Account reconciliation is the process businesses use to monitor, confirm, and record accounting documents. Because while philosophers can spend hours debating the possibility of a single source of truth, financial auditors — and government officials — pretty much demand it. Within a business, the accounting records being used internally and provided externally need to align every time. And if they don’t, you need to know why.
In this article, we’ll dive into the importance of those efforts, how they’re done, some common frustrations, and how to find resolution.
Account reconciliation meaning
Within accounting, reconciliation specifically covers matching the details and totals within your general ledger against externally facing documents, such as invoices, receipts, or bank statements. This verification effort must be applied across all your ledger accounts: assets, liabilities, equity, revenue, expenses, gains, and losses.
No further action is required if the figures match and the account reconciliation process is complete. However, if there is a discrepancy, you must investigate the cause and update your records once you’ve found it.
Why is account reconciliation important?
It’s difficult to overstate how critical having an accurate financial perspective is. Not only will tax and other government agencies expect your figures to be correct, but they’ll likely take punitive actions if your records are erroneous. At the same time, correct bookkeeping will also help to satisfy the curiosity of—and attract potential investment from—outside stakeholders.
Internally, reliable accounting records make it much easier to manage and predict overall cash flow and budget for ongoing operations. The clarity delivered by sound numbers makes process and payment abnormalities stand out, allowing you to address invoice fraud or other malfeasance more immediately.
Finally, customers prefer when your internal accounts receivable (A/R) systems accurately match the debts and payments tied to their specific accounts—a common sign that no errors are present.
Types of account reconciliation
Given the broad range of financial elements stored in your general ledger, there are quite a few avenues that might be covered by an account reconciliation. Some of the most common approaches will cover your:
- Accounts payable (A/P): which compares this line item in the general ledger to sub-ledgers, credit card statements, and other records of outgoing payments
- Accounts receivable: which matches A/R records and contra accounts with customer invoices and payment data
- Assets: which evaluates fixed and intangible assets against depreciation and amortization schedules, respectively
- Cash: which aligns general ledger cash account balances with external bank statements
- Cash equivalents: which matches short-term investments with investment statements (e.g., securities, bonds, treasury bills)
- Inventory: which contrasts accounting records with physical product counts and other asset inventories
- Liabilities: which compares general ledger accounts to accrued liabilities (e.g., wages, benefits, taxes)
How does the account reconciliation process work?
While most nations have some form of mandate for accounting standards in place — typically either Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) — few have legal guidelines dictating how account reconciliation should be handled. As such, there can be quite a bit of variability regarding the actual process. However, the approach typically follows one of two models.
The analytic method is less precise and is predominantly used to flag areas in need of a more detailed review. Typically, this approach leverages key performance indicators (KPIs) to estimate the range of certain ledger balances, and a rough match will prove sufficient to reconcile the account.
Conversely, the documentation method contrasts specific records — often down to a transaction level—and requires the two sets of figures to match precisely. This precision makes the documentation method the gold standard. In most cases, including those in this article, the phrase “account reconciliation” refers to this approach.
When discrepancies are identified using either model, you’ll want to isolate the variance and appropriately modify your records or the external documents.
When should account reconciliation be done?
You should perform these reconciliations at a minimum during your financial closings. Suppose you follow a less frequent closing schedule (e.g., yearly or quarterly). In that case, you might consider protecting your operations by performing more focused reconciliations (e.g., cash, accounts receivable) more frequently.
Some businesses participate in a continuous close process that relies on daily or weekly account reconciliation efforts. This approach helps to isolate and resolve errors, fraud, and other complications more quickly — a distinct advantage for high-volume or high-risk organizations — while also distributing the time and effort required for these measures across a longer period, delivering increased flexibility.
How to reconcile accounts: A step-by-step guide
Before beginning the reconciliation process, you’ll want to ensure you’ve gathered all the relevant documents needed for the endeavor. You should leverage as many externally sourced files from independent parties (e.g., bank statements, credit card bills) as possible. Their inclusion helps to limit the potential for internal fraud or an internal process failing to color the outcome.
You’ll also want to identify which ledgers or line items will be the focus of the reconciliation. For example, will you do a comprehensive review for your annual closing or will you exclusively zero in on your cash position?
Depending on these decisions, you’ll follow a process that looks something like:
Step 1: Compare balances
Ultimately, your goal is to match the ending balances of your ledger and whatever records or statements that you are comparing it to, so take a look at these figures as a first step. If they’re the same, you can theoretically end the process here. Just make sure that the reporting dates match for these totals as well.
Of course, if they don’t match, you’ll want to move on with the following steps. And as a precautionary measure, you might do so even if the totals do align — it’s always possible that a pair of errors or a whole sequence of them have cancelled each other out and could cause complications later on.
