What is Accounting Reconciliation?
Reconciliation in accounting is a procedure in which you or your accountant compare two sets of records–like a bank statement and your general ledger–to ensure that the numbers match up. The process is typically performed monthly, but you can also perform account reconciliations daily, quarterly, or even annually, depending on your company’s needs.
The underlying aim of the reconciliation is to ensure your finances are as they should be: that the amount of money you’ve spent and earned as an organization is accurate and complete. Any discrepancies could indicate human error, missed payments, or even fraudulent activity, which underscores just why reconciliation in accounting is so important.
How Does Reconciliation in Accounting Work?
Reconciliation in accounting might sound complex, but the task simply involves contrasting two pieces of data– typically an internal financial document like your general ledger and an external one from the bank, a supplier, or a client–to ensure that they correlate with each other.
While performing account reconciliations used to be a manual, time-intensive endeavor, with the rise of cloud computing-based accounting software, it’s easier than ever to perform an accounting reconciliation. Instead of having to manually compare datasheets, organizations can now use technology to automate and speed up the reconciliation process, making it touch-free, automatic, and real-time.
The Different Types of Reconciliation
Accounting reconciliation is a broad-scale term with several subcategories. Here’s a look at the different types you, your accountant, or your accounting software platform can perform.
As mentioned, how often you perform these reconciliations will depend on the nature of your business. Saying this, the general gold standard to aim for is once a month. Any longer than this, you risk missing out on discrepancies, creating more work for yourself in the long run.
Note that, for each type of reconciliation, there’s a follow-up process to use if you notice any discrepancies between the two amounts. We go over that towards the bottom of this article with our step-by-step process for performing an account reconciliation.
A bank reconciliation is the most common type of account reconciliation you will perform. It involves cross-checking the transactions in your company’s bank statement to your own general ledger to make sure the amounts match.
Accounts Receivable Reconciliation
If your bank reconciliation doesn’t add up, it might make sense to then perform an accounts receivable and accounts payable reconciliation. With the first type of reconciliation, you will compare your clients’ unpaid invoices with the accounts receivable total recorded in your general ledger to ensure the amounts are the same.
Accounts Payable Reconciliation
The accounts payable reconciliation process involves assessing the accounts payable balance (the amount you owe to your suppliers) in your general ledger with your supplier invoices to ensure everything matches up.
If your business has franchises or subsidiaries, then performing intercompany reconciliations will also be crucial. With this form of reconciliation, you’ll look to verify intercompany transactions to eliminate the risk of double entry and ensure accuracy.
Inventory reconciliation is the process of verifying that your physical inventory matches your recorded data. If you’re a service-based business, this won’t apply to you. But, for retailers and product-based businesses, this reconciliation is vital to perform regularly.
General Ledger Reconciliation
For the uninitiated, your general ledger is basically your company’s primary accounting record. The general ledger reconciliation aims to verify the validity of the ledger, ensuring that the transactions included are correct and complete.
To achieve this, you–or your accountant–will compare the general ledger to various source documentation like your bank account statement, invoices, and so forth.
If your business has employees on the payroll, then you’ll want to make payroll reconciliations part of your end-of-month process. With this form of reconciliation, the objective is to confirm that your employees are being paid the right amount.
It’s achieved by contrasting your general ledger with your payroll register and double-checking that all payroll data is correct.
Fixed Asset Reconciliation
A fixed asset, also known as a non-current asset, is a piece of property, software, or equipment that your business has purchased for long-term use, meaning you don’t plan to sell it or convert it to cash within the accounting calendar year.
Of course, most assets appreciate or depreciate over time, and that’s why fixed asset reconciliation is so important. With this process, you’ll compare your fixed asset register with your general ledger to ensure all figures are correct. By doing this, you’ll be able to ensure depreciation is accounted for, that assets are correctly logged, and that the purchase of new assets is necessary.
Tax reconciliations are imperative to ensure you don’t under or overpay tax. This form of reconciliation involves comparing your tax records, like sales tax and income tax, with your bank statements, invoices, and expenses to ensure your tax liability is correct.
Real-time Automatic Reconciliation
Real-time automatic reconciliation features are typically provided by accounting software platform providers. They use the power of artificial intelligence to streamline and enhance the reconciliation process, enabling you (or your accountant!) to use software to do the hard work for you.
Benefits of Account Reconciliation For Your Business
Accounting reconciliation is an essential process for sole traders and businesses, large and small. Here’s why:
- Accuracy: It’s incredibly easy to make a mistake when manually updating accounting information. Reconciliation directly combats this risk, enabling you to discover and correct any mistakes so that your financial statements are wholly accurate and true.
- Fraud detection: There’s always the risk that hackers could break into your accounting system. Luckily, regularly reconciling your accounts will help you spot and stop any incidents of fraud before they escalate.
- Enhanced insights: Account reconciliations empower you to trust the insights generated by your financial data, allowing you to make more confident, informed decisions about your business.
- Compliance: Reconciling your accounts is required by many regulatory bodies. To stay on the right side of the law, performing this reconciliation is a must.
- Nurture business growth: If you want to expand your business and get investment, you’ll need to know–without any doubt–the state of your finances, which is exactly what a reconciliation helps with.
How Do You Reconcile an Account?
Wondering what reconciliation in accounting looks like in practice?
Here’s how to perform one step-by-step:
- Compare the opening balances: Open your general ledger and look at the opening balance. Then, look at the opening balance on your bank statement. Ideally, both will agree, and you can move on to the next step.
- Note the closing balance difference: Now, look at the closing balance on your bank statement and on your general ledger. If there’s a difference, perform a simple sum to work out exactly how much isn’t accounted for.
- Look through your bank statement and update your internal document: Look through your bank statement, comparing it to the internal document, to find any missing payments, expenses, bank charges, and interest. Update your general ledger with this data. Also, check for any duplications that you might have accidentally included in your general ledger.
- Review the closing balance: Once you’ve updated your internal document, the closing balances on both pieces of data should match up. If the numbers don’t match up, don’t worry. Factors like cash being in transit or transactions being omitted can lead to these discrepancies. Should that happen, perform a reconciliation report, so you can justify the differences and make next month’s reconciliation easier for yourself.
Remember, too, that if you invest in accounting software, you can automate this process so that you no longer have to manually reconcile your accounts. With that in mind, here’s our view on the best accounting software for small businesses.
Examples of Account Reconciliation
Here’s a hypothetical situation to put account reconciliation in context.
Say that you’re a sole trader with a business account at a well-known bank. At the end of the month, you check your bank statement, which shows you’ve got $12,000 in the bank. According to your records, though, you should have $13,000.
To understand the discrepancy, you begin the reconciliation process, looking at the last month’s transactions to discover any expenses, invoices, interest payments, and so forth that have not yet been processed.
After doing this, you should be able to reconcile the mismatch and update the month’s ending balance in your general ledger.