Account Reconciliation: Process, Challenges, Best Practices

Introduction

As the end of the month approaches, accountants’ can often be found buried deep in financial books and countless receipts and invoices. This is because they are busy reconciling financial records to check for any errors or anomalies in the company’s financial entries. 

Account reconciliation is a fundamental step in the financial close and sets the basis for closing the accounts. But given the large volumes of data, matching records or reconciliation can be a strenuous activity. 

In this blog, we’ll deep dive into what account reconciliation is, its process, why reconciling accounts is important, and how automation and AI are transforming the traditional reconciliation process enhancing efficiency and accuracy.

What is Account Reconciliation?

Account reconciliation is the process of cross-checking a company’s financial records, like the general ledger (GL) and sub-ledgers (SL), with external documents, such as bank statements. Its purpose is to ensure accuracy and consistency of financial data, which is vital for informed decision-making and maintaining financial integrity.

It is a general practice for businesses to create their balance sheet at the end of the financial year as it denotes the state of finances for that period. However, you need to record financial transactions throughout the year in the general ledger to be able to put together the balance sheet.

While the entries in the general ledger are based on the facts of the moment, they may not always be accurate. When you receive a check from a customer, you may have recorded it as paid. But there are chances that the check could have bounced due to numerous reasons. Or the payment you made to supplier A went into the accounts of supplier B due to a clerical error.

Therefore, companies reconcile their accounts at the end of the month, quarter, or year. The account reconciliation spreadsheet is used  to create accurate financial statements, ensuring the company’s financial integrity and compliance.

Types of Account Reconciliation

Here are some of the most common types of account reconciliations that are crucial for maintaining accurate financial records:

1. Bank account reconciliation: This is considered to be one of the most common and important types of account reconciliation as it helps with cash flow management. It involves comparing a company’s bank statements with its accounting records to ensure all transactions are accurately recorded. 
2. Accounts receivable reconciliation: This involves reconciling the amounts that customers owe a company for goods or services with the accounting records. This ensures that all payments are received and correctly recorded in the accounting system.
3. Accounts payable reconciliation: This involves reconciling the amounts that a company owes to vendors or suppliers with the accounting records. This ensures that all payments are made and correctly recorded in the accounting system.
4. Inventory reconciliation: This involves reconciling the physical inventory count with the accounting records to ensure that all inventory is accounted for and correctly valued.
5. Payroll reconciliation: This involves reconciling payroll records with bank statements and tax filings to ensure that all payroll transactions are accurately recorded and all taxes are correctly withheld and paid.
6. Credit card reconciliation: This involves comparing a company’s credit card statements with its accounting records to ensure that all transactions are accurately recorded and any discrepancies are identified and resolved.
7. Fixed asset reconciliation: This involves reconciling the physical assets owned by a company with the accounting records to ensure that all assets are accounted for and correctly valued.
8. Expense reconciliation: This involves reconciling expense reports and receipts with accounting records to ensure that all expenses are accurately recorded and any discrepancies are identified and resolved.

What are the Steps Involved in Account Reconciliation?

The reconciliation process for different accounts may vary depending on the type of account. The following are the major steps involved in account reconciliation:

1. Identify accounts: The first and foremost step in the account reconciliation process is the identification of accounts that need to be reconciled. For example, a company might need to reconcile accounts, including accounts receivables, expense accounts, bank accounts etc. 
2. Collect information: Once the accounts are identified, all the necessary documents need to be gathered. If, for instance, the accounts payables account needs to be reconciled, you should have all the vendor information and invoices. 
3. Compare balances: The next step is to compare transactions in the company’s accounting records (general ledger) with external financial statements (bank statements if bank accounts are being reconciled). The accountant will check every transaction in the account being reconciled to ensure entries are recorded correctly. 
4. Identify discrepancies: While comparing transactions, the accountant may come across some errors in journal entries. For example, omitted transactions, delayed payments because of uncleared checks, or errors while recording a transaction. 
5. Check inconsistencies: If the accountant finds any errors or anomalies, they will then investigate the reason behind erroneous entries. For example, figuring out if the balances on two records aren’t matching because of omitted transactions or timing issues. 
6. Adjust entries: Next, the accountant will need to make adjusting journal entries to correct all the errors and discrepancies. For instance, if there were any unrecorded transactions, they would need to account for those in the journals. Similarly, if a transaction was recorded incorrectly, that will need to be corrected. 
7. Document reconciliation: Once the entries are adjusted, the next step is to document the entire reconciliation process. This step will include documenting all the inconsistencies and the adjustments made to balance the accounts. Documenting reconciliation is important because companies need these records in case of an audit or for future references. 
8. Get reconciliation reviewed and approved: The next step is to get approvals from the relevant stakeholders for all the adjustments made to balance the journal entries. The stakeholders will also review the changes for accuracy and to ensure all the adjustments needed are made. 
9. Record keeping: It’s important to maintain records of all the reconciliations done during the year for future reference or in case an audit happens. 
10. Repeat the process regularly: Account reconciliation is an ongoing process, so it’s important to repeat these steps regularly to ensure the accuracy and integrity of your financial records. The frequency of reconciliation may vary depending on the size and complexity of business, but it’s generally recommended to reconcile accounts at least once a month.

