Accounts Reconciliation (#168)
/In this podcast episode, we discuss the accounts reconciliation process. Key points made are noted below.
The Need for Accounts Reconciliation
What we’re talking about is making sure that we have complete documentation that backs up the balance in every account.
The one account that everyone reconciles is the cash account, but you can find bank reconciliation procedures all over the Internet, so I won’t deal with that here. The real question is, what’s the account reconciliation process for all of the other accounts.
So first, let’s talk about why this is important. If your books are audited, the auditors will want to see the detail for all of the accounts that roll up into the balance sheet. If something doesn’t belong in an asset account, they make you charge it off to one of the accounts that rolls up into the income statement, which usually means that your profits will take a hit. And, they’ll want to make sure that all liability and equity accounts are properly compiled.
This means that the balance sheet accounts need to be reconciled at least once a year, just before the audit begins. This can be quite a frenzy, with all kinds of nasty little discoveries of items that should have been charged to expense months ago. The result is usually a delayed start to the audit, and a bunch of unexpected charges to the financial statements at the last minute.
This trouble comes from not managing the process properly. And there are some things we can do about that.
Accounts Reconciliation Best Practices
My first suggestion is to keep all of the small stuff from ever appearing in the balance sheet to begin with. This means setting up a threshold level. If you have a justifiable asset to record below that threshold, don’t do it. Just charge it to expense. I usually make this point in regard to fixed assets, but it can also apply to prepaid assets.
Second point. If there’s an account that has an automatically-generated detail report behind it, then the balance in the detail report absolutely always match the total for the related general ledger account. There’re no exceptions.
This means the receivables aging report matches the grand total for the trade receivables account, and the payable aging report matches the grand total for the trade payables account. This makes it super easy to reconcile these accounts, because you know there aren’t any journal entries mucking up the account. If you have a justifiable reason for using a journal entry on either of these accounts – don’t. Instead, park it in some other related account that’s chock full of journal entries, and which you have to manually reconcile anyways.
Third point. If you have a default flag in your accounting software to make a journal entry a reversing entry, then set the default to a reversing entry. This way, any entry you make automatically flushes out of the system in the next reporting period, so it won’t be hanging around in your accounts for months. You can always turn off the reversing flag for specific entries, but try to keep it to a minimum.
Fourth point. Get rid of the really tiny accounts that only contain a couple of transactions a year. Dump them into a larger related account, so you can reconcile fewer accounts. The main exception is when you need to segregate this information for reporting purposes. Otherwise, dump the small accounts.
Next point. Set up a checklist item in your closing procedure for reconciling accounts. The intent is to have a reminder that you’re supposed to do this as part of every close. Now – do you actually have to reconcile every account as part of every close? No. Most of the accounts still have balances that are so small that there’s hardly any activity in them, so review them maybe a couple of times a year. But there’re some major accounts that you never miss. That means cash, trade receivables, fixed assets, trade payables, and equity – at a minimum.
Also, the auditors probably have some hot button accounts that they dig into in far more detail than you’d think possible. You know which ones they are – just think back to which accounts they examined in the last audit. Always flag these accounts for ongoing reviews.
Next is the timing of the reconciliations. You don’t actually have to reconcile an account as part of the closing process. In the middle of the close, you have people running around the department with their hair on fire, and the controller looking like the grim reaper – there might be just a tiny amount of pressure.
And when there’s too much pressure, you’ll skip a few reconciliations, and the next thing you know, it’s the end of the year again, and now there’s all kinds of unresolved issues in the accounts.
So instead, think about doing a nice, leisurely account reconciliation around the middle of the month. This means you’re reconciling to the balance at the end of the preceding period, so you’re not bothering to reconcile the current period. But the main point is to look for items that just don’t belong anymore. Flush those out as soon as you find them.
Also, if you do mid-month reconciliations, you don’t necessarily have to reconcile every account every month. Instead, have a schedule of which accounts you’re going to review in each successive month.
And yet another point is to have a schedule for all of these account reconciliations. If you don’t put them on the department schedule, there’ll always be reasons to delay them in favor of something else. For example, consider putting maybe a single account reconciliation at the top of your schedule for each day, so the recon gets done first. Another option is to figure out which is the slowest day of the entire month – like maybe a day when there’s no payroll to process, no inventory counts, no collections activity – whatever – and block out a good chunk of time for reconciliation work.
A key point in all of this talk of scheduling reconciliations is to do it when you have sufficient time, and when there’s not a rush. If you can do that, it’s much more likely that you can dive deep on an account and really make sure that everything belongs there.
And one final point. Consider maintaining a separate schedule of the contents of an account for each reporting period. That means you don’t keep revising the same detail backup information. Instead, there’s a record in place of how you justified each account balance in each reporting period. That gives you a really good history if you ever need to go back and see what was going on earlier in the year.