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Finance guide: all about account reconciliations
Learn how account reconciliations can help with generating accurate financial statements and the necessary steps to perform them.
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1 minute
September 6, 2024
Ken Boyd is a guest contributor. The views expressed are his and do not necessarily reflect the views of Rho.
To help generate accurate financial statements for stakeholders, founders should consider account reconciliations.
This post explains account reconciliations and how they can help create accurate general ledger balances. You’ll also learn what goes into the account reconciliation process and how to automate it.
Key highlights:
Eliminate late receipt submissions and streamline transaction reconciliation with Rho.
An account reconciliation compares details in the GL accounts, including journal entries and sub ledgers, to other documents and records.
The general ledger includes all accounts and the transactions for each account. The reconciled general ledger account balances generate the balance sheet, income statement, and cash flow statement.
The reconciliation compares general ledger data to receipts, vendor invoices, credit card statements, and other documentation. Any differences should be investigated and recorded in an account reconciliation template.
A reconciliation generally is complete when the accounting team has identified all differences between the general ledger and the supporting documentation. Businesses should reconcile each account during month-end close and as a part of the year-end close.
Companies reconcile both permanent accounts and temporary accounts:
When a business owner reviews the account balances on the first day of a new month, all income statement balances have a zero balance.
Every business should use double-entry accounting to record transactions. Generally Accepted Accounting Principles (GAAP) require companies to use the double-entry method. Single-entry accounting cannot be used to produce the financial statements.
To illustrate, assume that a business owes employees $5,000 in wages for the last month of December 2024 and that the wages are paid on January 5, 2025.
Businesses should post at least one debit and one credit for each transaction, and the total dollar amount of debits and credits should be equal.
Accountants should use the accrual basis of accounting which records revenue when earned and expenses when incurred. The accrual basis does not record revenue and expenses based on cash movements.
On December 31, 2024, the company debited wage expenses and credits accrued payroll for $5,000. On January 5th, accrued payroll is debited (reduced) and cash is credited for $5,000. The expense is recorded in 2024.
This method posts a single debit or credit for each transaction. When cash is received, revenue is increased with a credit entry. Cash payments generate a debit entry for an expense.
No entry is recorded on December 31, 2024. On January 5th, wage expense is debited for $5,000 and cash is reduced by $5,000. The expense was incurred in 2024, but this method records the expense in 2025.
Many businesses do not use single-entry accounting because the system does not allow the company to produce the balance sheet and other financial reports.
As mentioned above, businesses should reconcile each account in the general ledger. A bank reconciliation is performed on each cash account. The book balance (balance in the accounting records) is compared to the bank balance (balance per the bank statement), and all reconciliation discrepancies are investigated.
Bank reconciliations are particularly important because the cash account typically has a large number of transactions and cash accounts have a higher risk of error or fraud.
Owners that perform monthly account reconciliations generally have reliable accounting data to make informed decisions. Here are some additional benefits for businesses that perform reconciliations on each account.
The accounting staff can generate accurate financial statements when each general ledger account is reconciled.
A CPA firm’s audit opinion requires the auditor to assess the effectiveness of the company’s internal controls over financial reporting. Account reconciliations are one type of internal control that allows the business to produce accurate financial statements.
If you operate a public company or plan on issuing common stock in the future, you’ll need strong internal controls including an audit trail for each account reconciliation.
Company managers, investors, and other stakeholders analyze the financial statements. If the business consistently reconciles all accounts, the general ledger generally can be used to produce accurate financial statements each year.
Timely account reconciliations help to minimize the risk of fraud. Fraud is defined as willful intent to deceive, and individuals inside and outside the business may attempt to steal cash and other assets.
One common type of fraud is a fictitious payee. An individual attempts to convince the business to pay an invoice to a company name similar to a current vendor.
Assume that the business frequently orders supplies from “Midwest Lumber Supply.” An individual sends a fictitious invoice from “Midwest Lumber Suppliers.”
If the cash account is reconciled each month, the accountant may notice the fictitious invoice and halt any future payments to the payee.
As a company’s transaction volume increases, so does the risk of errors and omissions. Account reconciliations can uncover several issues:
Over time, a business may operate with dozens or hundreds of general ledger accounts. More accounts increase the risk of error, particularly when account numbers are assigned to a specific department or profit center.
For example, the Midwest division purchases a piece of equipment, and the fixed asset should be posted to account #4150-10. The bookkeeper makes an input error and posts the fixed asset to #4150-20.
Companies need to ensure that each monthly subscription payment is for a product or service currently used by the business.
For example, the bookkeeper reconciles the bank account and notes a $150 monthly subscription payment for software that is no longer used. The subscription can then be canceled.
