An account reconciliation is the actions taken to prove that an account balance is valid. The concept is most commonly associated with the bank reconciliation, where a company’s recorded cash balance is compared to the bank’s end-of-month bank statement and adjusted as necessary to make the two balances match. It is also a key task to be completed before an organization’s books are audited at the end of each year.
When you reconcile an account, you are proving that the transactions that sum to the ending account balance for the account are correct. This means you can prove one of the following two assertions:
Auditors want to see an account reconciliation for larger accounts, though reconciliations should be performed even in the absence of an auditor request, since this is a good accounting practice that leads to more accurate financial statements.
An account reconciliation is usually done for all asset, liability, and equity accounts, since their account balances may continue on for many years. It is less common to reconcile a revenue or expense account, since the account balances are flushed out at the end of each fiscal year. However, this may be done simply to verify that transactions were recorded in the correct account; a reconciliation may reveal that a transaction should be shifted into a different account. Usually, this means moving an expense into a different account.
There are two ways to reconcile an account, which are the documentation review and the analytics review. They are both described below.
A documentation review is the most common form of account reconciliation, and the one that auditors prefer. Under this method, call up the account detail in the accounting software, and review the appropriateness of each transaction listed in the account. For example, if you are reconciling the trade accounts receivable account, the balance in the account should exactly match the total of the open accounts receivable report.
Under an analytics review, create an estimate of what should be in the account, based on historical activity levels or some other metric. For example, estimate the amount of expected bad debts in the open accounts receivable account, and see if this approximately matches the balance in the allowance for doubtful accounts contra account.
If the account reconciliation reveals that an account balance is not correct, adjust the account balance to match the supporting detail. By doing so, you can always justify the account balances. Also, always retain the reconciliation detail for each account, not only as proof, but also so that it can be used as the starting point for account reconciliations in subsequent periods.