Essential considerations when employing Balance Sheet Account Reconciliations

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Posted by Ed McCaulley

Topic(s): Reconciliations, Accounting Automation, ERM

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Given the nature of the public sector industry, with its vast constituent base, any process and control failures can become highly visible, highly contentious, and highly damaging to an organization’s reputation. Yet, with budget constraints and the hiring challenges from the “Great Resignation”, how are we to keep our organizations’ safe and out from under this magnifying glass? The challenges are significant and demand rational approaches as well as application of one of the oldest — yet most effective — accounting control processes: balance sheet account reconciliations.

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Reconciliations have long been an important control for ensuring the accuracy of financial statements. Validating balances in general ledger accounts through the reconciliation process provides management with assurances that controls are in place and are working effectively.

Performing accurate and timely reconciliations receives considerable attention under various government regulations focused upon public sector reporting. For example, in the United States, the Office of Management and Budget’s (OMB) Circular No. A-123 (A-123), the Federal Managers’ Financial Integrity Act (FMFIA), and the Government Accountability Office’s (GAO) Standards for Internal Control in the Federal Government (known as the “Green Book”) have been at the center of Federal requirements to improve accountability in Federal programs and operations. Within the Green Book, “reconciliations” are specifically called out both as “transaction control activities” and “ongoing monitoring”. Yet even without the regulatory emphasis, it is because of their summary and comprehensive nature that reconciliations often become key, rather than secondary, controls.

As accountants and auditors, we should understand best practices related to account reconciliations and have a clear plan for reviewing reconciliations.

RECONCILIATION TYPES

There are various types of reconciliation, and each has nuances that will indicate the nature, timing, and extent of audit tests. Some of the more common types include:

  • Basic account reconciliations. Often far from basic or simple, these account reconciliations may be reconciled to an accounts receivable aging schedule, fixed asset ledger report, or an accounts payable report. There should be account reconciliations for all asset, liability, and equity accounts.
  • Bank account reconciliations. This type of reconciliation is between a bank statement and a general ledger account. Zero balance accounts (ZBAs) add a twist to the generic bank account reconciliation, because the bank account is swept or funded daily, leaving the end-of-day balance at zero.
  • Suspense account reconciliations. Suspense accounts are used as a “holding” account until the appropriate disposition or classification of the transaction can be made (e.g., a lockbox used for all deposits). Once the cash deposit is recorded on the organization’s books, the organization will then determine why it was received and book the corresponding entry to clear suspense (e.g., to post it against a notes receivable or to book revenue).

Thus, testing procedures should be added or modified to address the specific nature or characteristics of the account being reconciled.

BENEFITS

There are many benefits that come from performing high-quality account reconciliations, but here are the key benefits:

  1. Identify necessary adjusting entries before financial or other regulatory reports are issued, thus reducing restatement risk
  2. Identify operational issues earlier, when the problem is smaller, resolution is more manageable, and before the “fog of time” starts to obscure events
  3. Improved confidence in the financial statements from investors, managers, constituents, and external auditors
  4. Emphasizes to all employees the need for accuracy in transaction processing when the feedback is closer to the error

BEST PRACTICES

Both accountants and auditors should understand the best practices being utilized around account reconciliations. The following are practical ideas for improving the effectiveness of an organization’s account reconciliation efforts:

  • Formalize a policy for reconciling and reviewing all balance sheet accounts.
  • Complete a risk assessment of all balance sheet and off-balance sheet accounts and determine their risk level.
  • Designate a regular cycle for the process (e.g., monthly reconciliations for high- and medium-based risks and quarterly for low-based risks).
  • Complete account reconciliations by a specific calendar day of the subsequent month.
  • Use a standard format for preparing reconciliations across the organization, and ensure each reconciliation contains standard information.
  • Assign different individuals to both preparer and reviewer roles for each reconciliation to be performed.
  • Confirm that the preparer and the reviewer possess the adequate skill sets to perform their functions, understand the nature of the account being reconciled, and understand the documentation and analysis required to support and substantiate the account balance.
  • Consider automating the reconciliation process. There are various tools available to help with reconciliations. For example, many tools will automatically match up transactions from the G/L to the bank records, which frees reconcilers to focus on the more value-added task of researching unmatched records. Other tools help track the status of all reconciliations.
  • Consider use of continuous monitoring tools and testing to immediately alert staff to potential issues (e.g., search for duplicate payments based upon payee, amount, and payment date) when they can take preventative action, instead of waiting to detect the issue when the reconciliation is performed.

