In the financial world, reconciliation is an accounting process ensuring that two records agree. It’s a general practice for small and large companies to create their balance sheets at the end of the fiscal year.
Balance sheets are documents denoting the financial state of businesses at the end of each calendar year. Reconciliation is used to verify that the money leaving an account matches the actual sum spent. This is done by ensuring that the balance’s assets and liabilities match at the end of a particular accounting period (trimester, semi-annual, annual).
Definition
According to the Oxford Dictionary, there are two definitions of accounting.
- “A procedure for confirming that the balance in a chequebook matches the corresponding bank statement. This is normally done by preparing a bank reconciliation statement.”
- “A procedure for confirming the reliability of a company’s accounting records by regularly comparing [balances of transactions]. An account reconciliation may be prepared daily, monthly, or annually.”
The Generally Accepted Accounting Principles (GAAP) are a set of accounting standards, procedures, and principles organisations use to draft their financial statements. GAAP clearly states that account reconciliation aims to ensure consistency and accuracy in financial accounts. It ensures all cash inlays and outlays match between income statements and cashflow statements.
Reconciliation is a process that benefits companies as it helps them avoid balance sheet errors, which may have severe consequences. Furthermore, reconciliation can aid fraud detection, enabling organisations to instil financial integrity.
Other benefits of reconciliation are:
- Mitigates errors made by financial institutions
- Detects fraudulent withdraws from accounts
- Create an overall spending image
- Assesses if a company is overspending on fees
Account reconciliation is a vital internal control procedure. Public companies are obligated to execute it as part of their financial close.
Methods of Reconciliation
Regular and ongoing reconciliation must be performed for all balance sheet accounts to ensure the reliability of financial records. Robust reconciliation processes improve the accuracy of financial reports, enabling organisations to publish their financial statements without worry.
There are two ways to execute account reconciliation:
Documentation review is the most common method of account reconciliation. It’s a formalised technique of data collection involving the scrutiny of existing documents and records. This method is often executed with the assistance of accounting software.
Analytic review is a method that involves the comparison of financial and non-financial information. For example, historical activity can be used to estimate the transactions that should be in an account.
Regardless of the method used, identified mistakes should be corrected and adjusted for the account balance to match the supporting information.
Current Practice
In theory, there are no specific accounting standards for account reconciliation as there are no particular regulations mentioned by the International Account Standards (IAS), the Institute of Chartered Accounts in England and Wales (ICAEW), and the HM Revenue & Customers (HMRC). However, GAAP provides various rules for balancing different types of accounts. According to GAAP, account reconciliation is executed via double-entry accounting or account conversion.
Accounting Software
Accounting Software is arguably companies’ most efficient tool to carry out reconciliation procedures. It minimises errors and enables making decisions based on accurate financial information.
Manual vs Automated Reconciliation
In 2002, the Sarbanes-Oxley Act (SOX) emphasised that U.S. businesses need balance sheet reconciliation to be included within their own procedures instead of relying on external auditors. The legislation was enacted to shield the general public and shareholders from fraudulent practices and accounting errors. It also aimed to improve the accuracy of corporate disclosures.
SOX and similar laws worldwide have increased the pressure on companies to comply with account reconciliation. As a result, the accounting industry sought ways to automate the process, as manual reviews are notoriously strenuous.
By using software, small and large businesses can more easily automate their reconciliation processes, saving both time and expenses related to manual labour. As late as 2012, approximately 90% of companies used Microsoft Excel spreadsheets to reconcile their account manually.
Investing in automated reconciliation increases efficiency and lowers the chance of human errors but also offers centralised control, improved monitoring, augmented data security, reduced audit risks & costs, and improved accessibility.
