Reconciliation in Accounting: Definition & Examples

Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

Account reconciliation is required for all US companies under the Sarbanes-Oxley Act. Reconciliation assures the integrity of the financial statements and can also alert management to fraud and embezzlement. This lesson will go over the different types and general procedure.

What is Reconciliation?

JoAnn is a senior accountant for Big Box stores. One of her monthly duties is to do the reconciliation, an accounting process that uses two sets of records to ensure that reported figures are correct and in agreement.

Reconciliation is important to assure the integrity of the financial statements. Investors and potential investors rely on those financial statements to make important decisions about their money. JoAnn also knows that reconciliation is an early warning system that alerts management if there is any fraud or embezzlement going on!

Types of Reconciliation

Reconciliation became a requirement under the Sarbanes-Oxley Act of 2002. Generally accepted accounting principles (GAAP) consider two main forms:

  1. Double entry accounting is the system of debits and credits that all accounting students are familiar with. Every business transaction at Big Box is recorded with both a debit and credit entry. When a customer buys merchandise, the cash account is increased with a debit and the inventory account is reduced with a credit. The sum will always equal zero.

    The trial balance exercise reconciles the debits and credits that must equal out at the end. JoAnn knows that doing the trial balance periodically is a way to check for errors and omissions when data is input into the accounting system.

  2. Account conversion is when source documents like cancelled checks, receipts and supplier invoices are compared to the corresponding journal entries in the ledger.

Reconciliation is a necessary process
computer

Reconciling the Cash Account

JoAnn always starts the reconciliation process with the cash account. It's the most important one, as any fraudulent activity will show up in the cash account first! It will also catch any errors made by the bank, and JoAnn has caught a few of those.

The first step is to get the monthly statement from the bank and compare it to the cash balance in the accounting records. They never agree because the amounts are calculated on different days, but the difference should be something that can be explained.

Big Box has written some checks and made some nightly deposits since the bank statement was issued. When the bank statement is adjusted for those, most of the difference is usually accounted for.

The rest usually comes from bank fees and unusual items like customer checks being returned for insufficient funds. JoAnn makes journal entries to reflect monthly service charges and makes sure that the bad checks have been entered properly in the accounting system.

One day, JoAnn went through the process and could not account for a $1,000 difference. When she went to the check register she found a missing check. Big Box security took it from there and found the guilty employee who stole it and wrote a $1,000 check to himself. The employee was terminated and Big Box gave JoAnn a big gift certificate for finding out about the theft!

Other Important Accounts to Reconcile

Another big account to reconcile for a retailer is the inventory. Even if a perpetual system is used, it's important to do a physical inventory count at least once a year to verify that inventory amounts on the books are in fact there in the warehouse. Shortages can mean employee theft or short orders are being received from suppliers.

  • Accounts receivable can be reconciled by comparing payment records for individual accounts with the total to check for erroneous entries. Verification letters can also be sent to customers to confirm balances.
  • Accounts payable can be reconciled by comparing invoices and documents prepared when items are received with the amounts on the accounting records.

Depending on the particular business, other accounts may also need to be reconciled.

General Procedure

JoAnn has a general procedure to follow. Let's follow along as she reconciles accounts payable.

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