Don’t Neglect Account Reconciliation and Analysis in Audits

GUEST BLOG
Account reconciliations and analyses are often misunderstood and thought of as routine, low level activities which add little value. On the contrary, they are important activities in the financial closing process. Indeed, reconciliations are a key internal control activity and are instrumental in identifying accounting errors and omissions, including fraud, and ensuring the accuracy and completeness of financial information.

Savvy internal auditors know that general ledger account reconciliation observations are very common with areas of improvement being timely preparation and review, providing quality support, avoiding errors, and clearing aged reconciling items. Findings around account reconciliations and analyses are often leading indicators to more serious internal control weaknesses in financial reporting, and yet finance managers often do not embrace and remediate them as soon as possible. Some finance managers push back on such findings often citing lack of materiality. I find such reactions disheartening and perplexing.

Account Reconciliation vs. Account Analysis
Although they have the same ultimate objective—to ensure the account is complete, accurate, and supported, and to explain the balance—reconciliation and analysis are different. Reconciliation compares two sets of data, for example the general ledger and subsidiary ledgers (such as accounts receivable and accounts payable) or external data (such as bank and investment accounts); while analysis includes the thorough review of the account of subsidiary ledger activity.

Account analysis differs from analytical review, which compares and explains changes in revenue, costs and expenses, and other metrics between current and prior period actuals, and between budgeted and forecasted amounts. Analytical review deals primarily with material changes, unless management assigns lower variance thresholds (precision) to trigger review and provide explanations.

Basic account reconciliations involve comparing the general ledger and the subsidiary ledger to ensure that the general ledger activity and closing balance agrees with the detail and is complete and accurate. Examples include: billing and accounts receivable system, accounts payable, inventory management, fixed assets, and depreciation.

Accounts requiring judgment and estimation are best suited for analysis. Examples include customer rebates, sales returns and allowances, goodwill impairment, pensions, taxes, share based compensation, and others. For example, the customer rebate analysis should include looking at rebates paid and estimating those earned in the period factoring contractual terms. The ending balance of the account would represent earned rebates due to customers.

To analyze long-lived assets, a “roll forward” showing the change in activity and agreeing to the long-lived assets detail and account balance works well. If a subsidiary fixed asset system is used, the roll-forward should agree to the subsystem. I find this layout useful because it can be agreed to the opening balance, current period additions, disposals and adjustments, current period depreciation and the closing balance, and net book value by asset class. Adding variances (amounts and percentages) to show change from prior month, prior year, and capital budget will enable identifying errors in depreciation.

I prefer reconciliations and account analyses when they tell the “story” of an account. They connect numbers to business activities and provide explanations to ultimately enable those relying on financial information to make informed decisions. Because of their importance, they should be assigned to internal audit team members with experience in accounting and the company business, as well as those with intellectual curiosity, analytical and research skills, and the ability to synthesize information.

Best Practices in Account Reconciliation
To improve the account reconciliation process and related controls, adopt the following best practices:

1. To help balance limited resources and time constraints stratify the risk profile of general ledger accounts using high, medium or low ratings. Calculate risk profile using key criteria such as: account volume, complexity, materiality, judgment used, routine vs. non-routine transactions, systems involved, and other considerations. Complete high and medium risk account reconciliations monthly but always prior to finalizing the closing and publishing the financial statements. Low risk accounts can be completed quarterly or even semi-annually and even after the closing as adjustments will not be material.
2. Provide work instructions or Standard Operating Procedures (SOP) to employees on how to prepare and document them and a standard reconciliation template to ensure consistency. Ensure that employees review and understand material system transactions posted to the general ledger and manual journal entries to ensure that they have business rationale, are valid, are fully supported, and were posted in the right accounting period. The analysis should include re-performing calculations to ensure that the account balance is accurate. Consider that a reconciliation that just repeats the general ledger account activity adds zero value.
3. Assign each account to a preparer and a reviewer along with guidance relating to their role and responsibility, rotating them periodically so that the teams get exposure to all accounts.
4. Allow preparers and reviewers sufficient time to complete the respective activities; rushing through the work is counterproductive and neglects its importance.
5. Complete reconciliations after all the standard closing entries have been entered but before analytical review. This will improve the quality of analytical review as the financial data will be complete and qualitative.

Emphasize Internal Control
For internal control purposes, it is very important to have robust documentation to evidence control operation and segregation of duties between preparation and review. For most companies, account reconciliations are classified as key, preventive internal controls—some practitioners even consider them a “management review control.” Regardless, because of their importance, reconciliation controls need to include specific steps taken by the reviewer to complete the review, the precision criteria related to investigation triggers (such as variances, qualitative factors, or a combination), evidence of the review beyond mere signature and date, and documentation requirements. Being preventive, reconciliations need to be completed prior to the filing of financial statements so that material adjustments, if any, will be recorded prior to filing.

Several companies offer great software that help preparers and reviewers semi-automate and support account reconciliation preparation, review, and recordkeeping. Today, software can carry forward opening balances, automatically populate account activity and help with reconciliation evidencing and support. I do not believe that today’s software can actually perform the reconciliations or analyses automatically for the client, there is still need for accountants to go through every material transaction manually to understand, investigate, reconcile, and provide evidence. But today’s software offers improvements in task management and documentation requirements.

Take advantage of automation offerings but remember to follow the best practices, incorporate the reconciliation control and process in the monthly closing schedule, train employees on new technology, and praise employees for a job well done. Reconciliations are not a low level activity! Internal audit departments that place the required importance on them will help improve the financial closing process, deter fraud, and ultimately add value to the organization. 

Chris Dogas, CPA, CFE, CRMA is the VP of Internal Audit, North America at IPL Global. He is the founder of AS GRC Consultants LLP, which provides corporate governance services. Contact him at chrisdogas@asmgtc.com.