Financial reconciliation

by Admin
Updated: August 15, 2020

Financial reconciliation compares actual with expected figures to protect against errors and fraud

Financial reconciliation is the process of cross-checking actual and expected figures to increase confidence that the accounting records are an accurate representation of business performance. It helps protect against errors and fraud.

There are no generally accepted accounting principles (GAAP) relating to reconciliation and little legal requirement to include it (section 404 of Sarbanes-Oxley Act of 2002, applies to U.S. public companies). However, I wouldn’t trust the accounts of any business that doesn’t use it.

My mother taught me basic bookkeeping when I was very young. I have practiced reconciliation of my personal finances ever since I first had a bank account and in my businesses ever since I first had a business. It seems strange to me that not everyone does it.

Types of reconciliation

Conversion reconciliation compares details of actual transactions with the ledger used to record them. For example, review the actual receipts to verify an expense claim.

Internal reconciliation compares figures produced within a single organization. For example, income minus expenses should equal the change in the cash flow statement.

External reconciliation compares figures produced by different organizations. For example, if you maintain an ongoing record of what has been paid into & out of the bank and the bank sends you a statement, you should be able to agree them.

Discrepancies

When the figures don’t agree it’s usually caused by #1-3 of the following. If it’s not #1, #2 or #3, it might not be as extreme as fraud but it needs to be investigated without delay:

  1. Normal adjustments - when an allowance has been made for a transaction the exact amount of which is only known at the time of a report, e.g. interest on a loan statement.
  2. System errors - when an automatic process applies a charge incorrectly, e.g. a fee that should have been adjusted or a rounding error from a calculation.
  3. Input errors - when numbers have been recorded incorrectly either by manually typing the wrong digits or incorrect OCR (Optical Character Recognition).
  4. Fraud - when unauthorized charges or withdrawals have been made.

Example

The Sandbox example in the article about Spreadsheets shows a running total that ends up at -8. A reconciliation calculation adds up the total expenses (-20-120-18-20 = -178) and deducts this total from the starting amount (170) to arrive at the same figure (-8).

Whenever building a spreadsheet in which a total can be calculated in two ways like this, I recommend doing both and subtracting one from the other in a “reconciliation” cell that should always equal 0.

Practical considerations

Reconciliation can be an arduous process to do manually. It can be automated to some extent, however, part of the ability to recognize discrepancies for what they really are requires human involvement and the greater the familiarity with the accounts, the easier this involvement will be.

More info

“What Is Financial Reconciliation?” at reference.com

Financial reconciliation at investopedia.com

“Why is Reconciliation of Financial Statements Important?” at americanexpress.com

Internal links

Algebra Spreadsheets Understanding debt Go to Articles
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