Account Reconciliations are often an underappreciated control, tagged onto the end of the financial reporting process, when team members are tired and relieved in equal measures having survived yet another quarter close, and thoughts are already on the next set of challenges, or a well-earned break.
However, a well-managed account reconciliation process can help minimise many of the causes of the stresses which occur in the cycle.
This article lays out some best practices on how you can improve your account reconciliation processes:
Standardise the process
Only a few years ago, most account reconciliations were performed offline in Excel models. Nowadays, many systems will automate account reconciliation. However, only too often this actually means pulling in balances from various sub-systems and performing a comparison. Comparison merely involves identifying the difference between two accounts, or set of accounts. Reconciliation, on the other hand, implies that two accounts, or sets of accounts, agree, at least within an acceptable degree of tolerance.
Whether automated or not, a company should have a standardised, communicated account reconciliation process and templates. Lessons learned and best practices should be shared between units, and the mechanics for doing so established.
Here are the six criteria which make up a best practice account reconciliation:
- Documentation regarding the account and its reconciliation should be prepared. This documentation should include the following for all reconciled accounts:
- Account number, description and purpose. The description and purpose should be reviewed periodically and updated as the nature of the transactions change.
- The period being reconciled, and the frequency of the reconciliation. Some accounts may require monthly reconciliations, others quarterly, and some even annually.
- The types and sources of expected transactions, and how the account is to be reconciled.
- The expected signage of the balance of the account.
- Who the preparers and authorisers are.
- The dates of preparation and authorisation.
- Actions and the associated timescales required to correct any unreconciled (open) items.
- Other appropriate references, such as where reconciliations are stored, either physically or electronically.
There is an element of standing data in the above list, which would not change from one period to the next, although probably should be reviewed biennially.
- The closing balance in the general ledger account must equal the total of items listed; appropriate sub-ledgers, or independent sources.
Account reconciliations must substantiate the ending balance of a general ledger account. Roll-forwards (beginning balance + journal entries = ending balance) of account balances from prior periods does NOT constitute a reconciliation with two possible exceptions: Retained earnings and Foreign currency translation reserve accounts. For these accounts, roll-forwards of the balances are an acceptable practice to validate the account.
Reconciling items must be aged and identified with any other appropriate reference, including actions, if applicable, to clear and expected timing.
- The items listed must be supported and evidenced by third party documentation. In general, balances in accounts should be supported by documentation obtained from outside of the general ledger. A list of journal entries does NOT constitute a reconciliation.
Some non-industry specific account types and examples of suggested support are in the table below:
|Account||Examples of expected support|
|Accruals, sundry creditors||List of invoices and customers|
|Prepayments, sundry debtors||List of invoices, customers and release schedules|
|Fixed assets||Reference to Fixed Assets register|
|Bank accounts||Bank statements|
|Loans, including intercompany||Loan documents and interest schedules|
|Equity||Board minutes giving date and details of any capital injections|
- Open items must be resolved in the period in which it is reported. An open item is any amount improperly included in, or omitted from, an account balance identified in an account reconciliation.
- Account reconciliations must be peer-reviewed and as such the review documentation must be evidenced.
- The account reconciliation must be completed in a timely manner. Each account reconciliation should have a due date by when it should be completed, and open items cleared.
Time should be allowed in the process for the preparer to respond to enquiries by the reviewer. The dates should depend on whether a company has hard or soft closes, and their late adjustment process. Practically, many are driven by the time and resources available.
To be declared reconciled, and account reconciliation should meet ALL of the six criteria above.
For most companies, timing is a challenge. Where account reconciliations are performed during period-end close processes, it may be challenging to reconcile data that is constantly moving. Prioritising which accounts need to be reconciled, gaining the appropriate reviews and approvals, and ensuring an adequate audit trail for account reconciliations are some of challenges largely due to time constraints.
Take a risk-based approach
The finance team should identify the accounts which inherently have the greatest risk of having unreconciled items. This will vary by company and even by entity within a company. The risk assessment will take into account the value of the transactions going through the account, the complexity of the transactions, and the number of the transactions. In short, the standard risk calculation, i.e. probability multiplied by the impact. I recommend dividing into High, Medium and Low categories. This risk assessment may determine the frequency and timing of reconciliation, and the seniority of the reviewer.
The accounts which typically hold unjustified balances, outside of industry specific accounts, are the Sundry / Other – Assets/Liabilities, Accruals and Prepayments. Often any support for these balances consist of a list of journal entries, often both debit and credit entries. I recommend that these are classified as high/medium, depending on their closing balances, until a thorough review and reconciliation has taken place, when they probably could be re-classed as low. If necessary, break these accounts out into sub accounts to aid ownership and identification.
The last accounts to mention, and often the most difficult to reconcile, are two equity accounts, namely Retained earnings and Foreign currency translation reserve. For Retained earnings, one approach is to go back five years, take the audited balance as the starting point, and then reconcile the five-year movements. If issues are found in the five-year analysis, then it may be necessary to go yet further back. The Foreign currency translation reserve is a lot trickier, and it can depend on how well you trust your system’s calculation of the translation to functional currency, the elimination entries of Investment in Subsidiaries, disposals of foreign subsidiaries and the amount of manual journals. This can be tackled by entity/currency and to take a net asset value approach, although this will depend on how far back your records go.
Apply materiality thresholds
Common thresholds that companies set include unreconciled differences and required adjustments for that period. The latter should tie into your late adjustment policy.
Materiality can be defined both in terms of the size of the imbalance, in currency terms, and the size of the imbalance, in percentage terms. An effective materiality-based approach will apply a blend of the two.
Review and improve
All finance processes should be constantly reviewed in a bid to identify improvements. A common way of doing this is to monitor and report on relevant metrics. Common metrics, that should be reviewed on a regular basis, include overdue reconciliations, material reconciling/open items, aging of such items, number of reconciliations rejected on review and completeness by person or department. Reviewing these metrics over time will also give an indication on whether your process is improving or not.
Monitoring may identify a range of possible improvements, such as identifying the risk profile of the accounts and thus the associated reconciling processes. Monitoring may also help identify the appropriate materiality thresholds. It may even help identify technical improvements to the reconciling methods, and staff training needs.
I also recommend having process review workshops with other entities and/or departments in your company. This may reveal further process improvements, tools and utilities that may make the processes yet even easier.
Tools and automation
If you’re pursuing automation, as with any system implementation, make sure to conduct a proper review of your existing process – don’t simply lift and drop. An automated system should enable account reconciliation. Where automation can add value is in the production of dashboards (real time), automated extracts from sub-ledgers and the general ledgers, notifications to reconcilers when account reconciliations are due, and metrics. Furthermore, another advantage of using an automation tool is that they tend to centralise information and maintain effective audit trails.
As at the time of writing, I have yet to encounter an account reconciliation tool that truly automates the process, but I certainly know that there are many that augment the practice and offer a range of benefits. Many tools are becoming smarter by the day, utilising complex algorithms that automatically match accounts, or suggest possible matches. Whatever you choose, you need to carefully consider your processes, ensure that they are robust, and that they are fully understood.