What Is Account Reconciliation?
Any business has some record of transactions, inventory and balances. Most businesses also have some system to track income, purchases and long-term balances, usually through one or more external bank accounts.
Periodic comparisons among financial documents are necessary to ensure that there are no discrepancies in cash flow over that time period.
Such periodic comparisons are called account reconciliations.
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Account Reconciliation Meaning
Reconciliation is the accounting process that involves checking two sets of records, usually internal and external, to ensure that the numbers are correct and in agreement.
Account reconciliation is useful for both individuals and enterprises.
Reconciling personal checkbooks and credit card balances through matching of check numbers, credit card receipts and bank and credit card statements can help in assessing overall financial status of the individual.
Account reconciliation is even more important for enterprises. Business finance reconciliation ensures concurrence among the cash inflows/outflows and income statement, balance sheet, and cash flow statement. The accounts reconciliation process of a company may be as simple as matching the general ledger with the bank statement. Other accounts reconciliation examples include :
- Reconciliation between external bank and investment accounts
- Comparing the accounts receivable ledger and sub-ledger data
- Comparing accounts payable ledger and sub-ledger data
- Reconciling intercompany payables and receivables
- Comparing details of fixed assets between financial statements
Enterprise accounting reconciliation requires methodical systems for maintaining all transactional records, such as invoices, payment receipts, and account statements. It is part of the accounting close process that is performed at periodic intervals.
Finance reconciliation as part of the month end close process
The period during which account reconciliation is performed depends upon the volume of transactions in an enterprise. Periodic reconciliations in big accounts eases transaction matching and updates account balances in time. Most enterprises perform balance sheet reconciliations as a month end close process, during which all balance sheet accounts are reviewed to ensure that all transactions that occurred during the past month have been recorded and checked.
Finance reconciliation helps detect mistakes, discrepancies, or fraud in the accounting process. It also provides an insight into the financial health of the company. This process also facilitates financial and operational planning, and provides the basis for strategic decision-making.
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Steps in account reconciliation
While there is no general template for account reconciliation, double entry accounting, in which a transaction is entered in a general ledger in two places – the debit and credit – is considered a useful prerequisite.
Double-entry accounting is in itself an internal reconciliation process. In the double entry system, when a company receives an invoice, the invoice amount is credited to the accounts payable (on the balance sheet) and debits the same amount from the expense (on the income statement). Conversely, when a bill is paid, the amount is debited from the accounts payable and credited to the cash account. For every transaction, the debit and credit sides of the ledger must agree, reconciling to zero. The double-entry accounting system can help catch mismatches on either side of the entry with no ambiguities.
There are many kinds of reconciliations, as mentioned earlier. These may include bank statements, accounts receivable, inventory, fixed assets, intangible assets, accounts payable, tax payable, capital accounts, and liability reconciliations.
All of these reconciliations are made of four steps –
- bring forth information from previous reconciliation
- match the relevant data
- check for mismatch and resolve
- and finalize the reconciliation to be taken forward to the next cycle.
For example, the bank account reconciliation that forms a part of the month-end or year-end accounting close process consists of the following four steps:
Some specific activities can help the accounting reconciliation process:
- One-to-one check: The balance in relevant sub-ledgers or schedules are first matched to the balance in the general ledger, if applicable. Then, the account reconciliation process involves a comparison between the general ledger and the bank statement.
- Each payment and deposit is checked between both records, and any mismatch or lapse is flagged for follow-up and remediation. Account reconciliation also involves verifying items like prepaid expenses, accrued revenues, liabilities, and receivables against the balance.
- Checking cash outflow: All outgoing money must be reflected in both the internal account register and the bank account. Some outgoing transactions may not be reflected in the internal register because these are automatic bank processes like annual fees, charges, and fines. These must be entered to make the internal register complete. On the other hand, uncleared checks may be recorded in the internal register but not seen in the bank account - these must also be accounted for.
