Why is Reconciliation Important in Accounting?

Reconciliation is an accounting process that proves and documents that account balances are in agreement. It's a fundamental account process that ensures the actual money spent matches the money leaving an account at the end of a fiscal period. This is especially important for businesses and individuals to inspect fraudulent activity and to prevent financial statement errors.

At the end of every fiscal month and quarter, it's a good idea to reconcile an account. When reconciling an account, businesses and individuals prove that every transaction sums to the correct ending account balance. Generally, there are two ways to reconcile an account: reviewing documents and reviewing analytics.

Documentation review is a common process of accounting reconciliation. This process reviews the appropriate amount for each transaction and determines whether the amount in the account matches the actual amount spent. For example, suppose a responsible individual keeps all of his receipts and likes to make sure that the money he spent is going to the right places. He notices that he was charged 20 times on numerous occasions on his credit card bill.

These charges are small, and he neglects them assuming they are lunch expenses. Then, he inspects the company charging his credit card and realizes he does not have any receipts from this company. He calls his credit card company to dispute this and finds that his credit card information is compromised due to a criminal who gathered his information from a business he shops at regularly. The credit card company and the business reimburse him for the incorrect charges. This active account reconciliation allowed the individual to cancel his credit card and stop all fraudulent activity.

Analytics review is another common process that individuals or business can use for reconciling an account. Under this process, businesses estimate the actual amount that should be in the accounts based on previous account activity levels. This process is important for businesses to check for fraudulent activity or balance sheet errors.

For example, real estate investment company ABC purchases approximately five buildings per fiscal year, based on previous activity levels. The company reconciles its account every year to check for any discrepancies. This year, it notices that the estimated amount of its expected account balance is off by one whole figure. Based on previous account activity and purchasing, it estimates that its accounts payable should be $5 million. The actual accounts payable balance is $48 million for the year, which is a major discrepancy in its balances. The accountant of company ABC reviews its balance sheet and finds that the bookkeeper entered an extra zero at the end of its accounts payable by accident. The accountant adjusts the accounts payable to $4.8 million, which is approximately the estimated accounts payable.