Account reconciliation is a key accounting process for businesses of all sizes. Reconciling an account is an important skill that every accountant and business owner should possess. Simply knowing how to properly reconcile an account can prove essential to your financial health as it ensures your financial records are always accurate.
As important as account reconciliation is in accounting, there is not much focus on it in accounting classes. In fact, many accountants can enjoy a successful career without having to perform a single account reconciliation.
While you can perform account reconciliation manually, you can save valuable time and energy when you use accounting software tools to reconcile your accounts. If you use accounting software tools for your financial transactions, the software will automatically record your transactions, making it easy for you to perform account reconciliations.
In this article, you will learn everything you need to know about account reconciliation including how account reconciliation software works.
Let’s get started.
Account reconciliation is an accounting process, usually embarked on at the end of an accounting period, that makes sure financial accounting records are consistent and accurate. Generally done for general ledgers, account reconciliation involves the comparison of two independent but related records to make sure that transactions and balances correspond with each other.
The general ledger balance of an account is compared to independent systems, third-party data, or other supporting documentation to ensure the balance stated in the general ledger is extremely accurate. This process confirms that records of transactions are complete and consistent, helping companies make important business and financial decisions using very accurate records.
Nonetheless, account reconciliation comes in different types. Apart from reconciling internal records like general ledgers, some other account reconciliation processes include:
All these follow the same processes but only differ by the source or type of documents being reviewed.
Reconciling accounts is crucial to the month-end close process of a company. From the definition, one very clear and important use of account reconciliation is to prevent errors in financial accounting activities.
With the accounting activities of companies majorly done by humans, there is no writing off human error. Account reconciliation, therefore, serves as a chance for companies to get rid of this human error from their entire accounting process.
Companies also use the accounting process to prevent or, at least, check for fraud. Having to compare two accounting records helps a company accurately account for all its transactions. Where discrepancies arise, it helps you pinpoint the exact missing transaction and the accounting officer in charge of it.
In this way, fraudulent tampering of accounting records is reduced as it becomes harder to achieve without leaving traces.
One other use of account reconciliation is a company’s need to maintain an internal control environment that complies with Section 404 of the Sarbanes-Oxley Act.
This act mandates public companies to include an assessment of their internal controls over financial reporting with their annual report for the period. Account reconciliation remains an important tool in accurately achieving this.
Overall, account reconciliation plays an important role in a company’s risk management framework relating to accounting.
Account reconciliation aims to take care of inconsistencies in accounting records, with these inconsistencies undoubtedly caused by certain factors.
The time difference between when a payment or deposit was made and when this transaction is eventually recorded is one reason for discrepancies in accounting records. This was especially so when the physical legal tender was the main medium of exchange and recipients of money needed to get to deposit points to complete the whole deposit process.
When cloud-based accounting software is used, a deposit or payment recorded in it immediately gets started on the monthly bank statement.
Time lag causes inconsistencies in different accounting records and account reconciliation helps to take care of them. Thankfully, today, transactions are instantaneously communicated within minutes or hours between different records rather than days or weeks.
Errors in recording transactions are almost inevitable in the whole accounting process. This could be in the form of wrong digits, software errors, external errors from the bank, or mistakenly inputting a transaction in the wrong record.
Regular account reconciliation helps you spot these errors and make amendments before records are used for important business management processes, rather than relying on records filled with errors.
Another factor that seems to be unavoidable, no matter how diligent your accounting team is, is the total boycott of a transaction. Comparing accounts helps you spot transactions you have missed and keeps all your records as consistent with each other and accurate as possible.
The perpetuation of fraud is one of the very common problems facing a lot of financial institutions. Even though accounting processes help to monitor every transaction, fraudsters work with accountants to make changes to accounting records.
Nonetheless, not all accounting records are accessible to these fraudsters and their accomplice accountants, so comparing untampered records with those tampered with helps spot fraud and, possibly, the accounting officer involved. This is one very important cause of discrepancies account reconciliation aims to deal with.
The account reconciliation process typically takes place at the end of a financial or accounting period and these processes are generally executed on general ledgers.
To make sure that transactions and balances recorded in general ledgers are consistent, complete, and accurate, accountants go through the following steps:
To reconcile an account, you first obtain the necessary details of it. For instance, reconciling a general ledger requires you to obtain necessary details, such as the ending balance of the general ledger account, which is the balance as of the accounting period end date.
Depending on the account type, you may also require additional details presenting the whole activities executed on the account. These activities include details of debit and credit transactions in the account.
Once the necessary details of the account have been collated, the next step is to compare or reconcile its balance to that of supporting or independent documents.
The balance of a general ledger account, for instance, is obtained from independent systems, third-party data, or other supporting documents, such as bank statements and credit card statements. This step helps with additional independent information to verify the accuracy of the general ledger account balance.
Although not all discrepancies indicate an error in the general ledger account balance, it remains important to investigate each. Where the general ledger account balance is not consistent with or substantiated by information obtained from the supporting documents, the areas having these discrepancies should be noted.
Accountants then make research, investigate, and take appropriate actions to correct the discrepancies. As noted earlier, discrepancies are caused by various factors like timing differences, missing transactions, mistakes, or fraud, among others.
