What is Reconciliation?

Reconciliation is like checking your homework against an answer sheet...

Does everything match up? If not, either you or the answer sheet has an error. To understand the material, you will have to reconcile the different answers until the results match.

Reconciliation is the act of making sure two sets of financial records agree with each other. Companies reconcile their accounts by confirming that the account balances of two different financial records are the same — and if they aren’t figuring out why they aren’t. They must identify all differences in each account and correct them to create equal balances.

The purpose of reconciliation is to bring the general ledger (company record of credits and debits) up to date by accounting for omissions (transactions not recorded in the ledger) and timing differences (transactions not in a bank statement yet), and then correcting any errors.

People often reconcile their bank account with their record of deposits and withdrawals at the end of the month when they receive their bank statement. Some people use software or apps on their phone to keep track and help reconcile their accounts for them.

Personal account reconciliation involves looking for things you forgot to record, withdrawals, or deposits that haven’t hit the bank yet, bank fees, interest, errors, and anything weird. You want to make sure that the money you think you’ve got is the same as the money the bank says you’ve got. Reconciliation is often the first safety measure you can take against fraud and theft.

Businesses reconcile their accounting records to make sure they match bank statements or other internal ledgers at the end of each month, week, or day. For example, businesses may make journal entries to the financial ledger of a cash account to show items it found on a bank statement that it doesn’t have recorded yet in its accounting software (i.e., bank fees, interest, bounced checks, direct deposits, etc.). Then it adds or subtracts transactions to the bank statement balance that are in the ledger but haven’t yet reached the bank. The goal is to get the balances to match.

In most cases, business reconciliation involves a bank statement from a bank account and a general ledger kept by a company. But reconciliation is also done for other financial accounts such as credit accounts, loans, and internal accounts where a business keeps two or more records of the same transactions in different ledgers. For a business, the most significant reconciliation is the balance sheet reconciliation that draws on all sorts of ledgers and bank statements.

Reconciling an account means making sure that records of every financial transaction on a company’s ledgers match records from other sources. The other sources could be internal, such as sub-ledgers, or external, such as bank statements.

Companies generally reconcile an account or “do the books” at the end of each month, but they may reconcile accounts weekly or daily. Individuals often reconcile their accounts every month when they receive their bank statements. Accounting software can make reconciliation more manageable, but it will still require a human eye to confirm the entries.

In business, there are many different types of accounts that can be reconciled depending on the complexity of the company, such as:

• Bank account reconciliation: Comparing a bank statement to a cash flow statement or a general ledger
• Accounts receivable reconciliation: Comparing AR to an aging account (list of due dates of bills that clients owe)
• Accounts payable reconciliation: Comparing AP to an aging account (list of due dates of bills owed to vendors)
• Credit card reconciliation: Comparing a credit card statement to internal financial records
• Balance sheet reconciliation: Comparing a company’s general ledger to sub-ledgers, bank statements, and other internal financial statements

The steps in the account reconciliation process may be different for personal accounts and business accounts, and they range from simple to complex. The framework for a ledger reconciled against a bank statement is relatively straightforward:

1. Get copies of the bank statement and general ledger for the same period.
2. Check off all the transactions on each statement that match.
3. Set up a template, either manually or using a spreadsheet.

NEEDS IMAGE

1. Adjust the bank statement balance:
   a. Add deposits not showing in the bank yet (deposits in transit) b. Subtract outstanding checks that haven’t cleared the bank yet
2. Adjust the general ledger balance: a. Add interest received but not yet recorded b. Add EFTs (electronic funds transfers) not recorded yet c. Add missing receipts (deposits in the bank not recorded yet) d. Subtract any NSF checks from customers (bounced checks) e. Subtract bank fees not yet recorded
3. Check for errors: It’s easier to check for errors once you have accounted for timing differences and omitted items first.
4. Calculate the adjusted balance per bank and the adjusted balance per book. They should be equal. If they aren’t, go back through the steps again.
5. Prepare journal entries to adjust the ledger if needed: a. Use the date of the reconciliation b. Identify each entry that has not been recorded and needs to be c. Credit or debit each entry to show the correct balance in the account

In personal accounting, account reconciliation is essential to catch any errors or fraud and make sure you know how much you have in your bank account. You want the balances of your bank statement and record to be equal, and all of the transactions on each record to be justifiable. You look for things in your bank statement like:

• Over-billings
• Bank errors
• Overdraft fees
• Bank fees
• Theft - identity theft, bank card fraud, fraudulent billing
• Interest

You search your records for withdrawals or deposits that have not been posted to your bank account yet and any omission (transaction you forgot to record). Once you’ve adjusted each balance, they should be the same.

Personal account reconciliation is important to ensure your finances stay healthy — think of it like financial hygiene. Individuals who don’t reconcile accounts have a higher chance of over- or under-estimating their available funds, which can result in lost opportunities or unexpected overdraft fees. Plus, charges you’re not aware of in your records tend to act like a snowball that grows out of control. Reconciliation is also vital for catching foul play quickly.

For businesses, account reconciliation is not only necessary for tracking a company’s financial health, but it’s also a critical feature of the internal controls required by companies under the Sarbanes-Oxley Act (SOX). Internal controls are the policies a company has to ensure that its accounting practices are reliable and correct.

The Sarbanes-Oxley Act was enacted in 2002 after several accounting scandals involving publicly traded companies caused significant damage to shareholders and other parties. Sarbanes-Oxley requires CEOs and CFOs to sign off on their company’s financial statements and be held liable if the financial statements are fraudulent.

If an external auditor reports an error in a company’s quarterly and annual SEC filings, it can get a company in trouble and affect its value. Errors at this level are known as:

• material weakness: errors that shed doubt on a company’s accounting practice
• material misstatement: errors that could mislead investors, customers, banks, or others

By frequently reconciling accounts, companies can find these errors internally first so that the adjustments explaining the errors are promptly reflected in SEC reports. Account reconciliation is an integral step in confirming that a company isn’t accused of committing fraud, also known as “cooking the books,” to make it appear more profitable than it is.