What Is Account Reconciliation and Why Is It Crucial?

What Is Account Reconciliation?

Account reconciliation is the process of cross-checking a company’s financial records with external documents, such as bank statements. Its purpose is to ensure accuracy and consistency of financial data, which is vital for informed decision-making and maintaining financial integrity.

It is a general practice for businesses to create their balance sheet at the end of the financial year as it denotes the state of finances for that period. However, you need to record financial transactions throughout the year in the general ledger to be able to put together the balance sheet.

While the entries in the general ledger are based on the facts of the moment, they may not always be accurate. when you receive a check from a customer, you may have recorded it as paid. But there are chances that the check could have bounced due to numerous reasons. Or the payment you made to supplier A went into the accounts of supplier B due to a clerical error.

8 Common Examples of Account Reconciliations

An example of reconciliation in accounting is comparing the general ledger to sub-ledgers, such as accounts payable or accounts receivable. This ensures that all transactions are recorded accurately and any discrepancies are identified and corrected.

In this section, we look at some examples of accounts reconciliation to understand the scope of work involved in accounts reconciliation and the tools that can help ease the process.

Cash Balance in the Ledger & Bank Account

Often the cash balance in the book of accounts and the bank accounts may not match. This could be due to many causes like missed entries, bounced payments, charges incurred, interest accrued, and much more.

Accounts Payable

Accounts payable is the money a company owes to suppliers and vendors. The production and delivery of goods or services that the company deals with depend on smooth accounts payables. It is essential to reconcile the balance of accounts payables due to short payments, disputes, early payment discounts, and much more. This ensures smooth operations, supplier relations, market reputation, and much more.

Accounts Receivable

Accounts receivable is the amount that your customers owe you for the goods sold or services provided. You will need to give special importance to reconciling accounts receivables to ensure steady cash flow and good customer relations to name just a few reasons. You will need to check the bank and ledger balances to ensure that there are no short payments, deductions, disputes, and to stop credit facility for defaulting customers.

Expenses Paid in Advance

Companies often pay some expenses or for some purchases in advance, especially when they are regular. However, accounts need to be reconciled to ensure that goods or services were received or delivered as per the contract. Reconciliation at this time also helps evaluate if the expense needs to be continued or not.

Accrued Liabilities

In many companies, often a holiday period is given to customers during which the amounts due can be accrued as a liability. However, these sort of arrangements needs to be revisited, evaluated, and acted upon if required.

Inter-Company Transactions

In many organizations, there are subsidiaries, group companies, and so on. In such a situation, there can be inter-company deposits made, depending on the requirements of different companies. However, since each of the group companies has its legal entity and the books of accounts also need to be maintained separately. To ensure that all cash balance, liabilities, and assets are updated, periodic accounts reconciliation is required.

Assets (Sold & Bought)

Most companies have numerous assets including immovable property, machinery, inventory, cash assets, and more. Over time, these assets can be sold or written off according to their stage in the lifecycle or due to depreciation. Accounts reconciliation helps take stock of the assets that a company has and enables the balance sheet to reflect the true value.

Investments

Companies tend to invest in some projects or for taxation purposes or due to many other reasons. Periodic accounts reconciliation will ensure that the true value of the investments is reflected in the book of accounts.

How Often Should Account Reconciliations Be Performed?

Since accounts reconciliation is integral to ensuring proper management of the cash flow and other assets of the company, we need to look at when and how often should accounts reconciliation be carried out.

To ensure that the occurrence of the accounts reconciliation process takes place logically, it is critical to segregate based on the types of reconciliation:

Cash and bank balance: This reconciliation should be done every time you get a statement from the bank to ensure that you are accounting for differences at the earliest.

Accounts receivable and payable: In most instances, these follow a typical cycle from purchase or sales to payment or receipt of payment. You can either follow the same cycle (for instance 45-day credit cycle can follow a 45-day reconciliation cycle) or make the process more efficient, and carry out reconciliation once every two weeks. One of the best ways to mitigate the issue of receivable reconciliation is to automate the entire AR process.

Advance payments and accrued liabilities: To reconcile these payments and accrued liabilities, you can follow the same cadence as the payments themselves to ensure that all details are current.

Other categories: For inter-company transactions, assets bought and sold, and investments, it is best to carry out accounts reconciliation once every 3 months.

What is the Account Reconciliation Process?

To ensure accuracy and balance, the process of account reconciliation involves comparing the balances of general ledger accounts for balance sheet accounts to supporting sets of records and bank statements. Additionally, rolling schedules are maintained with beginning balance, additions, reductions, and ending balance for specific accounts.

Here is a step-by-step process for performing account reconciliation:

1. Collect all relevant financial records: Gather all financial records, including bank statements, invoices, receipts, and any other documentation related to the accounts you need to reconcile.
2. Identify discrepancies: Compare the financial records with the entries in accounting system. Look for discrepancies, such as missing or duplicated entries, incorrect amounts, or other errors.
3. Investigate discrepancies: Identified discrepancies, investigate them to determine the root cause. This may involve contacting vendors or customers, reviewing contracts, or checking for errors in accounting system.
4. Make adjustments: After identifying and investigating discrepancies, make any necessary adjustments to correct errors and reconcile the accounts. This may involve updating accounting system, adjusting entries, or reconciling payments.
5. Document changes: Whenever adjustments are made to financial records, be sure to document the changes. This helps ensure financial records are accurate and helps you track changes over time.
6. Verify accuracy: After making adjustments, double-check financial records to ensure that they are accurate and match external sources, such as bank statements or vendor invoices.
7. Repeat the process regularly: Account reconciliation is an ongoing process, so it’s important to repeat these steps regularly to ensure the accuracy and integrity of your financial records. The frequency of reconciliation may vary depending on the size and complexity of business, but it’s generally recommended to reconcile accounts at least once a month.