Investigating discrepancies helps to pinpoint the exact cause or nature of inconsistent balances and, consequently, determine the necessary actions to take.
If necessary, additional journal entries are made to correct any errors recognized after investigation of discrepancies.
The whole account reconciliation process is documented and stored for future audit purposes, with the general ledger reconciliation serving as a necessary process before a company gets to issue its financial statements.
There are two basic methods through which account reconciliation is executed: documentation review and analytical review.
The most common of both, the Documentation review method involves collating the account details of multiple accounts or statements and reviewing the consistency, appropriateness, or accuracy of each transaction.
Existing transactions or documents are reviewed and it is determined whether the amount recorded in the matches equates to the amount spent by the company. This review or reconciliation method is mostly carried out using accounting software.
A good example of where this method is in play is where a company maintains a record of all its receipts for purchases made and, at the end of an accounting period, embarks on account reconciliation. When conducting a reconciliation, comparing the receipt records with records in a cash book, the company notices that it was charged for ten additional transactions not recorded in the cash book.
The company’s bank is contacted to get information on these additional or missing transactions and a discovery is made that it was indeed a bank error. It is reimbursed for the incorrect deductions and rectification of these transactions brings consistency and accuracy to the receipts account, bank statement balance, and cash book balance.
This method involves direct comparison of documents, statements, or transactions and an absence of this review evidently makes the company lose money.
The documentation review method looks to be a tiring process but automation software that pulls records and documents from various sources through integrations and APIs exists. Rather than manually sifting through records, this technology helps you save time and energy.
The analytics review method involves the use of estimates to recognize discrepancies in accounting records and proves to be effective in identifying fraud and accounting errors.
This method for account reconciliation involves the use of historical account balance levels to determine the estimated account balance of the statement or accounting record under review. It estimates the actual amount that should be in the account based on previous account activity levels or other historical metrics gotten from previous accounting periods.
Historical details of cash accounts or bank statements are used to identify irregularities, balance sheet errors, or fraudulent activities. One example of where this method is used is a case scenario involving a company that records an average annual revenue of $50 million based on historical records.
Where the company’s current revenue is recorded to be $4.5 million, the analytical review method shows the company that this revenue size is way below its historical average and indicates the presence of discrepancies.
Upon investigation, the company discovers an accounting error where a zero was omitted and rectifies the record to bring the revenue value to $45 million, which is close to the estimated revenue projected.
Different automation software, which uses statistical models to provide mostly accurate estimations for this method, is available on the internet. Accounting errors are noted where there is a significant variation from the estimated projection.
Alongside human-based accounting activities, a lot of companies make use of open source accounting software to record transactions and reconcile differences between different statements or documents.
Nonetheless, account reconciliation, in this case, bank account reconciliation, works in the following ways.
Go through all transactions entered into internal records and compare them against similar transactions appearing in the bank statement. Check off transactions that are in agreement, and make a list of transactions in the bank statement that are not supported by any evidence, such as a payment receipt.
While comparing documents, check to see that all outgoing transactions are reflected in both the internal record and the bank account statement. For instance, you check for deductions in your internal records that have not been captured in your bank statement.
These charges include uncleared checks, internally recorded auto-payments that have not been deducted, ATM service charges, insufficient funds (NSF) charges, overdraft charges, or over-limit fees, among others. You then subtract these from your bank statement balance where they have not been reflected.
Next, you check that all incoming funds have been reflected in both your internal records and your bank account statement. You identify deposits and account credits that are yet to be recorded by the bank in the bank statement and add these to the statement balance.
Also, if the bank statement shows money deposits not reflected in your internal records, you make entries of these transactions.
After checking for deposits or charges that have not been reflected, you then check for any error from the bank’s side in relation to completed transactions that are reflected in the bank account statement. These are transactions that are not pending but recorded as completed but have inherent errors in them.
Although these do not occur very often, where they are spotted, you make amendments in the bank account statement, either by additions or subtractions. Contact the bank immediately to report the error.
Once these previous steps are completed, you then check that your bank account statement balance is equal to the balance in your internal records.
You may need to create a separate record on the discrepancies identified, especially where these discrepancies are large in number. This helps for more careful account reconciliation processes in the future and documentary evidence to external stakeholders.
Account reconciliation software is a computerized program that automates the account reconciliation process, making it more streamlined, quicker, and easier to execute than using paper-based manual spreadsheets.
Here is a rough breakdown of how account reconciliation software works.
This software automatically collects data from a company's various sources of financial information stored digitally across various platforms. These sources include ERP software systems, digitally generated bank files or statements, credit card processors, and merchant services.
Once data is gathered from these sources, the software, through advanced encoding, then compares account balances between documents from the different sources and identifies discrepancies. These are then investigated by accounting staff to identify the main cause of the discrepancies.
Account reconciliation software removes the burden of manually performing the task of comparing different account statements. It gives accountants more time to focus on analyzing discrepancies, risk mitigation, and exception handling.
Some of the popular features of this type of software include automated review and approval of accounting workflows, reconciliation templates, predetermined checklists to standardize the whole process.
Account reconciliation software presents you with integrated cloud storage for supporting documentation, which boycotts the need to import documents and aids the review and audit process. This software also provides links to applied policies and procedures for easy reference and allows you to take the necessary rectification actions from within it.
