly, and annually – is up to you. If you’re risk-averse or prefer having up-to-the-minute accuracy at your fingertips, you can reconcile accounts as often as you wish. Just note that, particularly for complex accounts, frequent reconciliation will be burdensome for employees unless you have robust reconciliation automation tools in place.

Why Do We Need to Reconcile Accounts?

You need to reconcile accounts to keep accurate and correct records. The reasons for doing so, of course, are innumerable. Proper bookkeeping through reconciliation accounting is critical to: 

• Protecting yourself against audit.
• Having an accurate picture of cash flow, particularly if you’re in a credit-heavy business.
• Positioning to quickly respond to a tender offer or M&A opportunity.
• Comply with regulatory guidance.
• And many, many more common business functions. 

Your specific industry or position might drive your personal reasons for encouraging accurate and frequent account reconciliation, but the ultimate answer behind why do we need to reconcile accounts is simply because you must.

If you slip on proper reconciliation, beyond exposing yourself to risk or missed opportunity, you’ll also quickly lose control of the process. Permanent accounts like those on your balance sheet retain their calculations between reporting periods, so a bad stat on your accounts receivable due to inattention or incomplete reconciliation today will persist tomorrow. And, as with many financial mistakes of this type, that small miscalculation or overlooked reconciliation will quickly snowball – and the further you get in time from the problem’s genesis, the harder it is to backtrack to identify and fix the mistake.

How Does Reconciliation in Accounting Work?

Basic reconciliation in accounting – checking cash against bank statements, for example – is very simple. For these basic reconciliations, you’re often checking something physical like cash or even inventory against paperwork, in this case, banking withdrawal/deposit statements or purchase orders for inventory.

General ledger account reconciliation is a different beast altogether. Remember that your seven general ledgers span the gamut of your operation’s finances, including entries on your balance sheet and income statements.

To reconcile general ledger accounts, you’ll usually want to divide and conquer as much as possible if you’re reconciling manually. This helps avoid mistakes from a sole employee reconciling all accounts while preventing fraud and generally serving as a good quality control check.

Then, you’ll pin down which general ledger account you’re ready to reconcile. In this case, we’ll reconcile our balance sheet PP&E assets with our accounts payable to ensure a recent vehicle purchase on credit is accounted for:

1. I see that, between periods, my PP&E increased by $10,000. For this simple example, we’re disregarding depreciation. I know the business bought a new work truck during the period and want to validate numbers through double-entry bookkeeping.
2. I check the purchase order and invoice for the vehicle purchase and ensure it says $10,000.
3. But, when I look at accounts payable, there’s a balance of $10,100. I list this alongside other discrepancies to return to later.
4. After reconciling other accounts, I begin the investigative process. In this case, I discovered the business owner paid the vendor for an aftermarket upgrade at the point of sale that wasn’t reflected in the invoice (you’ll deal with him later!). Noting the fix, you post an adjustment to your PP&E figure and revalidate both sides of the balance sheet.

Of course, complex accounts, non-cash expenses, and more can make scaled account reconciliation time-consuming, complex, and prone to error. This is why many companies are relying on artificial intelligence-driven accounting automation tools to streamline and ensure accuracy across their account reconciliation systems.  

Types of Accounting Reconciliations 

The two primary types of “big picture” accounting reconciliation are manual and automated. As the names imply, manual account reconciliation is done by hand using digital or physical records and checking them against one another in the system. By contrast, automated account reconciliation is an iterative, ongoing process that usually checks accounts against one another as transactions occur and again as part of periodic total reconciliation.

Beyond that, you’ll usually manage four accounting reconciliation processes:

1. Account activity. This type validates different general ledger activity to a real-world account, i.e., paying your insurer or building owner (prepaid expenses) or checking accounts receivable against an outgoing order.
2. Subledger activity. Some specific, discrete sub-ledgers like inventory or cash balance are reconciled independently to ensure physical value (of assets) or physical presence (cash) compares to activity properly.
3. Statement reconciliation. This checks credit cards, loans, and banking statements with their respective cash or credit balances.
4. Rollforward reconciliation. Unique to equity, this aspect of the balance sheet adds the current period’s additions or deductions to the previous period’s ending balance.  

Typical steps in the account reconciliation process

Account reconciliation, at its core, involves a meticulous comparison of figures across the balance sheet, embodying the essence of double-entry bookkeeping. Whether it's verifying that a $10,000 inventory purchase reflects accurately as both an asset and a liability, or ensuring cash balances tally with bank transactions, the process is integral to financial accuracy and integrity.

The procedure for cash account reconciliation typically unfolds as follows:

1. Note the ending cash balance as per the bank statement.
2. Deduct any checks issued but not yet processed by the bank.
3. Incorporate deposits still in transit.
4. Adjust for bank service charges and other unrecorded transactions.
5. Record the ending cash balance according to the general ledger.
6. Identify and investigate any discrepancies between the bank statement and general ledger balances.
7. Rectify any errors found, either by notifying the bank or adjusting the ledger entries as necessary.

For balance sheet accounts, the reconciliation process may involve:

1. Aligning the trial balance with the general ledger.
2. Rectifying any variances found.
3. Comparing the general ledger against detailed subsidiary records.
4. Investigating and resolving any discrepancies.
5. Ensuring both the general ledger and subsidiary ledgers accurately reflect all transactions, making any required adjustments to maintain consistency.

