Account reconciliation, defined as the process of assuring that bank statements equal what a company expects from their internal accounting statements, is required with every business that keeps financial statements. To explain simply, account reconciliations are making sure a checkbook balance matches bank statements. Taken to the next level, account reconciliation best practices include collecting relevant account data like invoices, checking account balances, correcting these balances, finding discrepancies, controlling policy to prevent discrepancies, and more. Account reconciliation procedures can be simple or extremely complex depending on the size and scope of a company.
Account Reconciliation Explanation:
Account reconciliation, explained below, is one of the most common yet important actions taken for managerial accounting. It is important to reconcile balance sheet accounts at the end of a period (month, quarter, or year-end) as part of the closing process. Doing so helps to identify errors before closing. Balance sheet account reconciliation is the comparison of the account’s general ledger trial balance with another source, be it internal, such as a subledger, or external, such as a bank statement. Differences caused by the timing of transactions, such as outstanding checks, are identified as reconciling items.
When preparing a general ledger reconciliation of an account to an aging different detail ledgers are used. Cash accounts are reconciled against a bank statement. Accounts receivable and accounts payable are reconciled against aging schedules. Inventory and fixed assets can be reconciled against a physical count.Account Reconciliation Formula:
There is no single account reconciliation formula. Depending on the processes of the company as well as the banking relationship, account reconciliation can occur in any number of ways. For a simplified formula, see below:
Balance per Bank Statements + Deposits in Transit - Outstanding Payments = Balance after Account Reconciliation
Account Reconciliation Calculation:
Account reconciliation calculations, for the average business, are a straightforward process.
Example: A company has a balance of $15,000 on Bank Statements; $5,000 deposits in transit; $7,000 in outstanding payments
Balance after account reconciliation = $15,000 + $5,000 - $7,000 = $13,000
Account Reconciliation Process:
Set up a reconciliation statement or reconciliation report in a spreadsheet, with the trial balance at the top of one column and the balance you will be comparing it to in the other column. Enter reconciling items below the appropriate balance and label it. When the sum of the two columns equals, then the account is reconciled.
Account Reconciliation Statement:
Balance per general ledger (source #1):
Add(Less) Items in general ledger not
Add(Less) Items in detail not in
Balance per detail (source #2):
Let’s now take a look at a four step process for an accounts receivable reconciliation and an accounts payable reconciliation.
Compare Trial Balance with Aging Schedule:
Compare the trial balance of receivables and payables with the balance of their respective aging schedules. If they are equal, move on to reconcile the next account. If not, move on to step two.
Review General Ledger Entries:
If the trial balance is greater than the aging schedule balance, it is likely due to a journal entry posted directly to the general ledger instead of to the subledger. Identify any such entries and move them to the subledger. In addition, let the amount of the difference guide you in your reconciliation. For example, if the difference is $100, look for transactions whose size is close to that. If this does not resolve the difference, move on to step three.
Review Subsidiary Ledgers:
Examine the sales journal (for receivables) and the purchases journal (for payables). Look for posted entries which were posted to the wrong account. This can be done by scanning the entries, looking for abnormal entries, such as credits to the receivables account or debits to the payables account. Examine any such entries to ensure that they are accurate. Look at the cash receipts and cash disbursements journals for receivables and payables, respectively. Again, scan for abnormal entries, such as debits to receivables or credits to payables. Use the unreconciled difference between the trial balance and the aging schedules to guide you. Repeat as needed, with an examination of the invoice register for accounts receivable and the purchase order journal for accounts payable.
Divide and Conquer:
Should the account remain unreconciled, focus solely on one side of the transactions you examine in the journals and follow those debits and credits to the balance sheet account. First, print the general ledger detail for the accounts to be reconciled. Cross out the reversing or correcting entries. Print the subsidiary ledgers (either accounts receivable detail or accounts payable detail). Cross out the in and out correcting entries. Using a unique check mark trace the transactions from the general ledger to the subsidiary ledger and vice versus.
Examine reconciling items that are not posted to determine if they should be prior to close. If the account is not fully reconciled, but the difference is immaterial, then an entry should be made to adjust the general ledger account balance, as long as the impact is conservative. If the difference is material, continue to examine the subledgers and journals that are a part of the revenue and expenditure cycles to identify the problem.
Tips and Tricks:
Transpositon Error - If you have an unlocated difference and it is divisible by "9" then the error may be that you have transposed a number. For example; you may have entered a "10" rather than a "1". (The difference is "9")
Account Reconciliation Example:
Molly is an CPA for a small business. She appreciates her work because she enjoys projects which take advantage of her analytical and quantitative nature.
Molly is currently doing some work for her employer. Her task today is to execute the account reconciliation policy for her boss. Molly sets down to begin her work.
Molly begins by collecting the proper data. She finds any bank statements, company financial statements, invoices, and any other relevant information which she can find.
Next, she sits down to perform the calculations.
The company has a balance of $15,000 on Bank Statements; $5,000 deposits in transit; $7,000 in outstanding payments
Balance after account reconciliation = $15,000 + $5,000 - $7,000 = $13,000
Molly performs the calculation again. Then, she performs the calculation a third time. No matter how many times she performs the calculation she gets the result of $13,000; $1,000 less than she should find. Molly does additional research and can not find any reason that this has happened.
Near the end of the day she contacts her employer with the information. At their next meeting, she shows her process and her results. The company is disturbed by these results and decides to take action. They contact the bank right away.
Molly was able to find a mistake in bank processing for the company. The company, eventually, is given $1,000 by the bank. Without Molly's help their $1,000 would have been lost in paperwork.
Molly is excited to have helped her employer recover the lost funds. She appreciates her CPA training and looks forward to helping companies in the future.