8 Common Examples of Account Reconciliation

To understand the reconciliation process better for different accounts, let’s take a look at a few examples of different accounts:

1. The cash balance in the ledger and bank account

   Often, the cash balance in the book of accounts and the bank accounts may not match. This could be due to many reasons, like missed entries, bounced payments, charges incurred, interest accrued, and much more.

2. Accounts payable

    Accounts payable is the money a company owes to suppliers, vendors, and employees. The production and delivery of goods or services that the company deals with depend on smooth handling of accounts payables. It is essential to reconcile the balance of accounts payables due to short payments, disputes, early payment discounts, and much more. This ensures smooth operations, good supplier relations, market reputation, and much more.

3. Accounts receivable

   Accounts receivable is the amount that your customers owe you for the goods sold or services provided. You will need to give special importance to reconciling accounts receivables to ensure steady cash flow and good customer relations. You will need to check the bank and ledger balances to ensure that there are no short payments, deductions, disputes, and to stop credit facilities for defaulting customers.

4. Expenses paid in advance

   Companies often pay for some expenses in advance, especially when they are regular purchases. However, accounts need to be reconciled to ensure that goods or services were received or delivered as per the contract. Reconciliation at this time also helps evaluate if the expense needs to be continued or not.

5. Accrued liabilities

    In many companies, a holiday period is often given to customers during which the amounts due can be accrued as a liability. However, these sorts of arrangements need to be revisited, evaluated, and acted upon if required.

6. Inter-company transactions

   In many organizations, there are subsidiaries, group companies, and so on. In such a situation, there can be inter-company deposits made, depending on the requirements of different companies. However, since each of the group companies has its own legal entity and the need to maintain separate books of accounts, they need to  ensure that all cash balances, liabilities, and assets are updated. They should also conduct periodic account reconciliation.

7. Assets sold and bought

   Most companies have numerous assets, including immovable property, machinery, inventory, cash assets, and more. Over time, these assets can be sold or written off according to their stage in the lifecycle or due to depreciation. Accounts reconciliation helps take stock of the assets that a company has and enables the balance sheet to reflect its true value.

8. Investments

   Companies tend to invest in some projects for taxation purposes, or for many other reasons. Periodic account reconciliation will ensure that the true value of the investments is reflected in the book of accounts.

Why is Account Reconciliation Important?

Account reconciliation is necessary to ensure an organization’s overall financial integrity. Every accounting team strives to consistently complete its reconciliation process efficiently and without errors. This is because reconciliations, when handled poorly, can snowball into larger issues later in the financial close. 

Thus, it becomes important that organizations establish a strong system of controls within the accounting department to successfully maintain the company’s financial records’ accuracy, integrity, and compliance with no errors. Some of the key benefits of account reconciliation are:

1. Improved accuracy and cash flow:Account reconciliation helps organizations proactively identify and resolve discrepancies, such as unrecorded payments and overpayments, in their financial records. This timely identification and resolution of risks helps organizations improve their cash flow, get paid for outstanding payments, and have accurate and up-to-date financial records.
2. Fraud prevention: Matching the company’s accounting records to external sources, such as bank statements, leads to detecting possible fraud, such as unauthorized transactions or embezzlement.
3. Compliance: Many regulatory bodies like Sarbanes-Oxley Act (SOX), MiFID II and Basel III require organizations to perform regular account reconciliations to ensure compliance with financial reporting standards. Failure to comply with these standards can result in penalties and legal action. Regular account reconciliation helps ensure the organization complies with all the regulations.
4. Better decision-making: Accurate and up-to-date financial records help both internal and external stakeholders make better and more informed decisions and give an overview of the company’s financial health, allowing better and more confident decision-making.

How Often Should Account Reconciliations Be Performed?

