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Reconciliation

Matching internal records of transactions against external sources

What is Reconciliation?

Reconciliation is the process of matching transactions that have been recorded internally against monthly statements from external sources such as banks to see if there are differences in the records.

 

Reconciliation

 

For example, the internal record of cash receipts and disbursements can be compared to the bank statement to see if the records agree with each other. The process of reconciliation confirms that the amount leaving the account is spent properly and that the two are balanced at the end of the accounting period.

 

The Reconciliation Process

In most organizations, the reconciliation process is usually automated, using accounting software. However, since some transactions may not be captured in the system, human involvement is required to identify such unexplained differences. The basic steps involved when reconciling transactions include the following:

 

1. Compare internal cash register to the bank statement

The first step is to compare transactions in the internal register and the bank account to see if the payment and deposit transactions match in both records. Identify any transactions in the bank statement that are not backed up by any evidence.

 

2. Identify payments recorded in the internal cash register and not in the bank statement (and vice-versa)

It is possible to have certain transactions that have been recorded as paid in the internal cash register but that do not appear as paid in the bank statement. The transactions should be deducted from the bank statement balance. An example of such a transaction is checks issued but that have yet to be cleared by the bank.

A company may issue a check and record the transaction as a cash deduction in the cash register, but it may take some time before the check is presented to the bank. In such an instance, the transaction does not appear in the bank statement until the check has been presented and accepted by the bank.

Conversely, identify any charges appearing in the bank statement but that have not been captured in the internal cash register. Some of the possible charges include ATM transaction charges, check-printing fees, overdrafts, bank interest, etc. The charges have already been recorded by the bank, but the company does not know about them until the bank statement has been received.

 

3. Confirm that cash receipts and deposits are recorded in the cash register and bank statement

The company should ensure that any money coming into the company is recorded in both the cash register and bank statement. If there are receipts recorded in the internal register and missing in the bank statement, add the transactions to the bank statement. Consequently, any transactions recorded in the bank statement and missing in the cash register should be added to the register.

 

4. Watch out for bank errors

Sometimes, errors may occur in the bank statement, thus, producing some differences between the internal cash register and bank statement. Possible errors include duplication errors, ommissions, transposition, and incorrect recording of transactions.

The errors should be added, subtracted, or modified on the bank statement balance to reflect the right amount. Once the errors have been identified, the bank should be notified to correct the error on their end and generate an adjusted bank statement.

 

5. Balance both records

The objective of doing reconciliations to make sure that the internal cash register agrees with the bank statement. Once any differences have been identified and rectified, both internal and external records should be equal in order to demonstrate good financial health.

 

Reconciliation Methods

Reconciliation must be performed on a regular and continuous basis on all balance sheet accounts as a way of ensuring the integrity of financial records. This helps uncover omissions, duplication, theft, and fraudulent transactions.

There are two ways of reconciling financial records, as follows:

 

1. Document review

The document review method involves reviewing existing transactions or documents to make sure that the amount recorded is the amount that was actually spent. The review is mostly carried out using accounting software.

For example, a company may review its receipts to identify any discrepancies. While scrutinizing the records, the company finds that the rental expenses for its premises were double-charged. The company lodges a complaint with the landlord and is reimbursed the overcharged amount. In the absence of such a review, the company would’ve lost money due to a double-charge.

 

2. Analytics Review

Analytics review uses previous account activity levels or historical activity to estimate the amount that should be recorded in the account. It looks at the cash account or bank statement to identify any irregularity, balance sheet errors, or fraudulent activity.

For example, Company XYZ is an investment fund that acquires at least three to five start-up companies each year. For the current year, the company estimates that annual revenue will be $100 million, based on its historical account activity. The company’s current revenue is $9 million, which is way too low compared to the company’s projection.

After scrutinizing the account, the accountant detects an accounting error that omitted a zero when recording entries. Rectifying the error brings the current revenue to $90 million, which is relatively close to the projection.

 

Final Word

Reconciliation ensures that accounting records are accurate, by detecting bookkeeping errors and fraudulent transactions. The differences may sometimes be acceptable due to the timing of payments and deposits, but any unexplained differences may point to potential theft or misuse of funds.

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Analysis of Financial Statements
  • Bank Reconciliation Template
  • Cash Larceny
  • Chart of Accounts

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