Back to Basics with Account Reconciliations

Hardly a day goes by when the financial news does not include a report on the impact of some complex instrument or tricky multi-level transaction on a company's financial health. Billions of dollars swing in the balance, tossed about even more by a combination of market forces and emerging valuation techniques.

The resulting financial reporting challenges are significant. They demand cool heads and rational approaches.

These times require a firm application of one of the oldest yet most effective accounting processes at our disposal: balance sheet account reconciliations.

Often relegating account reconciliations to the category of basic blocking and tackling, every new wave of “innovative” transaction structures instead relies upon unnecessarily complex reporting strategies — adding to the likelihood of a restatement.

Yet even the most intricate deals can be addressed without risking reporting issues or the enormous costs associated with reconstructing the underlying scenarios. In fact, any complex financial transaction can be worked through just by using the techniques of account reconciliations.

Just in case it's been a while since you looked at this utility player, account reconciliations is the process of comparing the general ledger balance for a specific balance sheet account with supporting documentation for what the balance “should be.” You ask questions and analyze the valuations, calculations and extrapolations, accruals, application of accounting principles, etc., that could possibly exist around a transaction. The result: You've validated the accuracy of balances — or corrected them by adjusting journal entries.

Since it's such a basic tool, it's mind-boggling that balance sheet account reconciliations have gone the way of the old ledger books. But this didn't happen overnight.

Before Sarbanes-Oxley, many companies had assigned the control to a corrective role, which is why companies were sliding by on last-minute corrections of misstatements the process identified.

Also, now that corporations cannot consult their external auditors, courtesy of SOX, because auditors are obligated to report internal control problems as part of the audit process, corporations must instead use methods that replace the auditor consultation. Account reconciliations is a solution for this reason as well.

In fact, we must consider account reconciliations the primary tool for detecting and correcting errors before the SEC filings are submitted. Yes, with today's lean internal accounting departments, finishing the account reconciliations within internal policy time frames — and with the requisite levels of quality and analysis — could be a nightmare. But this does not justify falling into the trap of simply rolling forward balances from period to period. Although this approach is quicker and in the short term can seem to be an acceptable solution, it is often the cause of a restatement.

CFOs and their teams can neutralize the nightmarish aspects of performing account reconciliations if they can work within best practices like these:

• Formalize a policy for reconciling and reviewing all balance sheet accounts.

• Complete a risk assessment of all balance sheet accounts to determine which should be classified as high-, moderate-, or low-risk-based.

• Designate a regular cycle for reconciling. A monthly basis for high- and moderate-risk-based accounts is best. Low-risk accounts may not need to be reconciled monthly, but should be completed quarterly.

• Complete the account reconciliations by a specific calendar day of the subsequent month.

• Use a standard format across the company for preparing account reconciliations.

• Every reconciliation must contain standard information. Assign one preparer and one reviewer to each balance sheet account.

• Each person assigned to reconciling an account must know and understand the purpose and activity of the account.

• Each person assigned to reconciling an account must know and understand the documentation and analysis required to support and substantiate the respective account balance.

• Each person assigned to reconciling an account must know the source of any required documentation, whether internal or an independent third party.

There are no guarantees, but by employing these practices, there's a lot less risk that the external auditor will find any misstatements or internal control issues in the SEC filings.

Bottom line: It's best to think like an external auditor. Account reconciliation will make it much less likely that you'll find what the auditor would undoubtedly uncover — not to mention the costly filing delays, surprises, and restatements that have dominated the airwaves since the turn of this new century.