Since accounts reconciliation is integral to ensuring proper management of the cash flow and other assets of the company, we need to look at when and how often accounts reconciliation should be carried out.

To ensure accuracy of accounts reconciliation, it is critical to segregate the different  types of reconciliation:

1. Cash and bank balance: This reconciliation should be done every time you get a statement from the bank to ensure that you are accounting for differences at the earliest.
2. Accounts receivable and payable: In most instances, these follow a typical cycle from purchase or sales to payment or receipt of payment. You can either follow the same cycle (for instance, a 45-day credit cycle can follow a 45-day reconciliation cycle) or make the process more efficient and carry out reconciliation once every two weeks. One of the best ways to mitigate the issue of receivable reconciliation is to automate the entire AR process.
3. Advance payments and accrued liabilities: To reconcile these payments and accrued liabilities, you can follow the same cadence as the payments themselves to ensure that all details are current.
4. Other categories: For inter-company transactions, assets bought and sold, and investments, it is best to carry out accounts reconciliation once every 3 months.

Common Challenges in Account Reconciliations and How to Solve Them

While the discrepancies that need to be addressed through account reconciliation are vast, we list here some of the most common ones:

1. Ledger and bank balances don’t match

   Here’s how such situations can be corrected:

   • Check for time differences or bank holidays causing delays in the amount showing up in the account.
   • Look for check-based errors like the number in figures and words not matching, wrong date, or signature errors.
   • Find out if the customer has raised a dispute but the finance department is not aware of it because the sales department has not updated them yet.
   • Consider automation of the receivables process to ensure that all the parties concerned have access to updated information.
2. Physical inventory does not match with inventory records

   Here’s how such situations can be corrected:

   • Make sure that the store management team does an entry every time they dispatch goods to customers.
   • Carry out periodical inventory checks physically to ensure that all the damaged and defective goods are accounted for and records updated about any exchanges or replacements.
   • Invest in a centralized system that ensures that inventory records are updated in real-time.
3. Actual customer credit balance is lesser than accounted for

   Here’s how such situations can be corrected:

   • Check with the sales team if they have received further orders from the same customer and this has not been updated in the system.
   • Ensure that a credit onboarding of customers (even existing ones) is a part of the process before agreeing on sales with delayed payments.
   • Have an automated credit application in place to ensure that the credit terms are agreed upon based on the latest credit and other information.
4. Amount paid by the customer is not completely reflecting in the bank

   Here’s how such situations can be corrected:

   • Check if the customer issued a stop payment because they were not happy with the quality or other aspects of the goods or services they received.
   • Delve deeper to find out if there were some charges that were imposed by the bank which you failed to account for in your entries.
5. Wrong amount was recorded in the ledgers

   Here’s how such situations can be corrected:

   • Look for early payment rebates that were agreed upon by both parties, which you did not consider while recording the amount.
   • Check for fees or penalties that you did not think about while making the entry.

Challenges With Manual Account Reconciliation Process

Spreadsheets have been the backbone of finance and accounting teams for decades. Despite technology changing and evolving over the years, finance professionals continue to rely heavily on outdated tools to manage the intricate and detailed reconciliation process required for the modern-day organizations. And because of this reliance on spreadsheets, organizations find themselves buried in a mountain of work while spending an inordinate amount of time and resources to maintain the highly manual process. Let us understand the challenges associated with the manual account reconciliation process:

1. Inefficient processes due to their time-consuming nature:Manual account reconciliation can be time-consuming, especially for businesses with large volumes of transactions. To add to the problem, some accounts require weekly or daily reconciliation, but due to staffing constraints, these reconciliations are often delayed until month-end close.. As organizations expand, the time and effort required for successful reconciliation also grows.
2. Inaccurate reporting due to manual intervention: Manual account reconciliation involves comparing large amounts of data across multiple systems, which leaves significant room for human error, especially when teams are involved in the month-end close process. 
3. Lack of standardization: Manual methods lack standardization of reconciliation processes. This leads to every department and subsidiaries performing account reconciliation differently, leading to inconsistencies and errors. 
4. Increase in potential risk and compliance issues: Traditional account reconciliation processes solely look at matching the fields and often ignore the patterns and trends visible in the data. Businesses can miss out on identifying potential fraud, thus increasing the organization’s risk profile.
5. Lack of visibility and difficulty in tracking changes: With huge volumes of data, it becomes difficult to keep track of all the changes made in the reconciliation process, especially with multiple stakeholders. Lack of visibility and accountability, makes the process error-prone. Issues such as disconnected spreadsheets or asynchronous email chains lead to increased workflow bottlenecks that impact the timeliness of the reconciliation process.