By reconciling the bank account, the business can avoid overdraft fees on the account. The credit card statement transactions are reconciled with the accounting records so that payments are submitted on time, avoiding late fees.
Account reconciliations can uncover excessive spending in a particular area. If the business doesn’t control spending, they may not have sufficient cash flow to pay all expenses and operate at a loss.
Assume that a salesperson’s monthly travel budget is $4,500 and all expenses are paid using a company credit card.
The credit card statement is reconciled with the travel expense account, and the bookkeeper notices that the salesperson spent $8,000 during the month. The bookkeeper provides the detail to the VP of Sales, so that the spending can be investigated.
Managers need accurate financial data to make decisions regarding business growth, product pricing, and capital expenditures.
Stakeholders are interested in businesses that have strong internal controls and produce reliable financial statements. Well-managed accounting departments build stakeholder trust.
The steps to complete an account reconciliation can be generalized and applied to most account balances.
There are two methods a business can use to complete an account reconciliation.
General ledger transactions are compared with receipts, vendor invoices, bank statements, credit card statements, and other documents. Accounts with large dollar balances and frequent financial transactions should be reconciled using documentation.
The accountant performs an analytical review by comparing account activity in past periods to the current period. This method may be suitable for small account balances or accounts with just a few transactions during the period.
Say, for example, that the office supply expenses account averages $200 in expenses per month. The bookkeeper is working on account reconciliations for March.
If March office supply expenses total $215, the business may rely on the analytical review and not use documentation. However, if office supply spending totals $700, the bookkeeper may review documents to determine why March spending was much higher than normal.
A document-based review provides more reliable and precise information than a strictly analytical review.
Use these steps to complete a document-based account reconciliation. To illustrate, assume that a sporting goods retailer is reconciling the inventory account for baseball gloves as of July 31, 2024.
Confirm that the July 1st balance agrees with the June 30th account balance. Inventory is a permanent account, and the account balance should carry over from one period to the next.
Inventory purchases are documented using vendor invoices, shipping receipts, and bank account documentation showing that the vendor was paid. Inventory sales are documented with client invoices and customer payment information from the bank reconciliation.
Review each July transaction in the general ledger, and compare the transaction detail to the supporting documentation. If inventory was increased by $3,000 on July 17th, the dollar amount should be supported by a vendor invoice, a shipping receipt, and a vendor payment of $3,000.
If any general ledger entries differ from the documentation, investigate the differences. Assume that the $3,000 July 17th inventory purchase in the general ledger does not match the $3,500 vendor invoice.
The accountant determined that $500 in baseball gloves were defective and returned to the vendor. Documentation of the returned gloves should be added to the files for the July reconciliation.
Some reconciliation discrepancies may require the accountant to post an adjusting entry to the general ledger.
File all documents related to each account reconciliation. Explain any differences between the documentation and the general ledger, and how the issue was resolved.
A general ledger transaction may differ from the documentation, and there are several reasons why these differences can occur.
The accrual basis of accounting requires a business to record adjusting entries due to the timing of a revenue or expense transaction. The end-of-year payroll expense issue above is an example. An expense entry is posted in 2024, and the payroll is not paid in cash until early January 2025.
Bank interest is another good example. A company may not post an entry to record July interest earned on a bank account until the July bank statement is received in early August.
Supporting documents are required before many transactions are posted to the general ledger. If a salesperson does not provide credit card receipts for business travel, the bookkeeper may not post expense entries until the credit card statement is received.
Human error can generate duplicate entries or coding errors, and the risk increases as the company scales. Growing businesses may have multiple transactions with the same vendor each month, and the vendor invoices may be very similar.
To explain, assume that a furniture manufacturer places 15 orders with Premier Lumber during June. The type of lumber, amounts, and other details are very similar. The bookkeeper may post a duplicate transaction or key in the wrong dollar amount due to the volume of journal entries.
A fictitious payee attempts to mislead the business into paying a fake invoice. If a fictitious invoice is paid, the general ledger entry for the transaction is not supported by documentation proving the purchase. This situation creates a reconciling item.
The goal of performing account reconciliations is to confirm the balance in each general ledger account. If every account balance is reconciled, the general ledger is reconciled and can be used to create the financial statements.
Here are the most common types of account reconciliations:
This reconciliation compares the cash account balance to the bank statement balance and other documents. Reconciling items include outstanding checks, deposits in transit, bank fees, and interest earned.
Customer invoices provide documentation for increases to the accounts receivable balance. Bookkeepers can verify decreases in accounts receivable by confirming customer payments.
Accountants can also perform analysis to evaluate the accounts receivable balance. If sales are increasing rapidly, the business may notice a similar percentage increase in accounts receivable.
When a business purchases goods and services on credit the accounts payable balance increases. Bookkeepers can confirm purchases by reviewing vendor invoices for asset purchases. Company payments to vendors reduce the accounts payable balance.
