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Why Is Reconciliation Important in Accounting?

Reviewed by Khadija KhartitFact checked by David RubinReviewed by Khadija KhartitFact checked by David Rubin

Reconciliation is a fundamental accounting process that ensures the actual money spent or earned matches the money leaving or entering an account at the end of a fiscal period.

Reconciling the accounts is a particularly important activity for businesses and individuals because it is an opportunity to check for fraudulent activity and to prevent financial statement errors. Reconciliation is typically done at regular intervals, such as monthly or quarterly, as part of normal accounting procedures.

Key Takeaways:

  • Reconciliation is an accounting process that ensures that the actual amount of money spent matches the amount shown leaving an account at the end of a fiscal period.
  • Individuals and businesses perform reconciliation at regular intervals to check for errors or fraudulent activity.
  • Reconciliation is typically done at regular intervals, such as monthly or quarterly, as part of normal accounting procedures.
  • There are two methods of reconciliation: documentation review and analytics review.
  • For small businesses, the main goal of reconciling your bank statement is to ensure that the recorded balance of your business and the recorded balance of the bank match up.

How Reconciliation Works

At the end of every fiscal month and quarter, it is good practice to reconcile an account. When reconciling an account, businesses and individuals verify that every transaction sums to the correct ending account balance. Generally, there are two ways to reconcile an account: reviewing documents and reviewing analytics.

Documentation Review

The documentation review process compares the amount of each transaction with the amount shown as incoming or outgoing in the corresponding account. For example, suppose a responsible individual retains all of their credit card receipts but notices several new charges on the credit card bill that they do not recognize. Perhaps the charges are small, and the person overlooks them thinking that they are lunch expenses.

At the end of the month, the account holder checks the transactions on the credit card bill with their credit card receipts and discovers that they have no receipts for some of the supposed lunch charges that appear on the bill.

Because the individual is fastidious about keeping receipts, they call the credit card to dispute the amounts. After an investigation, the credit card is found to have been compromised by a criminal who was able to obtain the company’s information and charge the individual’s credit card. The individual is reimbursed for the incorrect charges, the card is canceled, and the fraudulent activity stopped.

Reconciling your bank statement can help you avoid bounced checks (or failing to make electronic payments) to partners and suppliers.

Analytics Review

The analytics review approach can also reveal fraudulent activity or balance sheet errors. In this case, businesses estimate the amount that should be in the accounts based on previous account activity levels.

For example, real estate investment company ABC purchases approximately five buildings per fiscal year based on previous activity levels. The company reconciles its accounts every year to check for any discrepancies. This year, the estimated amount of the expected account balance is off by a significant amount.

Based on previous accounting activity and purchases, the estimate for accounts payable should be $5 million. The actual accounts payable balance is $48 million for the year, which is a major discrepancy in the balance sheet.

The accountant of company ABC reviews the balance sheet and finds that the bookkeeper entered an extra zero at the end of its accounts payable by accident. The accountant adjusts the accounts payable to $4.8 million, which is the approximate amount of the estimated accounts payable.

Reasons To Reconcile Bank Statements

Bank reconciliation is a very important task for any company. For small businesses, the main goal of reconciling your bank statement is to ensure that the recorded balance of your business and the recorded balance of the bank match up. It also helps you manage and monitor your cash flow.

Here are a few other reasons why businesses should reconcile their bank statement each month:

  • Identify fraud: Signs of fraud should be your first priority when reconciling transactions in your bank account. For example, were legitimate checks that you issued duplicated or changed? Were checks issued without authorization? Were there unauthorized transfers out of the account? Does the account have any missing deposits?
  • Validate data entry: Reconciling your bank statements allows you to identify any irregularities, such as entering wrong amounts, duplicating entries, and other data entry errors.
  • Confirm the accuracy of financial statements: It’s rare, but banks can make mistakes. Reconciling your bank statements is one way to confirm that your financial statement matches your bank’s statement.
  • Accurate tax reporting: In order to generate a correct tax return, you must reconcile your bank statements.
  • Controls theft: Reconciling your bank statements can also prevent employees or other people from stealing from your company.

In general, reconciling bank statements can help you identify any unusual transactions that might be caused by fraud or accounting errors. This process can be done formally or informally.

This is true for both businesses and individuals, who should both verify every transaction individually, making sure the amounts match perfectly, and, if not, making note of any differences that need further investigation.

Consequences of Not Reconciling Your Bank Statement

If there are any differences between the accounts and the amounts, these differences need to be explained. Reconciling your bank statements allows you to identify problems before they get out of hand.

Most importantly, reconciling your bank statements helps you catch fraud before it’s too late. It’s important to keep in mind that consumers have more protections under federal law in terms of their bank accounts than businesses. So it is especially important for businesses to detect any fraudulent or suspicious activity early on—they cannot always count on the bank to cover fraud or errors in their account.

The Bottom Line

Reconciling your bank statements simply means comparing your internal financial records against the records provided to you by your bank. This process is important because it ensures that you can identify any unusual transactions caused by fraud or accounting errors. As a business, the practice can also help you manage your cash flow and spot any inefficiencies.

Bank Statement Reconciliation FAQs

What Are the Steps To Reconcile a Bank Statement?

The first step in bank reconciliation is to compare your business’s record of transactions and balances to your monthly bank statement. Make sure that you verify every transaction individually; if the amounts do not exactly match, those differences will need further investigation.

In the event that something doesn’t match, you should follow a couple of different steps. First, there are some obvious reasons why there might be discrepancies in your account. If you’ve written a check to a vendor and reduced your account balance in your internal systems accordingly, your bank might show a higher balance until the check hits your account. Similarly, if you were expecting an electronic payment in one month, but it didn’t actually clear until a day before or after the end of the month, this could cause a discrepancy.

True signs of fraud include unauthorized checks and missing deposits.

When Is the Best Time To Reconcile a Bank Statement?

Reconciling your bank statements at least monthly is recommended. Some businesses with a high volume or those that work in industries where the risk of fraud is high may reconcile their bank statements more often (sometimes even daily).

What Appears on a Bank Reconciliation Statement?

Some businesses create a bank reconciliation statement to document that they regularly reconcile accounts. This document summarizes banking and business activity, reconciling an entity’s bank account with its financial records. Bank reconciliation statements confirm that payments have been processed and cash collections have been deposited into a bank account.

Read the original article on Investopedia.

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