Automation of Account Reconciliation Process

Automating account reconciliation processes can help navigate the challenges associated with manual reconciliations while simplifying and speeding up reconciliations. AI-powered automated accounts reconciliation software can manage repetitive tasks like transaction matching, allowing finance and accounting teams to drill down into open entries or exceptions that require additional attention and analyze patterns identified from date to devise strategic plans related to risk handling and ensure faster close.

Let’s understand the benefits of automating account reconciliation process:

1. Better data management: Automated accounting software solutions use data aggregation engines to integrate data from different sources, such as bank statements, invoices, accounting software, and payment records, into a single platform, eliminating room for errors and standardizing data formats. Automation further ensures that companies have the most recent and accurate data available for reconciliation. 
2. Incorporation on advanced technologies: Automated accounting solutions leverage technologies like AI, machine learning (ML), and robotic process automation (RPA) and are configured with defined rules of matching criteria, such as transaction type, amount, and date. Based on the matching criteria, the software automatically matches transactions across different systems into various data sets, such as bank statements and invoices. 
3. Increased efficiency:A key benefit of automating the reconciliation process is enhanced efficiency. It helps establish consistent workflows that standardize the reconciliation process across multiple users, departments, and locations. This can help ensure that all staff members follow the same process, reducing the risk of errors or inconsistencies. Such solutions also provide customized dashboards to help track key reconciling metrics in real-time.
4. Better compliance and audibility: Automated account reconciliation software helps ensure compliance with regulatory requirements by enforcing standard rules and procedures for data analysis, matching, and exception handling. This can help organizations avoid penalties, legal action and reduce risk.
5. Improved exception handling with anomaly detection:Automated account reconciliation solutions allow users to handle exceptions manually or to set up rules for the automated handling of exceptions. This helps to identify and resolve anomalies in a timely and efficient manner. For example, it can identify abnormal payment patterns, such as a customer consistently paying outside their normal payment terms or making payments in irregular amounts. This can help organizations identify potential disputes or cash flow issues before they become major problems.
6. Reporting and analytics:Automated reconciliation solutions provide real-time reporting and analytics capabilities, allowing users to monitor the reconciliation progress and identify issues that require attention. Such software provides insights into transaction patterns and trends, helping to identify potential issues and take proactive measures to address them.

How To Choose The Right Automated Account Reconciliation Software?

Choosing the right automated account reconciliation software can be a daunting task. We understand that. Below, you will find a four step guide to choosing the right vendor for your account reconciliation automation that offers maximum return on investment (ROI), efficiency, and savings.

1. Identify current challenges and inefficiencies

Check with your accountants, accounting managers, and controllers about the challenges they face in closing the books. Ask specifically about the types of errors or omissions they see when reconciling books.

Also, check previous years’ audit reports to identify repetitive mistakes and actions recommended by the auditors. Study the best reconciliation practices followed in the industry. If needed, work with third-party finance consultants to identify gaps and put together a transformation plan for your finance department. 

2. Assess organizational readiness

Nearly a third of the businesses are gearing up to digitally transform their accounting operations using a slew of technologies, including cloud, AI, analytics, and RPA. But the digitization of the accounting processes, including account reconciliation and financial close, requires strong back-end data management policies and infrastructure.

The following questions can help you assess whether your organization is ready to implement AI for its account reconciliation and other processes.

• Are all my invoices digitized or in electronic format?
• Do I have a central repository that collates all finance and accounting data collected via multiple systems?
• Am I sure none of my teams use paper-based books to store data?
• Is your accounting system cloud-based?

If you answered ‘yes’ to all the questions above, your organization is pretty much ready to embrace AI. For further confirmations and checks on how you can implement AI, don’t hesitate to sign up for a free consultation with our AI experts.

3. Set goals and expectations

Automating your account reconciliation process doesn’t mean that you can dismiss your accounting team overnight or improve efficiencies twofold immediately. Setting realistic expectations for AI implementation is key to understanding your ROI on AI spending.

Some goals you can achieve with HighRadius AI-based account reconciliation solutions, include:

• 30% reduction in month-end close time
• 100% general ledger accounts coverage
• 50% close task automation
• 90% transaction auto match rate
• 95% journal entry posting automation

4. Identify the right solution/vendor

AI investments are critical decisions that are not easily reversible. So, thoroughly checking the capabilities of the AI solutions you shortlist is crucial. Some of the factors that you need to consider when finalizing your AI partner are the features and capabilities of the solution, the cost, the strength of the datasets used to train the AI algorithm, and the support offered by the vendors, including update timelines, security features, up-time, and dispute resolution timelines.

