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 orcooking the books.
Key Takeaways
- Companies use account reconciliation to prevent balance sheet errors on their financial accounts, check for fraud, and ensure transactions are appropriately charged.
- In double-entry accounting, each transaction is posted as both a debit and a credit.
- Individuals can use account reconciliation to check the accuracy of their bank and credit card account statements.
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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.
| ABC Lawn Care | ||
|---|---|---|
| Account | Debit | Credit |
| Cash | $2,000 | |
| Equipment | $2,000 | |
| Revenue | $500 | |
| Accounts Receivable | $500 | |
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.
The account conversion method is where business records such as receipts or canceled checks are simply compared with the entries in the general ledger. This is similar to personal account reconciliation.
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.
How Often Should a Business Reconcile Its Accounts?
Businesses are generally advised to reconcile their accounts at least monthly, but they can do so as often as they wish. Businesses that follow a risk-based approach to reconciliation will reconcile certain accounts more frequently than others, based on their greater likelihood of error.
How Often Should Individuals Reconcile Their Bank and Credit Card Statements?
Individuals should reconcile bank and credit card statements frequently to check for erroneous or fraudulent transactions. If a personal ATM or debit card was involved in a fraudulent transaction, an individual's liability is limited to $50 if they notify the bank within two business days, but rises to $500 after two days and up to 60 calendar days. After 60 days, the Federal Trade Commission (FTC) notes, they will be liable for "All the money taken from your ATM/debit card account, and possibly more—for example, money in accounts linked to your debit account."
What Is Single-Entry Bookkeeping?
In single-entry bookkeeping, every transaction is recorded just once rather than twice, as in double-entry bookkeeping, as either income or an expense. Single-entry bookkeeping is less complicated than double-entry and may be adequate for smaller businesses. Companies with single-entry bookkeeping systems can perform a form of reconciliation by comparing invoices, receipts, and other documentation against the entries in their books.
The Bottom Line
Reconciliation serves an important purpose for businesses and individuals in preventing accounting errors and reducing the possibility of fraud.
Article Sources
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Journal of Accountancy. "6 Tips for Reconciliations."
Federal Trade Commission Consumer Advice. "Lost or Stolen Credit, ATM, and Debit Cards."
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