What is Reconciliation?
Reconciliation is an essential accounting procedure that involves comparing two sets of records to verify their accuracy and consistency. It ensures that accounts in the general ledger are not only correct but also complete. This process has applications for both personal and business financial activities.
Account reconciliation is invaluable for explaining any differences between two financial statements or account balances. While some differences might be acceptable due to the timing of various financial activities, unexpected discrepancies can be red flags indicating potential fraud or other discrepancies. Both individuals and businesses might engage in reconciliation on a daily, monthly, quarterly, or annual basis.
Key Takeaways
- Companies utilize reconciliation to prevent balance sheet errors, detect fraud, and make sure transactions are accurately recorded in the general ledger.
- In double-entry accounting, every occurrence is documented both as a debit and a credit.
- Individuals can also use reconciliation to verify the accuracy of their bank and credit card statements.
How Reconciliation Works
There is no uniform method for conducting reconciliation, but double-entry bookkeeping, a system mandated by generally accepted accounting principles (GAAP), is undoubtedly the most common among businesses.
In this system, each financial transaction is documented twice—as a debit in one account and a credit in another. For instance, when a business records a sale, it debits either cash or accounts receivable and credits sales revenue. Discrepancies caught through reconciliation can correct errors on either side. Ideally, debits and credits should balance out to zero in reconciliation.
Businesses that handle large amounts of cash often record variances called “cash-over-short” to reconcile expected and actual sums. When reconciling, debits and credits of the journal entry should match and equal zero.
Consider Mary, who starts a lawn care company. She invests $2,000 from her savings in equipment. For her first job, she earns $500. According to double-entry accounting, she credits her cash account for $2,000 and debits it for the equipment. For the job earnings, she credits revenue $500 and debits it for accounts receivable. Both her credits and debits will equal the same amount.
| Account | Debit | Credit |
|-------------|---------|---------|
| Cash | | $2,000 |
| Equipment | $2,000 | |
| Revenue | | $500 |
| Accounts Receivable | $500 | |
Types of Reconciliation
Reconciliation for Individuals
Many people periodically go through the statements of their checkbooks and credit card accounts, comparing their written checks and receipts with bank statements. This practice helps find errors and catch potential fraudulent activities. Additionally, it gives a better picture of one’s spending habits.
Once an account is reconciled, the transactions on the statement should match the holder’s records. For checking accounts, don’t forget to account for outstanding checks or pending deposits.
Reconciliation for Businesses
Companies must frequently ensure their accounts are accurate to avoid balance sheet errors, uncover fraud, and avoid negative auditor opinions. Businesses usually reconcile their accounts at the end of each month to ensure transactions are recorded in the correct general ledger accounts. They may adjust incorrect journal entries as necessary.
Some reconciliations align cash inflows and outflows among the income statement, balance sheet, and cash flow statement. Reconciliations also convert non-GAAP measures into GAAP-approved terms, such as EBITDA.
How Often Should a Business Reconcile Its Accounts?
Businesses are generally advised to conduct reconciliations at least once a month. However, a business may perform reconciliations more frequently, especially if they employ a risk-based approach. Accounts more prone to errors may be reviewed more regularly.
How Often Should Individuals Reconcile Their Bank Statements?
It is advisable for individuals to review their checking account statements each month to detect any unauthorized transactions quickly. Liability for fraud varies depending on how soon discrepancies are reported. The quicker one identifies and reports fraudulent activity, the lesser the liability.
What is Single-Entry Bookkeeping?
Single-entry bookkeeping records each transaction only once as either an income or an expense, unlike double-entry bookkeeping, which records every transaction twice. This system may be adequate for smaller businesses without complex financial transactions.
The Bottom Line
Reconciliation is crucial for both individuals and businesses to detect accounting errors and fraudulent activities, thereby maintaining financial integrity.
Related Terms: general ledger, fraud, cooking the books, double-entry bookkeeping, accounts receivable, liability.
References
- Journal of Accountancy. “6 Tips for Reconciliations”.
- Federal Trade Commission Consumer Advice. “Lost or Stolen Credit, ATM, and Debit Cards”.