How does HighRadius Transform the Account Reconciliation Process?

HighRadius’ AI-based Record-to-Report solution that enables faster Financial Close and accurate, automated Account Reconciliation.

It offers configurable matching rules and algorithms to identify and resolve variances in general ledger accounts and makes the financial data compliance and audit-ready.

1. Transaction Matching: With HighRadius’ Transaction matching feature, you can automate GL data extraction from ERPs and achieve 90% match rate.
You can automate your reconciliation process with accurate AI/ML-powered matching across data sources. 
2. Reconciliation Control Tower: With this feature, you can achieve 80% reconciliation automation. HighRadius gives you a list of active GL accounts for reconciliation, with variances and certification status per task.
3. Journal Entry Automation: HighRadius’s pre-built journal entry templates helps you automate 95% of journal entry tasks. You can automate your journal entry preparation for identified open items and clearing using customizable LiveCube apps and automate posting to ERP of your choice.
4. Reconciliation Progress Dashboard: You can improve productivity by 50% when it comes to account reconciliation with HighRadius’ Reconciliation Progress Dashboard. The feature helps you take proactive actions on potential delays to reduce days to reconcile.
5. Anomaly Detection: HighRadius’ AI-based anomaly detection solution helps you achieve 30% faster close rate and enhances your reconciliation process. The solution finds discrepancies automatically with AI-based alerts for potential anomalies and allows you to be compliance and audit-ready.

FAQs

Q1. How does reconciliation in accounting work?

In accounting, reconciliation refers to the practice of comparing two sets of financial records to make sure they are accurate and free from errors. The process typically involves comparing accounts in the company’s general ledger and sub-ledgers with external financial documents like invoices, receipts, and bank statements. 

Q2. What are the risks of not reconciling bank statements?

If you don’t reconcile your bank statements, you run the risk of fraudulent transactions, inaccurate financial reporting, compliance issues, errors in tax reporting, increased risk of frauds, bad credibility, and poor cash flow management. Due to these reasons, it’s important to periodically reconcile your bank statements. 

Q3. Why does accounting reconciliation matter for businesses?

It’s important for businesses to perform periodical account reconciliations as it helps them prevent fraud and theft, gives an accurate picture of cash flow, allows them to stay compliant and credible, and enhances their financial and tax reporting. All this ultimately enables businesses to make better financial decisions. 

Q4. What does it mean to reconcile accounts?

In accounting, the term reconciliation specifically refers to the comparison of two sets of financial records. During an account reconciliation process, a company compares its financial records with external documents. Companies use this process to prevent fraud, ensure their records are consistent, and stay compliant. 

Q5. What is bookkeeping reconciliation?

Bookkeeping reconciliation is used by companies to make sure their financial records are free of any errors. To do this, companies periodically reconcile their financial records with external documents. For example, a company may reconcile their general ledger and subledgers monthly with bank statements and vendor invoices. 

Q6. What accounts need to be reconciled?

Accountants typically perform an account reconciliation for all their asset, liability, and equity accounts. This process involves reconciling credit card transactions, accounts payable, accounts receivable, payroll, fixed assets, and subscriptions to ensure that all are properly accounted for and balanced.

Q7. What makes a good account reconciliation?

Accuracy and completeness are the two most important things when reconciling accounts. Additionally, reconciling accounts consistently is also essential. Companies usually perform monthly or quarterly reconciliations to have accurate financial records at the end of the year. 

Q8. What is the main purpose of an account reconciliation?

Account reconciliation is an internal control system that certifies the accuracy and integrity of a business’ financial processes. It helps in detecting discrepancies and fraudulent transactions. It’s important to perform timely reconciliations so companies can close the accounts easily at the end of the fiscal year.

Q9. Who should prepare the account reconciliation?

The accounting team in an organization is responsible for reconciling accounts at the end of each financial period to ensure that the GL balance is complete and accurate. In order to perform reconciliations accurately, accountants need to have all the relevant documents including bank statements and vendor information. 

Q10. What are some best practices to ensure account reconciliation accuracy?

1. Prioritize setting an accounts reconciliation process
2. Establish standard procedures acc. to statutory requirements
3. Automate processes to ensure better cash application
4. Study processes constantly to discover gaps and resolve the gaps
5. Use a risk-based approach to ensure that crucial processes are reconciled regularly