What Is Reconciliation in Accounting?
Reconciliation in accounting is the process of reconciling the balance between two different sets of documents.
For example, when you complete a bank reconciliation, you’re reconciling your ending bank balance with your ending general ledger balance to ensure that the two totals match, while finding and resolving any discrepancies found during the reconciliation process.
But before beginning the reconciliation process and focusing on the different types of reconciliations that should be completed, you’ll first need to understand the following accounting terms, including what they are and how they differ.
Debits and Credits
Debits and credits are truly the backbone of the double-entry accounting system, which states that every debit entry must have a corresponding credit entry for the books to remain in balance.
DEBITS (DR) | CREDITS (CR) |
---|
Debits are always recorded on the left side of the general ledger | Credits are always recorded on the right side of the general ledger |
A debit entry will increase the balance of both asset and expense accounts and will decrease the balance of liability, revenue, or equity accounts. | A credit entry will increase the balance of liability, revenue, or equity accounts, and will decrease the balance of asset and expense accounts. |
Though you may not see the process if you’re using accounting software, because this is generally automated, if you enter a debit to an account you will have to enter a corresponding credit for the account to remain in balance.
For example, when you pay your utility bill, you would debit your utility expense account, which increases the balance and credit your bank account, which decreases the balance.
Cash and Accrual Accounting
Cash and accrual accounting methods have many differences.
Cash accounting is the easiest way to manage your accounting, and provides a better picture of your cash flow, but is only a suitable method for very small businesses.
Accrual accounting is more complicated but provides a better insight into the financial health of your business. There are significant differences between these two methods.
CASH BASIS ACCOUNTING | ACCRUAL BASIS ACCOUNTING |
---|
Revenue is recorded when cash is received | Revenue is recorded when cash is earned |
Expenses are recorded when they are paid | Expenses are recorded when they are incurred |
Taxes are paid on cash that has been received | Taxes are paid on income earned, even if not yet received |
Not allowed under GAAP rules | Necessary for businesses that follow GAAP rules |
While very small businesses can use cash basis accounting, if you have employees or have depreciable assets, you’ll need to use accrual basis accounting.
Balance Sheets
Balance sheets and profit and loss statements are both essential resources for determining the financial health of your business.
A balance sheet is used for determining what a business owns (assets) and what it owes (liabilities). A balance sheet also displays owner equity, which is part of the accounting equation of:
assets = liabilities + owner’s equity
Balance sheets and profit and loss statements are both essential resources for determining the financial health of your business.
Profit and Loss Statements
A profit and loss statement, also known as an income statement summarizes revenue and expenses that have been incurred during a specific period.
A profit and loss statement displays revenue earned for that period, then subtracts the cost of goods sold, interest expense, and other operating expenses from the revenue to determine net income for the period.