What Is Reconciliation?

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. Reconciliating 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.
  • There are two methods of reconciliation: documentation review and analytics review.

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, for example.

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.

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.