This structured approach not only streamlines financial reporting but also fortifies the business against inaccuracies and the risks they pose.

Manual vs. automated accounts reconciliation

Account reconciliation's primary aim is to ensure accuracy and consistency in financial reporting. It involves comparing ledger balances on both sides of the balance sheet, ensuring transactions are mirrored accurately as assets and liabilities. This process is not limited to the reconciliation of purchases and payables but extends to verifying cash balances through careful examination of banking transactions against ledger entries.

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Methods of Account Reconciliation

The process of account reconciliation is more than a task for the accounting team; it's a crucial practice for ensuring the accuracy of your financial records. There are two primary approaches to account reconciliation, each catering to different needs.

1. Documentation Review: The go-to strategy for most businesses, this method scrutinizes every transaction to confirm that recorded amounts align with actual expenditures. Its reliance on factual data rather than approximations makes it highly accurate.
2. Analytics Review: This approach leans on statistical analysis, utilizing historical data and other metrics to identify discrepancies. It's particularly useful for detecting inconsistencies that may indicate human error or potential fraud.

Choosing the right method hinges on your specific requirements, aiming to maintain integrity and precision in your financial reporting.

When Does Reconciliation Occur?

Account reconciliation isn't just a task for the end-of-month flurry but a crucial shield against financial mismanagement, essential for businesses aiming for pristine financial health. Typically, it's performed right before the month wraps up, ensuring any discrepancies found can be corrected with adjustments in the general ledger within the current accounting period. This ritual is especially vital during the year-end close, allowing a window for thorough checks and balances on significant accounts before sealing the records.

However, the rhythm of reconciliation can vary, with some businesses opting for weekly or even daily reviews, particularly for high-transaction accounts or those of a sensitive nature. This more frequent engagement not only sharpens the accuracy of financial statements but also mitigates the risk of significant errors. Yet, it's a double-edged sword: while frequent checks bolster financial integrity, they also demand more time and diligence, underscoring the delicate balance between vigilance and efficiency in financial management.

Benefits of Account Reconciliation

The perks of diligent account reconciliation extend far and wide, making it a cornerstone practice for businesses across the spectrum. Here’s the scoop on its undeniable benefits:

• It ensures your general ledger (GL) balances are on point by matching them with external documents, keeping your financials sharp and trustworthy.
• By spotting and correcting errors—be it miscalculations, omissions, duplications, or the all-too-human slip of swapping numbers—accuracy takes the front seat.
• It acts as a detective, uncovering any oddball activities that might hint at fraud.
• Keeps those pesky overdraft fees at bay, as a well-reconciled GL offers a clear snapshot of your cash status.
• It’s a money-saver, revealing any covert charges (think storage fees or fuel surcharges) and questioning their validity.
• Sheds light on unexpected happenings, like a delayed shipment or inventory discrepancies, helping you stay ahead of the game.

In essence, account reconciliation is not just a task for the number crunchers; it’s a strategic play for keeping your financial health in prime condition.

Common Account Reconciliation Discrepancies and their Causes

Usually, simple mistakes are easily rectified – if you identify them quickly and remediate them immediately. Remember, small mistakes in the general ledgers tend to compound and become big mistakes quickly as the error gets carried across reporting cycles.

Common discrepancies include:

Fraud

The rarest, least-common discrepancy, fraud can still have the biggest impact on your financial standing if not caught immediately. This is why dividing lines of effort when manually reconciling accounts is crucial, as it is a cursory check on employees’ work before locking in a reconciliation.

Timing

Timing mistakes are common since businesses work on different reporting schedules, i.e., a vendor’s invoice says Q4 of a fiscal year, but that same period is your Q1 of the following year. This is why matching dates, rather than periods, is critical if you haven’t effectively onboarded your vendor or supplier within your ecosystem.

Omissions and mistakes

Employees don’t know what they don’t know, and if you don’t diligently ensure your bookkeepers have access to the whole range of accounts and vendor payment paperwork, omissions can happen and create a maddening reconciliation process as employees hunt down an issue they’ll never find without help. Likewise, mistakes are common and are a reason to have someone double-check all work before validating a reconciliation.

Duplication and miscoding

Depending on your tech stack, system glitches or human error can cause certain transactions to post twice or get miscoded in the system. This is easy to fix but often difficult to identify.

Conclusion

Remember, to reconcile accounting processes is the financial equivalent to the carpenter’s measure twice, cut once mantra, but in reverse. Improper or ineffective account reconciliation can be devastating, particularly if the error isn’t quickly caught and snowballs between periods. 

Risks include:

• Failing an audit, which results in fines or even criminal prosecution if the error is deemed deliberate fraud.
• Misrepresentation to investors or buyers.
• Missed payments for credit accounts or over-drafting bank accounts if cash balances are incorrect.
• Misestimated inventory, creating overage (and carrying costs) or missed sales opportunities.

Of course, as with many aspects of business, finance automation is increasingly leveraged by owners when reconciling accounts. Automation can nest within your procurement ecosystem and with existing accounts, quickly matching transactions between, for example, a paid vendor invoice and cash deductions. This makes account reconciliation an iterative, ongoing process that gives you immediate visibility of your financial health. These automation tools also streamline end-of-period reporting by quickly validating each reconciliation and match before generating a financial statement – saving a ton of time and effort while protecting against the many risks of improper reconciliation.