When you reconcile an account, you are proving that the transactions that sum to the ending account balance for an account are correct. This means you can prove one of the following two assertions:
- That the transactions included in a revenue, expense, gain, or loss account belong in that account, and so should not be shifted into an account that more closely matches the nature of the transaction; or
- That the transactions included in an asset, liability, or equity account are valid, and so should not be flushed out of the balance sheet by shifting the transactions into accounts associated with the income statement.
Auditors want to see an account reconciliation for larger accounts, though you should perform reconciliations even in the absence of an auditor request, since this is a good accounting practice that leads to more accurate financial statements.
An account reconciliation is usually done for all asset, liability, and equity accounts, since their account balances may continue on for many years. It is less common to reconcile a revenue or expense account, since the account balances are flushed out at the end of each fiscal year. However, this may be done simply to verify that transactions were recorded in the correct account; a reconciliation may reveal that a transaction should be shifted into a different account. Usually, this means moving an expense into a different account.
There are two ways to reconcile an account, which are:
- Documentation review. A documentation review is the most common form of account reconciliation, and the one that auditors prefer. Under this method, call up the account detail in the accounting software, and review the appropriateness of each transaction listed in the account. For example, if you are reconciling the trade accounts receivable account, the balance in the account should exactly match the total of the open accounts receivable report.
- Analytics review. Under an analytics review, create an estimate of what should be in the account, based on historical activity levels or some other metric. For example, estimate the amount of expected bad debts in the open accounts receivable account, and see if this approximately matches the balance in the allowance for doubtful accounts contra account.
If the account reconciliation reveals that an account balance is not correct, adjust the account balance to match the supporting detail. By doing so, you can always justify the account balances. Also, always retain the reconciliation detail for each account, not only as proof, but also so that it can be used as a starting point for account reconciliations in later periods.