Accounts Reconciliation

What Is Reconciliation?

Reconciliation is an accounting process that compares two sets of records to check that figures are correct and in agreement. Account reconciliation also confirms that accounts in the general ledger are consistent, accurate, and complete.

Account reconciliation is particularly useful for explaining the difference 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, or annually.

Understanding Account Reconciliation

A Major Reconciliation Tool is Double-Entry Accounting

There is no standard way to perform an account reconciliation. However, Generally Accepted Accounting Principles (GAAP) require double-entry accounting—where a transaction is entered into the general ledger in two places—and is the most prevalent tool for reconciliation. Double-entry accounting is a useful way of reconciling accounts that helps to catch errors on either side of the entry. 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.

In double-entry accounting—which is commonly used by companies—every financial transaction is posted in two accounts, the income statement and the balance sheet. One account will receive a debit, and the other account will receive a credit. For example, 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).

A Double Entry Also Can Affect the Balance Sheet Only

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, the 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).

In account reconciliation, debits and credits should balance out to zero.

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. With every transaction in the general ledger, the left (debit) and right (credit) side of the journal entry should agree, reconciling to zero.

Key Takeaways

Companies must reconcile their accounts to prevent balance sheet errors, check for fraud, and reconcile the general ledger.
In double-entry accounting, each transaction is posted as both a debit and a credit.
Individuals also may use account reconciliation to check the accuracy of their checking and credit card accounts.

Reconciliation in Personal Accounting

Periodically, many individuals reconcile their checkbooks and credit card accounts 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 determine whether money is being fraudulently withdrawn.

By reconciling their accounts, individuals also can make sure that financial institutions (FI) have not made any errors in their accounts, and it gives consumers 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 pending deposits or outstanding checks.

Reconciliation in Business Accounting

Companies must reconcile their accounts to prevent balance sheet errors, check for fraud, and avoid auditors’ negative opinions. 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 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. GAAP requires that, if the direct method of presenting the cash flow statement 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-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.