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Reconciliation of Books | Types, Best Practices, Useful Tips – As we all know, Books of Accounts are the blueprints of any business. Maintaining the Books of Accounts is the key to financial management.
However, maintaining books of accounts is not enough. It is also necessary that the accounts should be accurate and complete. There are various checks and controls possible to ensure this but one of the most basic and essential way is “Reconciliation of Books”.
- What is reconciliation?
- When is reconciliation done?
- What is the period for which reconciliation is done?
- Why should reconciliation be performed?
- Best practices for the reconciliation process
- How does a reconciliation statement look like?
- What are the types of reconciliations?
- Useful tips for Ms Excel while performing reconciliations
What is reconciliation?
It is a process which compares two sets of records and analyses the differences between the two sets, if any.
These two sets of records can be anything from the entire gamut of Books of Accounts. Generally, one set of record is a ledger from the company’s Books itself which needs to be reconciled and the second set of record is obtained from internal or external sources.
e.g. comparing the bank book (internal source) vis-à-vis the bank statement (external source).
When is reconciliation done?
It is generally carried out before the closure of accounts. It is advisable to do it on a monthly basis so that the books are up-to date but they can also be done on a quarterly or annual basis.
Heavier the volume, more should be the frequency of reconciliation so that the reconciliation process is smoother.
They should be done on an annual basis before the Books are certified by the auditors. In fact, most of the reconciliations are a pre-requisite for audit testing purposes. Since the enactment of Sarbanes Oxley (SOX) in 2002, reconciliations have become even more important as the compliance required have risen to a different level.
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What is the period for which reconciliation is done?
One of the key aspects to take care while performing reconciliation is that the period for both sets of records should be the same.
In continuation with the example stated above, it is very illogical to compare bank book extracted for the period 01-Jan-16 to 31-Mar-16 to the bank statement for 01-Jan-16 to 30-Jun-16. There should be a common base for comparison.
Also, a very important thing to consider is that the Opening or Beginning balance should always be equal for both the set of records. In the above case, if the balances on 01-Jan-16 are not equal, this difference should first be rectified rather than going ahead with the reconciliation for 01-Jan-16 to 31-Mar-16.
Why should reconciliation be performed?
- It is easy to manipulate books of accounts. One way of detecting fraud is through reconciliation. Let us understand this with an example.
- The cashier of ABC Corporation is committing fraud by not recording cash received from customers. By doing this, the customer and cash ledgers are unchanged and he can pocket the cash received.
- A simple way to detect frauds like this is to perform customer ledger reconciliation. When the Customer’s ledger in the Books of ABC is compared to ABC’s ledger in the customer’s Books, the balances will not tie and the fraud will be detected.
Ensure records are complete:
- At times, there are certain activities that affect our books but not be routed through the accounts team and hence, may go undetected.
- A small example is a cheque deposited by a customer directly in the bank account. If the customer does not inform, the bank ledger as well as the customer ledger will be incomplete leading to misrepresentation of facts.
Ensure records are accurate:
- There are chances of human errors in the process of accounting.
- One example of human errors is incorrect placement of digits e.g. Actual value of sales was Rs. 99,736 which was incorrectly recorded as Rs. 97,936.
- These can be found out while reconciling accounts. These are nothing but transposition errors and in this case, the difference is generally divisible by 9.
Best practices for the reconciliation process
Some of the best practises which can be adopted so that the reconciliation helps achieve its purpose are as follows:
- Companies should set up a Reconciliation Process to be followed internally. This should cover the frequency, key accounts for which reconciliation is to be done, standardised formats, etc. These processes will vary depending on the volume, type of industry, high risk areas, etc. The policy should be prepared and circulated to the Finance & Accounts team on a regular basis.
- Segregation of duties should be followed. This means that employee recording the entries in the books of accounts should not be a part of the reconciliation process. This will ensure that the work done by one is checked by another.
- Authority matrix for maker-checker process should be followed. Basically, reconciliation statements should also be prepared and checked by different employees on the basis of the designation. Executive can prepare the reconciliation statement and the same can be checked by the Manager.
- Proper sign-off should be taken by the preparer and checker so that people feel responsible enough.
- Strict timelines for the completion of reconciliations should be set to detect frauds and to take timely actions.
- Scope of the internal audit should also include checking of these reconciliation statements.
- Approval process should be set for passing rectification entries (if any discovered during the reconciliation process) for correcting accounts. This will ensure that the middle and upper management is updated from time to time.
- Supporting documents (such as Bank Statement, Customer’s ledger, etc.) should form a part of the Reconciliation Statement on which sign-off is to be obtained.
How does a reconciliation statement look like?
A reconciliation statement should be as simple as possible. It should include basic details such as which ledger is being reconciled, what is the period of reconciliation, when is the reconciliation prepared, who has prepared, checked, approved, etc.
The following is a simple format of the reconciliation statement:
|Bank Reconciliation Statement as on 31-Mar-16|
|Bank Account No. 00000xxxxxx|
|Balance as per Books of Accounts on 31-Mar-16||xxx|
|Balance as per Bank Statement on 31-Mar-16||xxx|
|Prepared By: Accountant|
|Checked By: Manager|
|Verified By: Finance Controller|
Either of the two sets can be taken as the base and adjustments should be added or subtracted, thereby arriving at the balancing figure.
