Account reconciliations seem so simple – yet why is it that they are so often challenging to keep on top of and to do well? We propose below some simple concepts – starting with the account reconciliation design through to their execution – that will improve your reconciliation process and also simplify their performance through clearly stated objectives and framework.
This is Part 3 of a 3-part series. Parts 1 & 2 provided a summary of the account reconciliation process and Part 3 goes into best practices. If you haven’t read Parts 1 or 2, you’re encouraged to do so before reading Part 3.
DOCUMENTATION and SUPPORT
The benefit of the reconciliation is derived not only from the analysis and conclusions drawn, but from the quality and integrity of information on which those judgments are based. The account reconciliation should be supported by information from both sides of the reconciliation. That is, support for general ledger activity and period balances being reconciled; and related transactional, sub-ledger or supporting systems and internal/external data sources used to evaluate the activity recorded The reviewer/user of the reconciliation should be able to quickly agree data from the reconciliation to its source to conclude that the information was properly captured and used.
General Ledger – The ending account balance and activity being reconciled need to be supported through the reconciliation. The reconciliation should include the final or closed period-end ledger balance and related ledger detailed postings. If this support is provided in an electronic format it should be in the form of a scan from a report, or PDF file format or other format that cannot be easily changed or inadvertently altered. For the posting detail – the detail may be provided in a spreadsheet or list format to aid in the reconciliation analysis. For these formats, it should be clear through record counts, and control totals that the detail agrees to the original source – and the reconciliation should also clearly indicate those integrity checks performed to support the overall reconciliation. See also IPE/End User Reports below.
“Permanent” Sources – The reconciliation should also include support for initial balances or transactions and agreements driving the accounting activity over the duration of the business transaction. For example, reconciliation of a pre-paid 3-year lease would include the lease contract extract that shows the terms/duration and value of the lease and accounts payable support for the timing and value of the payment being amortized. These elements should be included and retained as “permanent” type supporting documentation over the 36 monthly reconciliation periods of the life of the 3-year lease supplemented by monthly supporting ledger detail of each month’s amortization recorded.
Transactional Activity – The reconciliation includes agreement of transactional, source system activity to what is ultimately recorded to the ledger account. The reconciliation support should include the source system data at an appropriate level of detail to perform a meaningful reconciliation that can identify the source and timing of potential differences. The level of detail is important to isolate and appropriately identify and measure errors so that they can be properly corrected, and their cause identified to improve operating processes. Again, consideration should be focused on how all this information is generated (such as from user reports) and controlled or protected throughout the reconciliation process to ensure the ongoing integrity of that information. Control totals and record counts among other controls should be clearly labeled and evident in the reconciliation.
3rd party sources – 3rd party data sources such as bank data, or other vendor activity should be considered in the design of the reconciliation. Important considerations are the availability and timing of the information (relative to reporting deadlines), and the detail and level of granularity to be provided (relative to accounting classifications and activity matching). While 3rd party sources carry particular value when assessing activity due to its independent nature (compared to internal data); the integrity of it must protected like any other data source. Consider how the data is to be obtained (i.e. email vs. download) and used (summarized, filtered, copied vs. keyed into the reconciliation) so that it can be properly protected, controlled and retained with the reconciliation.
Remediation – The ultimate goal of the reconciliation is to ensure accounts are properly stated. To achieve that, adjustments may need to be recorded to correct for errors identified by the reconciliation. It is important that the reconciliation not only call out the error(s) identified, but the steps taken to correct it. This should all be documented in the reconciliation, and included in the associated support. For example, the recording of a correcting journal entry can be highlighted or otherwise identified in the ledger detail to evidence the correction, or a copy of the detailed journal entry recorded can also be maintained with the support. Other transactional systems may provide different types of documentary support for the correction recorded. Regardless of the system, it is important the documentation is sufficiently detailed to identify the transaction or type of adjustment made, its value and the date performed/recorded.
IPE/End User Reports – As noted above, user generated reports or internally produced data sources provide particular challenges when controlling the integrity of the information. Control of this type of data is generally focused on three phases: data generation (query), data use and transfer, and data retention. The query parameters and outcome of the query should be documented such as through screenshots capturing the search parameters and statistics of the outcome of the query (such as number of records created, and related sub-totals and totals). This summary information will be compared to the data as it is used in the reconciliation ensuring the data was not changed or records deleted during transfer and use. Lastly, the data must be secured, such as through password protection, to ensure it does not change after it has been prepared and reviewed.
LINKAGES to the CLOSING PROCESS
The account reconciliation process is obviously tied to and ultimately driven by the overall accounting closing/financial reporting process. Changes in design to the closing process have the potential to not only simplify and strengthen account reconciliations but also the integrity of the overall reporting process. Consider the following areas of opportunity in the design of your closing process.