When a parent company does business with a subsidiary the activity is considered an intercompany transaction.
Assume for example that a subsidiary sells a price of equipment to the parent company for $50,000. Here are some of the accounting issues related to the transaction:
The seller’s gain or loss should be eliminated when the parent and subsidiary companies are posted in a consolidation. The seller’s cost basis also becomes the buyer’s cost basis. All of this activity should be reconciled.
Inventory is often one of the largest asset account balances on the balance sheet. Businesses perform a physical inventory count and compare the items counted in inventory to the detailed inventory list in the general ledger.
Differences between the inventory count and the general ledger are investigated and documented.
Asset purchases are confirmed by reviewing vendor invoices. When an asset is disposed of, a bookkeeper can review the sales agreement and cash deposits.
An accountant can recompute the tax liability using the tax rate and other sets of records. Here are two examples:
Companies post deferred tax asset or liability balances due to differences in depreciation and other accounts. Businesses also pay payroll taxes and property taxes.
Businesses often issue debit and credit cards to employees for corporate travel and other purchases. Each time a card is used, the cardholder should provide a receipt to the accounting department.
Companies perform debit card transaction matching using the bank statement and credit card activity is compared to credit card statement. Accounting software can automate the process.
If your business uses digital wallets such as Apple Pay or PayPal, you should reconcile each payment and deposit with the related bank account. The reconciliation process is similar to a credit card reconciliation.
Companies that do business in multiple currencies reconcile foreign currency transactions.
To illustrate, assume that a U.S.-based business purchases raw materials from Germany. The company converts U.S. dollars into Euros and completes the purchase. An accountant reviews the bank activity, and the exchange rate for the transactions, and confirms receipt of the raw materials.
Real-time payments (RTPs) are processed immediately, and the system operates continuously 24 hours each day. Unlike ACH transactions and other payments transfers between banks occur in real time.
Accountants reconcile each payment and deposit using bank statements and other records.
Successful businesses apply these best practices to the account reconciliation process:
Every account is reconciled at the end of each month and year. The accounting department should minimize the days required to complete the reconciliation process. A faster closing process allows the staff to identify reconciling items quickly, and reduce the risk of errors and fraud.
A business should have a written procedures manual for each routine task, including account reconciliations. The manual documents how each task is performed, who completes the task, and how often the work is completed.
Companies should use segregation of duties for account reconciliations. If a bookkeeper performs the reconciliations, the supervising accountant reviews and approves the work. No one in the accounting department can have check signing privileges.
A clear set of procedures improves communication and ensures that all reconciliations are completed on schedule.
Several stakeholders need access to the records used to perform reconciliations. When an audit is conducted, the CPA firm will test the company’s internal controls by reviewing account reconciliations and documentation.
If the accounting department determines that the general ledger requires a prior period adjustment to correct an error, the prior year’s account reconciliation data will be reviewed.
As mentioned above, the accounting staff should investigate differences between the general ledger and supporting documents as soon as possible.
Account reconciliation software automates many tasks required to reconcile all general ledger accounts. Businesses use software to complete reconciliations in less time and with fewer errors. Here are some features that you may find in account reconciliation software:
Receipts, invoices, and other documents are scanned and uploaded into the software. Reviewers can scan documentation as they review a reconciliation.
Users can create an automated template for each account reconciliation. An accounts payable template, for example, is formatted to include each vendor’s name, address, a description of the items purchased, and the dollar amount.
The software can perform an automated comparison of general ledger data with bank statements, credit card statements, and other documents. This eliminates time-consuming manual review and sharply reduces the risk of errors.
Account reconciliation software can also be integrated with your ERP or accounting software.
It is difficult to track the status of each required account reconciliation using manual data entry in a spreadsheet. Software can track the status of each account reconciliation, and provide automated alerts to complete a reconciliation or to review.
Businesses can set up automated controls that dictate who can access a particular account reconciliation, and who is responsible for the review.
The reconciliations and supporting documents are stored on the cloud, and managers determine who can access the data. Automation makes it much easier to search and find accounting data. An outside accounting firm can get a read-only version of the information to perform an audit.
At a minimum, every account in the general ledger should be reconciled at the end of each month and year.
Owners should consider reconciling cash multiple times each month as the business scales. Cash is a high-volume account with a higher risk of errors or fraud.
Here are the steps to perform an account reconciliation:
Businesses perform account reconciliations to verify that all general ledger account balances are correct. The general ledger balances are used to generate the financial statements. Companies can also uncover errors, wasteful spending, and fraudulent transactions.
An account reconciliation is a key internal control to generate accurate financial statements. Successfully generating accounting information necessitates clean data; however, obtaining this level of data can require numerous hours. Leverage technology to save time.
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