Step 2: Focus on the details
You’ll want to continue your matching efforts at the transaction level, a process that is commonly referred to as ticking and tying. Each exchange — along with its corresponding values and dates — should be reflected on both sets of documents, so make note if an additional event occurs on either record. Bear in mind that depending on the type of account reconciliation you are performing, you may actually need to review multiple files to cover all of the relevant transactions for a given ledger or line item.
Step 3: Investigate the discrepancies
For every one of the variances flagged in Step 2, you’ll want to chase it back to its root. These may be caused by incomplete files, poor math, an overlooked surcharge, or a host of other reasons. However small the inconsistency is, though, you’ll want to know the source—especially if you’re hoping to prevent it from being a problem again during your next reconciliation.
Step 4: Resolve the differences
Depending on the causes you identify, you’ll likely need to take some form of corrective action—but not always. If some of your outgoing invoices had incorrect totals, you might need to amend those with credit notes or create whole new documents. Alternatively, if the discrepancy is caused by a disputed or delayed payment cycle, you might need to amend your ledger with an adjusting journal entry—an action that will record the unrealized income or expenditure within the appropriate reporting period.
No matter what you do, be sure to document any and all changes to assist with future reporting or auditing efforts.
Step 5: Confirm the balances
When whatever adjustments that need to be made have been made, return to Step 1 and verify that your totals now match. If there is still a discrepancy, repeat the steps above until all issues are resolved.
Example of account reconciliation
Let’s imagine there’s a business called Mom and Pop’s Soda Shoppe (MPSS), a producer of small-batch, non-alcoholic beverages located in Macon, Georgia. Their flagship offering, Mom’s Pop, is the most popular red-wine flavored soda in the country. While the business lacks sufficient staff and resources to engage in account reconciliation every month, it does perform this crucial task as part of each quarter’s closing.
As the previous year drew to a close, MPSS noted an issue when reconciling its assets-focused general ledger, particularly related to the company’s cash standing. The business had initially compared the total as reported on its year-end bank statement ($307,000) against the balance of the ledger ($330,000), noting a $23,000 discrepancy.
After careful investigation, the beverage company determined that $15,000 of the missing funds were attributable to a last minute payment from one of its customers that had not yet landed in the corporate bank account. Another $1,000 were tied to service charges from a payment kerfuffle caused by a financially-challenged customer back in November. Unfortunately, the remaining $7,000 was due to internal fraud—namely an unscrupulous manager who had embezzled the funds.
Now aware of the dispensation of this $23,000, MPSS adjusted its financial records, added an adjusting journal entry to its ledger, and notified the authorities of the financial impropriety. With these changes now made, the business was able to complete its account reconciliation and quarter closing.
7 causes of account reconciliation discrepancies
As you might imagine, there are all manner of mistakes, interruptions, and other challenges that can cause your general ledger to be out of sync with the outside world. But typically, these anomalies will fall into one of the following categories:
- Doppelgangers: System hiccups or common human error can sometimes cause a transaction to be recorded more than once (e.g., duplicate invoices, duplicate payments)
- Errors: Despite the best efforts of your staff, it’s not uncommon for typos, inaccuracies, or other slip-ups to be included in your financials—particularly for documents created and populated using manual processes
- Fraud: Criminals, both external and internal, would like your money, and they’ve developed quite a few strategies to get it
- Miscalculations: The wrong formula in the wrong place can quickly corrupt your account totals, financial reports, and overall account reconciliation efforts
- Omissions: If an unexpected charge (e.g., a service fee) never makes it to your ledger, don’t be surprised when you have to hunt down this anomaly during the closing period
- Routing: Sometimes the right figures are recorded but they’re put in the wrong general ledger account
- Timing: Within credit-based transactions, the gaps between order, delivery, invoicing, and payment can cause quite a discrepancy when you are trying to properly document assets and liabilities in the accounting period that they occur
Streamline account reconciliation with Invoiced’s automated solutions
The most common reconciliation discrepancies are typically either caused by or at least complicated by human error. These discrepancies can be avoided with the right accounts receivable automation platform — particularly one that includes validation steps within its processes.
Consider our Accounts Receivable Automation software. Its broad integration capabilities let you seamlessly migrate account and financial data between your billing and enterprise resource planning (ERP) solutions, avoiding the potential for transcription errors to interrupt the efficiency of your processes. Similarly, our Automation Builder feature lets you customize and automate your A/R workflows, incorporating validation steps that limit the potential for fraud.
Meanwhile, our Cash Application AI can ensure that payments are correctly attributed to the appropriate ledger accounts while also flagging process anomalies—like duplicate payments—for further review. Thanks to Flywire software’s global payment capabilities, our platform can now manage transactions in over 140 currencies, helping you accelerate payment timelines for customers anywhere.
Ready to streamline your reconciliation processes? Schedule a demo to see what Invoiced can do for you today.
