What is account reconciliation? (Balances and discrepancies)
By Indeed Editorial Team
Published 8 April 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Account reconciliation is the process of checking that the information in a company's general ledger and balance sheet are accurate. Companies reconcile their accounts to prevent errors on the balance sheet and financial statements and to reconcile the general ledger. This process can help you identify accounting errors, discrepancies or possible fraud. In this article, we explain what account reconciliation is, why it's important and how discrepancies arise.
What is account reconciliation?
Account reconciliation compares two sets of accounting records to ensure the figures are correct. The process also confirms that the accounts in the general ledger are correct and complete and that the debit and credit accounts balance to zero. Bookkeepers or accountants may perform the reconciliation either frequently, such as on a daily or weekly basis or less often, such as at the end of an accounting period or the end of the tax year.
Why is account reconciliation necessary?
Account reconciliation is an important process to ensure the company's financial statements are accurate and complete. Reconciling balance sheet accounts identifies any discrepancies that may require investigation. Posting a journal entry adjustment can often resolve an error. Some discrepancies may indicate possible fraud.
The reconciliation process is an important element of a company's internal controls, which enables it to comply with Section 404 of the Sarbanes-Oxley Act. This mandates that a public company's annual financial reports include 'an Internal Control Report stating that management is responsible for an "adequate" internal control structure and an assessment by management of the effectiveness of the control structure. Any shortcomings in these controls must also be reported. In addition, registered external auditors must attest to the accuracy of the company management assertion that internal accounting controls are in place, operational and effective.'
Generally accepted accounting principles (GAAP) require double-entry accounting. This means entering transactions into the general ledger in two places, one as a credit and the other as a debit. For instance, when a company sells an item, the transaction is posted as a debit to accounts receivable in the balance sheet and as a credit to the sales account in the income statement. Since debits and credits should balance to zero, double-entry accounting can detect input errors.
Smaller companies may reconcile their accounts using the conversion method. This is a comparison between receipts or cancelled cheques with the general ledger entries. This is a fast and simple way to record income and expenditure.
Related: 13 essential accountant skills
Balance sheet-only entries
It's possible to post a double-entry journal entry that only affects the balance sheet. Balance sheet accounts include cash, accounts receivable, accounts payable, allowance for bad debts, inventory, investments, equipment, furniture and fixtures, depreciation and others. With every transaction in the general ledger, the debit and credit sides of the journal entry should balance out to zero.
Example: A company borrows £50,000 from the bank as a long-term loan. The accountant debits the cash account, which is an asset on the balance sheet and credits the long-term debt account, which is a liability on the balance sheet.
Companies usually reconcile their accounts monthly after they've closed their books for the previous month. This involves reviewing all balance sheet accounts to ensure transactions were posted to the correct general ledger account. They may raise a journal entry adjustment if a transaction was posted to the wrong account, A company must complete its account reconciliation process before it can certify the integrity of its financial information and issue its financial statements.
GAAP and non-GAAP
Reconciliation ensures that cash in and cash out amounts agree between the income statement, balance sheet and cash flow statement. If a company uses the direct method of presenting the cash flow statement, GAAP requires the company to reconcile cash flows to the income statement and balance sheet. If the company uses the indirect method, then the cash flow from operations is already recorded as a reconciliation of the three financial statements.
Non-GAAP earnings is an alternative accounting method to measure a company's earnings. These pro-forma figures, which exclude one-time transactions, often provide a more accurate measure of a company's financial performance. Non-GAAP measures include earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation and amortisation (EBITDA), adjusted revenues, free cash flows and core earnings.
What is the account reconciliation process?
This is usually performed at the end of a financial period. It involves comparing internal accounts with external accounts. This includes reviewing payments and deposits, examining bank statements for all cash in and cash out transactions and ensuring there are receipts for payments made. Specifically:
The accountant checks each general ledger account to verify that their balances are complete and accurate.
The accountant compares the general ledger account balance with independent systems, third-party data or other supporting documentation, such as bank account and credit card statements.
The accountant investigates any discrepancies and takes appropriate remedial action, such as raising journal entries to correct errors.
All data, analyses and actions taken are recorded for audit purposes.
What causes discrepancies?
Discrepancies identified in the reconciliation process may be caused by various factors. These include posting errors, timing differences and missing transactions. The accountant investigates any discrepancies and corrects posting errors. Here are some examples:
Original entry errors
An original entry error occurs when an incorrect amount is posted to an account. Since the same incorrect amount is reflected in accounts related to that transaction, all the accounts involved would balance. For instance, the bank account in the general ledger reflects an amount of £8,900 but the bank statement shows the company's account balance is £8,000. On inspection, the accountant finds that the company posted a payment received as £1,000 instead of £100. The accountant can correct this by raising a journal entry adjustment for £900.
Duplication errors are self-explanatory. It's a transaction that is posted twice. A journal entry adjustment can reverse the duplicated entry.
Error of omission
This is when an entry isn't posted for a transaction. For instance, an accounts payable account wasn't credited when the company purchased goods on credit. This generally happens when companies receive many suppliers' invoices and some may get lost or misfiled. It can also happen if a company neglects to provide an invoice for a one-off cash sale transaction.
Entry reversal is when a debit entry is posted as credit and vice versa. For instance, the cost of raw materials and inventory account is credited instead of debited and the finished inventory account is debited instead of credited. This can be corrected with journal entries.
Error of accounting principle
This happens when an accounting principle is applied in error. For instance, equipment purchased is posted as an operating expense instead of a capital expense or fixed asset. The operating expenses account is for day-to-day operating expenditure and is listed in the income statement. The capital expenses or fixed assets accounts are listed in the balance sheet.
This happens if someone records a debit or credit to the correct account but to the wrong subsidiary account or ledger. For instance, the payment received is correctly credited to accounts receivable but to the wrong customer. The error would show up in the accounts receivable subsidiary ledger, which reflects all customers' invoices and transactions. The same can happen with a payment to a supplier, where the transaction is posted to accounts payable but to the wrong supplier.
This happens when an error is compensated by the offsetting entry that's also incorrect. For instance, someone posts an incorrect amount to one account and the same incorrect amount to the corresponding account.
Example: Someone posts a £1,000 transaction to the inventory account which is balanced by the same wrong amount posted to accounts payable.
When a transaction is posted in the general ledger but not the supporting data (or vice versa), it may be due to a timing difference. For instance, the cash account in the general ledger reflects a balance of £50,000 but the bank statement shows an account balance of £55,000. The accountant identifies that a company cheque for £5,000 has yet to clear the bank's system and can make a note of the legitimate discrepancy in the reconciliation.
When a transaction is posted in the general ledger but not the supporting data (or vice versa), it could also be due to a missing transaction. For example:
When reconciling a credit card payable account, the general ledger balance is £6,000 but the credit card statements shows a balance of £5,400. The accountant's investigation reveals that some transactions included in the credit card statement were erroneously omitted in the general ledger. Therefore the £600 discrepancy is legitimate.
When reconciling a credit card payable account, the general ledger balance is £4,000 but the credit card statements shows a balance of £6,000. The accountant's investigation reveals that some transactions posted in the general ledger have not yet been processed by the credit card company. Therefore the £2,000 discrepancy is legitimate.
Personal account reconciliation
Many individuals also reconcile their personal accounts, particularly bank accounts. Here are some reasons for doing this every time you receive a bank statement:
detect errors, such as missed payments or calculation mistakes
track bank fees and penalties
monitor debit orders and future-dated payments
identify fraudulent transactions
Disclaimer: The model shown is for illustration purposes only, and may require additional formatting to meet accepted standards.
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