Types of Account Reconciliations

Here are some of the most common types of account reconciliations:

1. Bank account reconciliation: This involves comparing a company’s bank statements with its accounting records to ensure that all transactions are accurately recorded.
2. Accounts receivable reconciliation: This involves reconciling the amounts that customers owe a company for goods or services with the accounting records. This ensures that all payments are received and correctly recorded in the accounting system.
3. Accounts payable reconciliation: This involves reconciling the amounts that a company owes to vendors or suppliers with the accounting records. This ensures that all payments are made and correctly recorded in the accounting system.
4. Inventory reconciliation: This involves reconciling the physical inventory count with the accounting records to ensure that all inventory is accounted for and correctly valued.
5. Payroll reconciliation: This involves reconciling payroll records with bank statements and tax filings to ensure that all payroll transactions are accurately recorded and all taxes are correctly withheld and paid.
6. Credit card reconciliation: This involves comparing a company’s credit card statements with its accounting records to ensure that all transactions are accurately recorded and any discrepancies are identified and resolved.
7. Fixed asset reconciliation: This involves reconciling the physical assets owned by a company with the accounting records to ensure that all assets are accounted for and correctly valued.
8. Expense reconciliation: This involves reconciling expense reports and receipts with accounting records to ensure that all expenses are accurately recorded and any discrepancies are identified and resolved.

Common Challenges in Account Reconciliations and How to Solve Them

While the discrepancies that need to be addressed through accounts reconciliation are vast, we list here some of the most common ones:

Ledger and bank balances don’t match

Here’s how such situations can be corrected:

• Check for time differences or bank holidays causing delays in the amount showing up in the account
• Look for check-based errors like the number in figures and words not matching, wrong date, or signature errors
• Find out if the customer has raised a dispute but the finance department is not aware of it because the sales department has not updated them
• Consider automation of the receivables process to ensure that all the parties concerned have access to updated information

Physical inventory does not match with inventory records

Here’s how such situations can be corrected:

• Make sure that the store management team does an entry every time they dispatch goods to customers
• Carry out periodical inventory checks physically to ensure that all the damaged and defective goods are accounted for and records updated about any exchanges or replacements
• Invest in a centralized system that ensures that inventory records are updated in real-time

Actual customer credit balance is lesser than accounted for

Here’s how such situations can be corrected:

• Check with the sales team if they have received further orders from the same customer and this has not been updated in the system
• Ensure that a credit onboarding of customers (even existing ones) is a part of the process before agreeing on sales with delayed payments
• Have an automated credit application in place to ensure that the credit terms are agreed upon based on the latest credit and other information

Amount paid by the customer is not completely reflecting in the bank

Here’s how such situations can be corrected:

• Check if the customer issued a stop payment because they were not happy with the quality or other aspects of the goods or services they received
• Delve deeper to find out if there were some charges that were imposed by the bank which you failed to account for in your entries

Wrong amount was recorded in the ledgers

Here’s how such situations can be corrected:

• Look for early payment rebates that were agreed upon by both parties, which you did not consider while recording the amount
• Check for fees or penalties that you did not think about while making the entry

Account Reconciliation Best Practices For Ensuring Accuracy

Here are five best practices that can help your organization to improve the account reconciliation process.

1. Give priority to setting an accounts reconciliation process
2. Establish standard procedures in keeping with statutory requirements
3. Automate processes like accounts receivable to ensure better cash application
4. Study the process constantly to discover gaps in the process and resolve these gaps
5. Use a risk-based approach to ensure that crucial processes are reconciled regularly

How HighRadius Can Help You With Account Reconciliations?

HighRadius’ Account Reconciliation software combines artificial intelligence (AI) and machine learning (ML) to ensure account reconciliations are done quickly and accurately.

1. Improve reconciliation accuracy up to 90% by leveraging out-of-the box matching rule system, analyze large volumes of data with accuracy – thereby reducing reporting errors
2. Detect anomalies in real-time and take proactive steps to address the issue rather than waiting until the month-end reconciliation process
3. Stay on top of your process with a reconciliation checklist of tasks corresponding to your accounts, comprehensive backup documents, and automated certification and decertification of accounts
4. Automatically post journal entries to your ERP and eliminate manual updates for all of the variances identified in your reconciliation

FAQs

What accounts need to be reconciled?

Accountants typically perform an account reconciliation for all their asset, liability, and equity accounts. This process involves reconciling credit card transactions, accounts payable, accounts receivable, payroll, fixed assets, and subscriptions to ensure that all are properly accounted for and balanced.

What makes a good account reconciliation?

Accuracy and completeness are the two most important things when reconciling accounts. Additionally, reconciling accounts on time consistently is also essential.

What is the main purpose of an account reconciliation?

Account reconciliation is an internal control that certifies the accuracy and integrity of an organization’s financial processes. It helps in detecting discrepancies and fraudulent transactions.

Who should prepare the account reconciliation?

The accounting team in an organization is responsible for reconciling accounts at the end of each financial period to ensure that the GL balance is complete and accurate.