Account Reconciliation Explained with Types

What is data reconciliation?

Data reconciliation (DR) is a term that describes a phase of a data migration in which the target data is compared to the original source data to ensure that the migration architecture has correctly transferred the data.

Reconciliation means comparing different sets of data in order to check that they are in agreement. The process ensures that the data sets are correct, comparable and matching. In the world of finance and accounting, businesses need to ensure the validity of their transactions and the accuracy of company accounts. For this purpose, they reconcile their various accounts at the end of a particular accounting period and confirm their balances.

Account reconciliation is important for any business to prove or document its account balance. Periodic account reconciliation will help find discrepancies in transactions or amounts if any. These discrepancies (also called breaks) are investigated further and necessary corrections are made in the accounts to ensure correct balances.

Different types of reconciliation in accounting

It’s easier to understand account reconciliation by taking a closer look at some common reconciliation examples. There are five main types of account reconciliation: bank reconciliation, customer reconciliation, vendor reconciliation, inter-company reconciliation and business-specific reconciliation. Let’s explore each one of them in detail.

What is bank reconciliation?

Bank reconciliation or bank statement reconciliation is the process of verifying the bank balance in a business’ books of account by comparing them with the statement of account issued by its bank (called the bank reconciliation statement). Bank reconciliation is a type of internal control used by many companies to verify the integrity of data between the bank records and their official records. Here, each and every transaction in the bank statement is compared with the company’s internal records (normally cash account) to check both records are matching. Here are some commonly seen issues that result in mismatches in records:

• Issued cheques have not been presented to the bank or the bank has dishonored a cheque.
• A banking transaction (eg. credit received, bank fees, penalties) has not yet been recorded in the entity’s books
• Either the bank or the entity made an error while entering records.

Periodic bank reconciliation is important to spot missed payments and calculation mistakes. It will also help identify theft and fraud and track accounts payables and receivables. Depending on the volume of transactions, entities can choose to do bank reconciliation on a daily, weekly or monthly basis.

Vendor reconciliation

Vendor reconciliation is defined as the reconciliation of accounts payable for a vendor with the statement provided by the particular vendor. Here, an entity reconciles vendor balance in its books of accounts with the balance in the books of the vendor. It ensures that there are no discrepancies or mistakes in the amount a vendor charges an entity and the goods or services the entity receives from the vendor. The steps in vendor reconciliation are:

• Getting a statement of account from the vendor. The statement must have invoice-wise detail of each transaction.
• Comparing the statement with the vendor accounts as per the entity’s books of account.
• Adjusting for any difference, which should be separately shown in the reconciliation statement.

Customer reconciliation

In customer reconciliation or accounts receivable reconciliation, an entity compares the outstanding customer balance or bills to the accounts receivable as entered in its general ledger. Customer reconciliation statement acts as proof that there is no material inaccuracy in the accounts of the company. It helps unveil any error or irregularities in customer-related accounting. It will also help identify fraudulent activity pertaining to accounts receivable.

A part of account closing activity, customer reconciliation is normally conducted at the end of the month before an entity issues monthly financial statements. If any irregularity is identified while doing customer reconciliation, it should be corrected on time before preparing monthly financial statements.

Inter-company reconciliation

Intercompany reconciliation is the process in which a parent company consolidates all the general ledgers of its subsidiaries in order to eliminate intercompany flows. The process identifies possible mismatches between subsidiaries due to mistakes in invoicing and other transactions such as loans, deposits and interests. This is important to normalize an increase in assets, liabilities, income and expenses of group companies arising out of intercompany transactions. It also helps minimize bank transaction fees, optimize liquidity, and reduce financial and currency costs as well as risks. The process will also identify any unrecorded transactions or balances on the books group companies.

Business-specific reconciliation

In addition to the above-mentioned reconciliation types, every business needs to prepare other reconciliations based on specific needs. Costs of Goods reconciliation is a good example here. A business that has any form of inventory should prepare this reconciliation statement to match balances on the cost of goods sold account calculated using two methods:

Cost of goods sold = Opening Stock + Purchases – Closing Stock

Cost of goods sold = Sale – Profit

These two methods of calculation should lead to the same amount. If not, records are to be investigated to find out reasons for imbalance.

Other account reconciliations

Given below are some other reconciliation types that we normally come across in the financial world.

Credit card reconciliation

Credit card reconciliation is similar to bank account reconciliation. Here, an organisation matches credit card receipts with credit card statements issued by a financial institution. It helps institutions ensure that the amount billed in the credit card statement matches with actual payments. If the credit card company has committed any error, it should be reported and rectified.

Balance sheet reconciliation

Balance sheet reconciliation is the process of matching the closing balances of all the accounts of the company that forms part of the company’s balance sheet. It is done to ensure that entries used to reach the closing balances are entered and classified accurately so that balances in the balance sheet are appropriate.

Cash reconciliation

It is the process of verifying if the amount of cash in a cash register matches the actual cash on hand at the end of a business day. Cash reconciliation compares cash balance and cash receipts with one another. It is an effective tool to detect employee theft or incorrect accounting records. It also helps improve cash forecasting with an accurate view of business cash balances.

Modern technology in reconciliation

The types of reconciliation mentioned above has a unique workflow. There are many rule-based reconciliation solutions that are heavily customised to meet each of the needs. However, they have the following drawbacks:

• Adding new data sources may require a large amount of reengineering work. New regulatory standards such as Basel III and MiFID II have significantly changed the scope of reconciliation, mandating financial institutions to reconcile data stretching to more than 65 fields.
• Rules-based record matching may not always work with new asset types (in financial services) and deals involving complicated calculations.
• While RPA solutions could handle matching, exceptions/breaks management is still laborious and costly. Many organizations are finding it difficult to resolve breaks on time and meet compliance standards.

There are also new-age reconciliation solutions that can handle any account reconciliation with ease and accuracy. As in the case of any other processes, AI and machine learning are revolutionizing the way businesses reconcile data. A fully automated end-to-end reconciliation solution is the need of the hour to manage the pain points of traditional reconciliation professionally.