What is Account Reconciliation: Definition and How It Works

Updated June 24, 2022

Many companies and people reconcile their accounts to make sure they're in good financial standing. Reconciling your accounts is a great way to detect fraudulent charges or monetary discrepancies on your various bank accounts. In this article, we will define account reconciliation, the various methods of the process and how to perform account reconciliation.

What is account reconciliation?

In accounting, account reconciliation refers to the process of comparing internal financial records with external monthly statements to ensure they agree. For example, if you purchased a sweater for $20, you'd want to make sure that not only was $20 spent, but that $20 left your account and was reflected in your bank statement. You could use your store receipt to compare the amount you were charged with your bank statement to verify this.

Why should you reconcile accounts?

It's important to reconcile your financial accounts regularly to ensure that you know how much money you have and where it is being spent. If there are any overdrafts on your accounts, overcharges or cases of fraud happening, it's best to know sooner rather than later. This could potentially save you money in the future. If you have an accountant, reconciling your accounts will help them produce reliable financial statements. If you have a company, performing account reconciliation is equally as important as it ensures an accurate balance sheet.

Account reconciliation methods

Whether you're performing account reconciliation as an individual or for your company, the process will need to be done on a routine, regular basis to avoid financial discrepancies. Here are the two methods of account reconciliation:

1. Documentation review

Considered the most common method of account reconciliation, documentation review consists of reviewing any documentation to ensure the amount spent is equal to the amount recorded. This method is often done through accounting software. For example, you might find that your landlord overcharged you for rent after looking at the documentation. You can then speak to your landlord to receive reimbursement for the amount you were overcharged. Without using documentation review, you wouldn't have noticed you were overcharged for rent.

2. Analytics review

The analytics review method gauges past account activity or historical activity levels to estimate the amount that should be reflected in the account. For example, based on historical account activity, your business estimates $50,000 in annual revenue. Your business's current revenue is $5,000, however, which is much lower than what was initially projected. Then, let's say an accountant found an error in the recorded number. Rectifying this to reflect a much closer—or the correct—revenue would balance the accounts.

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How to perform account reconciliation

To verify that the monetary value leaving your account is the same amount spent, it's important to perform the account reconciliation process. Both amounts should balance by the end of the accounting period. Understanding how to perform account reconciliation is vitally important in helping to uncover potential theft or fraudulent transactions. Once you understand how to balance these records, you'll be in better financial health. Here are the steps to take when performing account reconciliation:

1. Compare your records with your bank statement

First, you'll need to have both the internal and external records on hand. Once you have them, review them and detect any differences in the transactions made. For example, if you purchased groceries for $100, you'll want to see $100 reflected in your bank account and vice versa. To rectify any errors, this will need to be proven by evidence. In this case, the documentation serves as your evidence.

2. Identify any discrepancies

To identify a discrepancy, you'll need to search for charges listed on your receipt that are not reflected on your bank account and vice versa. Take careful consideration into making sure the money leaving your account and the money being spent is recorded on both records. If you detect any situations in which a balance was reflected on one means but not the other, this is indicative of a discrepancy. If there are any discrepancies, you'll need to remedy the situation by adding the correct transactions to both records.

For example, if you spent money on a new book and the charge shows up on your receipt but not on your bank statement, an error has occurred. If the charge is shown on both your receipt and your bank statement, however, these two are balanced and the account is reconciled. It's important to note that this should be done for all of your transactions. Additionally, some charges will take a longer amount of time to be reflected on your bank statement, so it's important to give the charges a decent amount of time to reach your statement before proceeding.

Though not always the case, it's possible your bank made an error. This could include duplication, omissions and inaccurate reporting. Any of this could cause both records to be labeled as unbalanced. Such errors should be corrected on the records to reflect the correct amount. In this circumstance, don't be afraid to call the vendor or business to verify the charge.

3. Balance the records

Once you've compared the external and internal financial documents and rectified any discrepancies, you've balanced both accounts and have therefore achieved account reconciliation. This means you or your business is financially healthy.