What Is Reconciliation?
Reconciliation is an accounting procedure that compares two sets of records to check that the figures are correct and in agreement. Reconciliation also confirms that accounts in a general ledger are consistent and complete. Reconciliation can be used for personal as well as business purposes.
Account reconciliation is particularly useful for explaining any differences between two financial records or account balances. Some differences may be acceptable because of the timing of payments and deposits. Unexplained or mysterious discrepancies, however, may warn of fraud or cooking the books. Businesses and individuals may reconcile their records daily, monthly, quarterly, or annually.
- Companies use reconciliation to prevent balance sheet errors on their financial accounts, check for fraud, and make sure that transactions were appropriately booked to the general ledger.
- In double-entry accounting, each transaction is posted as both a debit and a credit.
- Individuals can also use reconciliation to check the accuracy of their bank and credit card account statements.
How Reconciliation Works
There is no standard way to perform an account reconciliation. However, generally accepted accounting principles (GAAP) require double-entry bookkeeping—where a transaction is entered into the general ledger in two places—making it the most prevalent tool for reconciliation among businesses.
In double-entry bookkeeping, every financial transaction is posted in two accounts: a credit account and a debit account. So, when a business makes a sale, it debits either cash or accounts receivable (on the balance sheet) and credits sales revenue (on the income statement). Reconciliation can be used to catch errors on either side of the entry. In the reconciliation, debits and credits should balance out to zero.
Similarly, when a business receives an invoice, it credits the amount of the invoice to accounts payable (on the balance sheet) and debits an expense (on the income statement) for the same amount. When the company pays the bill, it debits accounts payable and credits the cash account. Again, the left (debit) and right (credit) sides of the journal entry should agree, reconciling to zero.
As a simple example, suppose Mary starts a lawn care company. She uses $2,000 that she has in her personal savings to purchase equipment. She then uses the equipment to complete her first lawn-care project, which pays her $500.
Using a double-entry accounting system, as shown below, she credits cash for $2,000 and debits her assets, which is the equipment, by the same amount. For her first job, she credits $500 in revenue and debits the same amount for accounts receivable. Both her credits and debits are reconciled and equal the same amount.
|Mary’s Lawn Care
It’s also possible to make a double-entry journal entry that affects the balance sheet only. For example, if a business takes out a long-term loan for $10,000, its accountant would debit the cash account (an asset on the balance sheet) and credit the long-term debt account (a liability on the balance sheet).
Another way of performing a reconciliation is via the account conversion method. Here, records such as receipts or canceled checks are simply compared with the entries in the general ledger, in a manner similar to personal accounting reconciliations.
Types of Reconciliation
Reconciliation for individuals
Many people reconcile their checkbooks and credit card accounts periodically by comparing their written checks, debit card receipts, and credit card receipts with their bank and credit card statements.
This type of account reconciliation makes it possible to check for errors and detect any possible fraud. It’s also a good way for someone to get an overall picture of their spending.
When an account is reconciled, the statement’s transactions should match the account holder’s records. For a checking account, it is important to factor in any outstanding checks or pending deposits.
Reconciliation for businesses
Companies need to reconcile their accounts to prevent balance sheet errors, check for possible fraud, and avoid adverse opinions from auditors. Companies generally perform balance sheet reconciliations each month, after the books are closed for the prior month. This type of account reconciliation involves reviewing all balance sheet accounts to make sure that transactions were appropriately booked into the correct general ledger account. It may be necessary to adjust some journal entries if they were booked incorrectly.
Some reconciliations are necessary to ensure that cash inflows and outflows concur between the income statement, balance sheet, and cash flow statement.
Cash flow can be calculated through either a direct method or indirect method. GAAP requires that if the direct method is used, the company must still reconcile cash flows to the income statement and balance sheet.
If the indirect method is used, then the cash flow from the operations section is already presented as a reconciliation of the three financial statements. Other reconciliations turn non-GAAP measures, such as earnings before interest, taxes, depreciation, and amortization (EBITDA), into their GAAP-approved counterparts.
How Often Should a Business Reconcile Its Accounts?
Businesses are generally advised to reconcile their accounts at least monthly, but they can do so as often as they wish. Businesses that follow a risk-based approach to reconciliation will reconcile certain accounts more frequently than others, based on their greater likelihood of error.
How Often Should Individuals Reconcile Their Bank Statements?
It’s a good idea to reconcile your checking account statement (or at least give it a careful look) when you receive it each month. One reason is that your liability for fraudulent transactions can depend on how promptly you report them to your bank.
The rules vary depending on whether the thief used just your account number or your physical ATM or debit card. In the first instance, you aren’t responsible for any transactions you didn’t authorize as long as you report them within 60 calendar days after your statement was sent to you.
If your ATM or debt card was involved in a fraudulent transaction, your liability is limited to $50 if you notify the bank within two business days of noticing your card is missing, but rises to $500 after two days and up to 60 calendar days. After 60 days, the Federal Trade Commission (FTC) notes, you’ll be liable for “All the money taken from your ATM/debit card account, and possibly more—for example, money in accounts linked to your debit account.“
What Is Single-Entry Bookkeeping?
In single-entry bookkeeping, every transaction is recorded just once (rather than twice, as in double-entry bookkeeping), as either income or an expense. Single-entry bookkeeping is less complicated than double-entry and may be adequate for smaller businesses. Companies with single-entry bookkeeping systems can perform a form of reconciliation by comparing invoices, receipts, and other documentation against the entries in their books.
The Bottom Line
Reconciliation serves an important purpose for businesses and individuals in preventing accounting errors and reducing the possibility of fraud.