What is reconciliation?
This article is for educational purposes and does not constitute financial, legal, or tax advice. For specific advice applicable to your business, please contact a professional.
In accounting terms, reconciliation refers to the comparison of two different sets of data to check for discrepancies. A company needs to reconcile accounts in order to ensure that the data in its general ledger is accurate, complete, and consistent.
Reconciliation is commonly used as a check against fraud and human error. If payments are duplicated or changed, it may be a sign of suspicious activity. It can be carried out over a range of time periods, and can occur every year, quarterly, monthly, or even daily.
In line with generally accepted accounting principles (GAAP), reconciliation is usually achieved using double-entry accounting. This is where every transaction requires accounts to create an entry in the credit and debit accounts on the balance sheet.
There are many examples of where reconciliation is used in business finance. Here’s one:
Let’s say an enterprising student sets up a hairdressing business to make money in their free time. They use $1,000 savings from their summer job to buy equipment such as scissors, clippers, hairdryers, dyes, shampoos and conditioners. This capital expenditure enables them to carry out their first job. Their first customer pays $150 for a haircut and dye.
Using the double-entry accounting system, the student credits cash for $1,000 and debits their assets (tools and products) by the same amount. For their first job, they credit $150 in revenue and debits accounts receivable by the same figure.
Both the student’s credits and debits are the same on their financial statement, so we know that they are reconciled.
Alternatively, an account conversion method can be used. Here, much like in personal accounting, records like receipts are compared with the entries in the general ledger. This can be simpler for smaller businesses with limited time and accounting resources.
Different types of account reconciliation
Reconciliation is applied to numerous accounts and relationships within an organization. Common forms of reconciliation include:
bank reconciliation/bank statement reconciliation
balance sheet reconciliation
free cash flow reconciliation
and even personal reconciliation of your individual bank account
However, these fall into two discrete methodologies: documentation review and analytics review.
Documentation review compares the value of every transaction with the amount logged as incoming or outgoing in the corresponding account. An example of this would be comparing retained receipts with a personal or company credit-card statement. If there are purchases made on the card that cannot be linked to a corresponding receipt, this may be an indication of fraud and the company or individual can act accordingly.
The analytics review process involves estimating the amount that should be in the accounts based on historic account activity and purchases. Accounts can be monitored on a regular basis in this way to check for discrepancies from one period to the next.
Frequently asked questions about reconciliation
Why is reconciliation important for businesses?
Reconciliation is very useful in spotting threats to your company’s financial health. Reconciling your company’s various accounts using internal and external records can help you to spot evidence of mistakes. It can also highlight fraud that could render your financial statements inaccurate, as well as impinging on operating cash flow.
How does the reconciliation process work?
There is no single method used for account reconciliation. However, it usually requires the comparison of documentation against account data (documentation review). Alternatively, account activity can be measured against historic precedent to detect fluctuations and discrepancies (analytics review).
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