In the above format, Bank book is taken as the base. However, if the Bank Statement is taken as the base, all the adjustments will be reversed. Following two cases will help to understand this better:
Case A – Taking the Bank Book as the base
|Balance as per Books of Accounts on 31-Mar-16||9,700|
|Add:||Cheques issued but not deposited||10,000|
|Bank Interested credited by Bank||75||10,075|
|Less:||Bank Charges not recorded||175||175|
|Balance as per Bank Statement on 31-Mar-16||19,600|
Case B – Taking the Bank Statement as the base
|Balance as per Bank Statement on 31-Mar-16||19,600|
|Add:||Bank Charges not recorded||175||175|
|Less:||Cheques issued but not deposited||10,000||175|
|Bank Interested credited by Bank||75||10,075|
|Balance as per Books of Accounts on 31-Mar-16||9,700|
What are the types of reconciliations?
Basic reconciliation statements which are important and prepared in day-to-day business accounting:
- Bank reconciliation
- Vendor reconciliation
- Customer reconciliation
- Inter-company reconciliation
- Business specific reconciliation
We will discuss each of these statements in detail:
#1 – Bank Reconciliation
A bank reconciliation statement is prepared with reference to actual transactions reflected in the bank statement vis-à-vis transactions recorded in our bank book.
Some of reasons for difference between the bank book and bank statement are:
- Cheque issued to a vendor but presented at a later date
(At times, there are cheques which appear in the bank statement which are very old. They are stale and cannot even be deposited anymore. It is better to write them off and keep the Bank Book clear.)
- Amount deposited by a customer directly in our bank account
- Bank interest credited by the bank
- Bank charges debited by the bank
- Bank errors (Although rare, errors can happen by data entry errors are also possible by bank)
All payment and receipt related activities are tracked through the bank book. Reconciling it helps to keep it updated.
To make our lives easier, most of the accounting ERPs have built in features which help to extract the bank reconciliation statement directly.
The basic concept used in these ERPs is recording the “bank date” for each transaction. A bank date is the date on which the transaction is reflected in the bank statement. ERP extracts a report on the basis of the “Document Date” vis-à-vis “Bank Date”.
#2 – Vendor reconciliation
A vendor reconciliation statement is prepared to make sure that the accounting entries passed in the books of the vendor are in line with the accounting entries passed in our books.
Reasons for deviations are as follows:
- Purchase returns booked by us may not be booked by the Vendor.
- Cheques issued by us may not be reflected in their books. This generally happens when the cheque is misplaced or lost in transit
- Goods-in-transit not recorded by us but recorded by the vendor.
#3 – Customer reconciliation
A customer reconciliation statement is very similar to a vendor reconciliation. It is prepared to check if the customer’s books are in sync with our books. Most corporate treat a customer reconciliation as a priority over vendor reconciliation. This is because money is receivable from customers and it is always better to reconcile so that the payments are not pending on account of some issues with regards to accounting entries.
Reasons for deviations are as follows:
- Returns booked by customer not appearing in our books
- Taxes deducted by the customer not accounted for in our books
- Goods-in-transit recorded as sale in our ledger
- Payments directly transferred to our bank account not recorded
A good practice is to perform monthly reconciliations of customers on a rotational basis. Let us that a corporate has 100 odd customers and reconciliations of around 10-15 customer ledgers should be done on a monthly basis.
Also, once the reconciliation is complete and certified by both the parties, a balance confirmation certificate for the given period can be issued. This will ensure that the opening balances needed not be checked again. This also helps to resolve disputes.
#4 – Inter-company reconciliation
Group companies (Holding, subsidiary, etc.) have to prepare consolidated Books of Accounts. These Books need to eliminate inter-company transactions such as sale from Holding Co. to its Subsidiary Co. For this, it becomes utmost important that their Books of Accounts are always in sync and hence, should be reconciled regularly before the consolidation process is done.
#5 – Business specific reconciliation
Every business will have to prepare other reconciliations over and above the basic ones mentioned above. An example for this is the Costs of Goods reconciliation
This reconciliation will not be applicable to the service industry as they do not hold inventory. However, it is very important for businesses which hold inventory.
What is cost of goods sold?
Cost of goods sold = Opening Stock + Purchases – Closing Stock
Cost of goods sold = Sale – Profit
Cost of goods can be arrived by either of the two methods. Both need to be the same amount. If not, a reconciliation statement should be prepared to find out reasons for differences. Also, a physical verification of the Closing Stock should be carried out and the same should be reconciled to the Closing Stock appearing in the Books of Accounts.
Useful tips for Ms Excel while performing reconciliations
- A standardised template should be prepared with all key formulae in Excel. (Format illustrated above can be used)
- In case of Vendor / Customer reconciliation, Invoice No. acts as a common field which can be taken as a base for performing Vlookup function and making the reconciliation process easier. Make sure to do a paste special after using Excel Vlookup Function.
- Filter out debit and credit entries separately and reconcile them individually. Another way to separate out entries is to filter them on the type i.e. Payments, Invoices, Returns, Other Adjustments. Reconciling these separately and then adding up the differences will prove to be helpful.