- Checking cash inflow: All inflows must be matched. As before, cash inflows may only be seen in the bank account and not the internal register, such as interest payments, cash-back rewards, etc. These must be included in the internal register. Cash payments to the company will not be reflected in the bank statement and must be flagged.
- Ensure accuracy of balances: Bank statements are generated by computerized systems, and there are usually no errors in the arithmetic. Internal documents such as spreadsheets can have errors in the calculation if the formulae are entered wrong. Balances must be checked before completing the reconciliation process.
At the end of the account reconciliation, the general ledger must mirror all transactions and match all related documents, including bank statements, sub-ledgers, and schedules.
Causes of account reconciliation discrepancies
Account balances may not match between the compared documents due to four reasons – data entry mistakes, procedural mistakes, timing differences and fraud.
Data entry mistakes
Raw data entry not followed by verification steps has been shown to have an error rate as high as 4%. To put that in perspective, there are 2 errors for every five entries made. This significantly large number can affect even small sets of data. A 2009 experiment found that data entry operators make up to 10.23 errors when processing data from thirty datasheets.
These errors could arise from human factors such as exhaustion, carelessness, ignorance or apathy. They could also arise from mistakes in the formula used for calculating various accounting quantities.
When many steps are involved in a business process, any procedural mistake in one of the steps may snowball into larger mistakes that can be difficult to catch unless checked on time. A classic example of a multi-step process is invoice processing. Invoice processing includes not only the organization of cash-flow but also handling of vendors and suppliers to ensure streamlined and timely procurement procedures.
The entire process involves multiple players, and even with excellent coordination, mistakes can crop up at any of the steps, leading to reconciliation problems.
The dates of invoice processing and the receipt of the actual payment can sometimes vary. While such differences are greater when there is check or cash payments involved, recent trends in online transfers have somewhat mitigated this problem
Fraud can be internal or external, and may involve siphoning money off the internal source or external source, all of which can lead to reconciliation issues at the end of the day.
Careful attention to details and the engagement of multiple players in the account reconciliation process can help minimize fraud.
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Benefits of finance reconciliation
Account reconciliations ensure consistency and accuracy in financial record keeping and reporting. For private companies, they provide accountability across all tiers; in public companies, account reconciliations are essential for reporting financial results to external stakeholders. Whilst there is no regulatory rule for businesses to perform regular reconciliations, it is well-accepted that they can help keep business and financial information up to date. Some specific benefits of account reconciliation are:
- It ensures that the accounts in the general ledger are consistent, accurate, complete and prevents delays during audit.
- It keeps tabs on the financial status of the company and prevents overdrafts and over spending.
- It helps year end audits by validating all accounts, saving time during tax and audit periods.
- A reconciliation is a crucial process for businesses of all sizes to maintain accurate financial records.
- Finance reconciliation can help spot errors, fraud, theft, or other negative activity, which can save you money and keep you out of legal trouble in the long run.
- It helps calculating net income because reconciliation can fill in missing data such as interest and fees.
- It can convert non-GAAP measures, such as earnings before interest, taxes, depreciation, and amortization (EBITDA) into their GAAP-approved counterparts.
- It can help companies meet mandates of internal controls assessment along with their annual report or other financial statements.
Nanonets in the finance reconciliation workflow
At its core, data collection is the fundamental task of any account reconciliation workflow. This is where Nanonets can help.
Nanonets can help in automating the account reconciliation process by:
All these features of Nanonets allow for a fast and accurate account reconciliation process and efficient management of resources.
Tilman J. Fertitta, American billionaire and businessman, said “Don't ever let your business get ahead of the financial side of your business. Accounting, accounting. Know your numbers.”. The account reconciliation process is an important activity that helps enterprises and accountants know their numbers so that the business does not get ahead of the financial aspects. AI-supported software like Nanonets can be part of the larger account reconciliation automation ensemble to help your company stay competitive and efficient.