What Is Account Reconciliation?

What Is Account Reconciliation?

Reconciliation is an accounting procedure that compares two sets of records to check that the figures are correct and in agreement and confirms that accounts in a general ledger are consistent and complete. In double-entry accounting, each transaction is posted as both a debit and a credit.

Businesses and individuals may use account reconciliation daily, monthly, quarterly, or annually. Unexplained or mysterious discrepancies may warn of fraud or cooking the books.

Bookkeeping

There is no standard way to perform an account reconciliation. However, generally accepted accounting principles (GAAP) require double-entry bookkeeping—where a transaction is entered into the general ledger in two places. Every financial transaction is posted as a credit and a debit. When a business makes a sale, it debits either cash or accounts receivable on the balance sheet and credits sales revenue on the income statement. In the reconciliation, debits and credits should balance out to zero.

Banks and retailers can make errors when counting money and issuing cash to customers as change. Variances between expected and actual amounts are called "cash-over-short." This variance account is kept and reconciled as part of the company's income statement.

Double-Entry Accounting Example

ABC is a lawn care company that purchases $2,000 worth of equipment. The equipment is used to complete ABC's first lawn-care project worth $500. Using a double-entry accounting system, as shown below, ABC credits cash for $2,000 and debits assets, which is the equipment, by the same amount. For the first job, ABC credits $500 in revenue and debits the same amount for accounts receivable. Both credits and debits are reconciled and equal the same amount.

Types of Reconciliation

• Individuals: Many people reconcile their checkbooks and credit card accounts by comparing their written checks, debit card receipts, and credit card receipts with their bank and credit card statements. This type of account reconciliation makes it possible to check for errors and detect any possible fraud. When an account is reconciled, the statement's transactions should match the account holder's records.
• Businesses: Companies reconcile their accounts to prevent balance sheet errors, check for possible fraud, and avoid adverse opinions from auditors. Companies generally perform balance sheet reconciliations each month, reviewing all balance sheet accounts to make sure that transactions are appropriately booked into the correct general ledger account. It may be necessary to adjust journal entries if they were booked incorrectly.

Direct and Indirect Cash Flow

Some reconciliations are necessary to ensure that cash inflows and outflows concur between the income statement, balance sheet, and cash flow statement. Cash flow can be calculated through either a direct method or an indirect method. GAAP requires that if the direct method is used, the company must reconcile cash flows to the income statement and balance sheet.

If the indirect method is used, the cash flow from the operations section is already presented as a reconciliation of the three financial statements. Other reconciliations turn non-GAAP measures, such as earnings before interest, taxes, depreciation, and amortization (EBITDA), into their GAAP-approved counterparts.

The Bottom Line

Reconciliation serves an important purpose for businesses and individuals in preventing accounting errors and reducing the possibility of fraud.