There are no guarantees but employing these practices can help reduce the risks… of fraud, financial loss, or misstatements, while identifying operational issues early before they become too large.

INTERNAL AUDIT’S ROLE

Internal audit should be responsible for independently assessing compliance with stated procedures. When performing audits of reconciliations, it is essential that auditors consider various attributes. Including the following testing procedures can help auditors perform a complete and adequate review.

  1. Does the “balance per the general ledger” on the reconciliation agree to the amount reported on the general ledger? One common problem is not reconciling to the full general ledger balance (e.g., to a subaccount, to only the cash or accrual or tax subledgers, or to only a subsidiary account).
  2. Does the “balance per bank” or “balance per system” agree with the bank or system report? A recurring issue is reconciling the general ledger activity to the general ledger balance rather than to an outside, confirming source. Reconciling one general ledger source to another, such as a trial balance to an online balance report, will accomplish nothing — unless the intent is to test the general ledger system’s reports.
  3. Are there any unreconciled differences? Unreconciled or unknown differences should set off alarm bells. These differences mean the reconciliation work has not successfully identified all reconciling items. This typically indicates that the individual preparing the reconciliation does not have the appropriate skills, did not devote the time necessary to complete the reconciliation, or simply does not have access to all the appropriate data required. Be careful about de minimis limits that some groups have established. The theory behind a de minimis limit is that the difference is too small to warrant the time and effort to track down the difference and that it is more efficient to simply write off the unreconciled amount. However, the use of de minimis limits have dropped out of favor because the unreconciled balance may be hiding more than one error if the transaction amounts offset each other. In other words, a $10 unreconciled balance might be two or more transactions… a million-dollar credit, largely offset by a $999,990 debit.
  4. Are reconciling items being cleared timely? Unless the reconciling items identified are purely timing issues, they should result in some action (e.g., a journal entry or an entry to correct a subledger). These actions should clear the item before the next reconciliation is performed. If they are not cleared, it is an indication that the work is not being performed. As many organizations are operating with lean accounting departments, completing account reconciliations both correctly and timely can be a difficult task. However, staff shortages do not justify rolling reconciling items forward from period to period. Although this approach is quicker and may seem to be an acceptable solution to the overworked individual performing the reconciliation, it is often the cause of a restatement.
  5. Was the reconciliation signed by the preparer and reviewer, and are the preparer and reviewer different individuals? Having both roles is important for three reasons. First of all, it introduces a measure of segregation of duties, especially useful in smaller organizations where everyone wears multiple (and sometimes incompatible) hats. Secondly, the reviewer may offer a broader understanding of the transactions flowing through the account. Finally, the reviewer also should help ensure that reconciliations are being performed with consistent diligence between accounts.
  6. Was the reconciliation completed on time? Reconciliations should be completed before the data or report for the next reconciliation becomes available. Thus, a bank account reconciliation would be considered late if it was not completed before the next month’s bank statement was received.
  7. Has the organization established a monitoring control over reconciliations? Reconciliations are such an important control that many organizations have implemented an organization-wide policy or centralized monitoring to ensure their timely completion. All balance sheet accounts should be reconciled.

SUMMARY

Performing appropriate and timely reconciliations is a critical control function that should be in place in all organizations. Although account reconciliations may seem mundane and repetitive, a strong account reconciliation process is an important component of a solid system of internal controls. Implementing account reconciliation best practices — such as accountability, risk-based prioritization, and reconciliation automation — provides management with insight into the substance of transactions and account balance content. A robust reconciliation process can identify necessary adjusting entries before financial or other regulatory reports are issued, while also reducing restatement risk, improving investor confidence, and eliminating write-offs.

For more on this topic(s), see: Reconciliations, Accounting Automation, ERM

Originally Posted on 18 November, 2022

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