What Is Reconciliation in Accounting?

Reconciliation in accounting is a practice that safeguards your business against the pitfalls of errors and fraudulent activities in financial statements. Regardless of whether your accounting system consists of a comprehensive ledger or simply a collection of invoices, your business is at risk. According to reports, nearly 1 in 10 fraud cases come from financial statements. This loss can greatly affect your business and might even complicate future growth.

To counter these risks, reconciliation is considered a crucial defense mechanism. It is designed to detect and correct any accidental errors or intentional misrepresentations in your financial records. 

In this blog, we'll explore what reconciliation is in accounting, how you can calculate it, and tips to optimize it.

What Is Account Reconciliation?

In accounting, reconciliation of accounts is a comparison of records to ensure they're identical. In turn, this allows you to notice errors and ensure the completeness of your ledger.

Furthermore, this accounting practice has multiple uses, such as identifying fraud in your business or even spotting trends in discrepancies in your ledger. 

Types of Reconciliation in Accounting

You can use reconciliation in different scenarios, and each has its own procedure due to the formats different individuals and companies use. In particular, you're likely to encounter the following types of reconciliation:

1. Bank Reconciliation

Bank reconciliation compares transactions in your statements and the ledgers you keep. It allows you to notice discrepancies between how much you receive/pay through your bank and what your staff has acknowledged in your ledger.

2. Intercompany Reconciliation

Intercompany reconciliation compares the ledgers of smaller divisions and subsidiaries to verify that the records of the transactions between them are accurate. 

3. Credit and Debit Card Reconciliation

You can use credit and/or debit card reconciliation to verify that your ledger matches credit/debit bank statements.

4. Inventory Reconciliation

With inventory reconciliation, you can check the completeness and accuracy of your inventory stock records. It works by comparing the records of your inventory balances.

What Does Reconciling an Account Involve?

In general, there are three ways of doing reconciliation. The most commonly accepted one comes from the generally accepted accounting principles. It requires you to use double entries, which in your ledger should balance out to zero. In particular, you need this method of reconciliation if you're going to compare your accounts receivable/payable or your inventory.

Alternatively, you can use single-entry reconciliation. This is a much simpler method that only has items listed once as an expense or an income. When you have these kinds of records, you need to compare your ledger to external records such as a bank statement or an invoice.

The third way you can reconcile your accounts is an analytical review, which uses estimates. With this method, you'll compare your records to your past accounts to find out if your current records are out of the norm. This is particularly useful when you're trying to discover if your discrepancies are due to theft as opposed to a mistake.

To better understand how reconciliation works in practice, let's explore an example of reconciliation account. Let's say that you own a boutique with the following double-entry ledger:

Since the past range was $82 – $98, the current $698 is clearly out of the norm, which could be a sign of fraud.

Why Account Reconciliation Is Crucial for Your Business

Depending on the region, laws may require your business to do periodic reconciliation using specific methods. For example, in the USA, public companies must reconcile their financial records using the US generally accepted accounting principles. 

Nevertheless, if your business is not subject to such laws, you should still use reconciliation because it has these benefits:

• Discrepancy Explanation: You can use reconciliation to find where a discrepancy in your balance comes from. In particular, if a periodic ledger shows missing payments, you can reconcile it with the records of the next period if the payment was simply late.

• Fraud/Theft Identification: By comparing records, you can find inexplicable balances, which can be a sign of criminal activity.

• Mistake Correction: Using official records such as bank statements, you can correct mistakes in your ledgers and avoid legal penalties.

• Informed Decision Making: Reconciliation offers you more complete and accurate ledgers, which leads to an accurate understanding of your financial situation. Therefore, you can make better decisions about future expenses.

• Increased Trust: When you reconcile your accounts, your stakeholders will see that you care about having accurate accounts and identifying fraudulent behavior.

Tips to Reconcile Your Accounts

Now that you know what reconciliation is in accounting, here are ways you can perfect your reconciliation procedure:

• Reconcile Regularly: Even if you have a small company, you should conduct reconciliation monthly, if not more often.

• Keep Detailed Documentation: You should keep detailed ledgers and file all relevant records.

• Use Separate Accountants: The employee who creates the first ledger should be different from the accountant who reconciles it. Therefore, employees are less likely to hide fraudulent behavior successfully.

• Create a Reconciliation Protocol: This protocol should have clear steps, encourage communication and discrepancy reporting, and automation to reduce human error.

Conclusion

Now that you know that reconciliation in accounting is a way of verifying the accuracy of your financial records, the most common method is double-entry. However, you can also compare your single-entry ledger to external financial records. Alternatively, you could use your past accounts to check if your current accounts are within your norm or if there was fraud or theft. 

This practice may not be a must for your company. However, it brings many benefits, such as increased trust and better decision-making.