Chart of Accounts – The design of the chart accounts can influence the ability to effectively identify accounting and reporting errors through the account reconciliation process. Specifically, the degree of granularity of the account hierarchy can make the difference between a manageable volume of homogeneous transactions with common drivers that can be evaluated together, to a collection of dissimilar activity with offsetting trends that may mask irregularities and require time consuming analysis. The added advantage to reporting is that it is easier to systematically aggregate activity across accounts than trying to separate out transactions from a combined account. See Account Granularity below.
Account Set-up – When a new ledger account is set-up in the chart of accounts, the reconciliation and review responsibilities should be assigned (and communicated) at the same time, ensuring there are no delays completing reconciliations. Account set-up should also provide the reporting entity the opportunity to set-up their-own detailed accounts at a level of break-out and detail sized to their operations that promotes oversight. See Account Granularity next.
Account Granularity – Similar to the issues noted earlier of varied activity captured by miscellaneous and other type accounts there are other accounts of the same nature (e.g. asset or liability type) combining activity from multiple/varied sources with different underlying operating drivers. By combining these different type transactions, the overall operating trend of the account may be difficult to determine and may mask errors that would otherwise be obvious. An example is a prepaid account combining different agreements of different durations, end dates and amounts. If the individual agreements/prepayments were segregated and reported separately in individual accounts – they could be much more easily monitored (i.e. a simple review of ending balances or period to period activity to verify individual amortizations). Having separate accounts and greater granularity would eliminate the need for otherwise time consuming analysis to break out, match and validate individual elements comprising the overall balance.
Opponents to this approach cite the complexity of having a larger ledger to accommodate multiple accounts. However the transparency and ease of review from more granular reporting and separate accounts more than offsets any additional ledger volume/size issues. With segregation from increased granularity – there are also opportunities to automate reporting monitoring of the individual balances, and account activity since they (now) follow a predictable trend which can be checked and flagged for unusual or unexpected activity – simplifying and strengthening controls. However, if you are still not convinced – consider an intermediate solution where journal entries and journal entry support provide the same level of detail breakout by contract/driver, consistently listed in the same order as in the reconciliation to facilitate a quick 1:1 review. While simple, the approach also accommodates any changes needed due to new or expiring agreements/prepayments rolling into or out of the account. While the example we gave is for prepayments – the concept applies equally to all account types.
Automated Journal Entries – By using automated recurring (or sometimes called “standard”) journal entries, the method and focus of the reconciliation can be simplified relying on the consistent design and operation of the automated entry. When reviewing activity posting to an account, use of automated entries can lend new authority to the transaction, reducing need for further review of the posting since it is a “trusted transaction”. The nature of the reconciliation review can then change, focusing on critical operating elements of the automated entry (such as end date/duration) and related change management type controls. The resulting, new nature of the reconciliation, is often much simpler to perform than an end-to-end review of manual journal entries and their data sources.
Closing Accounts – If accounts are no longer being used, they should be blocked from use and/or deleted. The benefit to the reconciliation process is that the list of accounts to monitor is shortened and the risk of improper recording, such as when the account is informally (and inappropriately) repurposed, or inadvertently posted to, is reduced.
Restricting Account Access – Where possible, restricting access to post to an account will limit the opportunities for improper recording from unauthorized, uninformed or inappropriate sources; improving the integrity of reporting and simplifying its reconciliation.
Formalizing Reports – Reconciliation often uses end user reporting (user generated reports) to perform and support the analysis. As noted earlier, this often requires a series of additional steps and controls (i.e. IPE controls) to ensure the integrity of the data throughout the process, lengthening the time required to complete and document the review. Consider formalizing those recurring and regularly used reports so that they are scheduled by the system to automatically run as often as needed. By standardizing the running of the reports and the report parameters used, it can reduce or eliminate the IPE control needs of the reconciliation. Instead, the integrity of the standardized report will addressed through the IT change management process, when or if the report design changes.
HOW WE CAN HELP
We’ve touched on a number of factors that can strengthen your account reconciliations and overall financial reporting process. While these recommendations are conceptually simple – each reporting process is unique with its own challenges, number of moving parts and actors.
To develop and implement these changes we can help you:
- Understand your particular reporting and reconciliation process, identifying, cataloging, categorizing and prioritizing its many inputs and data sources.
- Understand potential (hidden) weaknesses, complexities or opportunities within the current processes.
- And help prioritize an approach to design and implement customized, meaningful changes for your organization. Whether it is helping with the design of specific account reconciliations or the complete reconciliation process, (and even) the financial reporting and close processes.
- Contact us – we’d be happy to be a sounding board for your concerns and share thoughts on possible approaches. Given the importance of the financial reporting process and recent GAAP changes – isn’t it time for a design evaluation?