Preparing reconciliations is an essential function of an accounting department in local government finance departments. Reconciliations not only ensure the account balance in the general ledger is complete, but if done properly, they should also tell you if the account balance is correct. Unfortunately, this last step is often missed. In this article, we will discuss the key benefits and roadblocks to help your team determine if your account reconciliation are really reconciliations.
What is a reconciliation?
A reconciliation is a process of comparing two sets of records to ensure that they are in agreement. That’s the nerdy accountant definition. To put it more simply, a reconciliation is a line-item detail of what an account balance is made up of. Lets take accounts receivable as an example. The reconciliation can be the detailed accounts receivable subsidiary ledger’s total and comparing it to the accounts receivable balance on the general ledger. Ideally they will tie….often they don’t. In order to reconcile the two records, you have to investigate the difference. As accountants, sometimes we have to channel our inner Sherlock Holmes. Perhaps there are journal entries that were posted to the general ledger that were never recorded in the accounts receivable subsidiary ledger. Whatever the differences are, we need to investigate and document them.
A more detailed look at a reconciliation.
How do we prepare a reconciliation, you ask? Reconciliations differ depending on the type of account you are reconciling. For accounts such as cash, accounts receivable, accounts payable, inventory and capital assets, you likely have subsidiary ledgers that feed directly into the general ledger. The most common way to reconcile those accounts is to run a ledger detail and compare the balance to the general ledger, then investigate any differences.
A ledger detail is a report that shows the individual transactions that make up a subsidiary ledger account balance. For example, a ledger detail for accounts receivable shows the invoices, payments, and adjustments that affect the amount owed by customers. A ledger detail can also provide information about the dates, amounts, and descriptions of the transactions.
Once we’ve identified any variances, we need to review them to ensure they are reasonable and accurate. For instance, a reconciling item between the bank account and the general ledger may require the general ledger to be adjusted. In that case, you would prepare a journal entry and update your reconciliation.
Why are ledger details not reconciliations?
Other accounts do not have subsidiary ledgers, such as long-term debt, payroll liabilities, deposits payable, and many others. For these accounts, you cannot reconcile between the subsidiary ledger and general ledger as most of the transactions in these accounts were the result of journal entries. Often times, auditors will request a reconciliation and they are provided with a general ledger detail of the account. It is essential to recognize that general ledger details and the reconciliation process serve different purposes. The general ledger details provide a comprehensive breakdown of individual transactions that have posted to an account…these are the tiny details that make up the big financial picture. It’s the ‘who, what, when, where, and why’ of each transaction. In contrast, reconciliations focus on verifying the overall accuracy and alignment of various financial records by comparing them to the general ledger…their job is to uncover any mismatches and issues to confirm the general ledger balance is accurate.
What is the most common missed step in the reconciliation process?
Often times, accountants miss the final step in the reconciliation process. Once they prepare a reconciliation and the details reconcile to the general ledger, they often stop. However, just because you know what an account balance is made up of, doesn’t mean that account balance is correct. Once you know what the balance is made up of, you must review the details to determine if the items should still be there.
Let’s take a look at two reconciliations for the accounts payable account. Both reconciliations show a detail that ties to the general ledger balance. However, Example A has a “balance forward” that has no detail and doesn’t allow for a review of those items to ensure they are still outstanding. As a best practice, balance forward items should not be included in reconciliations. All reconciling items should be detailed out. Example B shows a year end accrual entry that is summarized, however this entry can be pulled with ease and should tie 100% to the balance listed.
A good tip for this step is to look at the dates of the items and the types of transactions. For instance, if you process accounts payable checks on a weekly basis and you don’t hold open invoices in your accounts payable module, then your accounts payable balance at the end of the year should only have the final few items that were entered but hadn’t been processed for payment plus your year-end accruals. If you see items from earlier in the year or prior years, those likely need researched and written off. This is also the perfect time to review the allowance for doubtful accounts for receivables. You already have the subsidiary ledger details, sort by invoice date and review those that are older than 90 days. Depending on your policy, you may need to write some off or set up an allowance for doubtful accounts.
Conclusion
In summary, the reconciliation process is not complete until you verify that the items in your account balance are accurate and current. You should avoid using balance forward amounts and instead provide details of all reconciling items. You should also review the dates and types of transactions to identify any errors or adjustments that need to be made. By doing so, you will ensure that your general ledger balances are reliable and reflect the correct balances for decision makers and your auditors.
If you’re unsure if your reconciliations are really reconciliations, we’re always here as a resource and would he happy to help you assess your month-end and year-end reconciliation process. Contact us today!
