For an organization to be a functional, functional, functional entity, the financial statements must be correctly and timely reconciled.
In addition to the importance of accounting for accurate reconciliation of financial statements, you may also require professional auditing services because of the amount of risk involved for errors in your company's calculations.
If you are being audited by an independent third party then you need to make sure that your financial statements are reconciled accurately with tax information reported on forms 1099-MISC and K-1s.
This article will break down why reconciliation is important and what types of reconciliations there are in accounting.
What Is the Importance of Reconciliation in Accounting?
1. Accuracy
If your financial statements are not accurate, you will not be able to make business decisions such as whether to invest money or take out a loan based on inaccurate information. A company's worth will also be undervalued if financial statements are inaccurate.
2. Details
An important value of reconciliation is to provide additional details on the differences between two different versions of the same financial statement (statement of cash flows and income statement).
Reconciling statements is sometimes required to provide additional detail that would otherwise be unavailable for businesses that prepare their tax returns based on financial statements.
3. Security
Many organizations with multiple locations use a centralized database to calculate financial statements. This is used to provide security and prevent errors. The database system can detect when reconciliarization errors occur (and prevent them) in the financial statements.
Reconciliation errors could also lead to large discrepancies between the financial statements of two different locations of the same business entity (an error in one location would be undetected in another location).
What Are Some Types of Reconciliations?
1. Balance Sheet
A balance sheet is a list of assets and liabilities for an organization at a certain point in time (the date you prepare your financial statement). This is an accounting report that every business should prepare.
It is a key document because it provides details on how much cash and how many assets are available to a company. A reconciliation of the balance sheet is done to find the differences between the amounts of assets reported on tax returns and those reported in a financial statement.
2. Statement of Cash Flows
The statement of cash flows shows how cash was used (or generated) by an organization during the year and where it will be used (invested) for future expansion or sales.
This statement also shows what has been invested in capital expenditures (money given to employees or other organizations for the purchase of fixed assets such as buildings, equipment, land, etc. that will last for a long period).
The statement of cash flows does not show what has been spent on inventory items (items that have an expiration date such as food, merchandise, etc.) or money given out in the form of charity, bonuses to employees, and other forms.
3. Income Statement
The income statement is prepared to show where all the money that was earned during the year was spent. It also shows what was taken out as investments in capital expenditures. The income statement is made up of three categories: sales revenue, cost of goods sold, and operating expenses.
What Are Some Errors That Could Result from Reconciliation?
1. Errors on the Income Statement
The income statement shows the income earned by an organization during the year (sales revenue, cost of goods sold, or operating expenses). There are two types of errors that can occur with the income statement: Sales Revenue Errors and Cost of Goods Sold Errors.
Sales Revenue Errors occur when income earned in a given period is not reported as sales revenue for that period.
For example, if a company estimates that it sold 10% more products than it did during a certain period (1 million units instead of 994 million units), then the company's profit would be overstated by 10% (making a hypothetical amount available for use in future periods). The same concept applies to the cost of goods sold.
2. Errors on the Statement of Cash Flows
On reports, the statement of cash flows shows where cash was spent during a specific period and what has been invested in capital expenditures.
Cash receipts are listed under operating activities and cash payments are listed under investing activities. Operating Activities refer to the day-to-day operations of a company like collecting revenue or paying salaries.
Investing Activities refer to the purchase of short-lived, non-productive assets (daily expenses are not considered capital expenditures).
A difference between the two categories would be reconciled to correct errors. For example, if an organization received a large cash payment from its supplier in 2014, but then reported most of that cash as an operating activity in 2015 then you have an error in reconciling your statement of cash flows.
3. Errors on the Balance Sheet
The balance sheet lists assets, liabilities, and owner's equity. An error could be listed on this statement if assets or liabilities are not reported correctly.
For example, if you take out a loan to purchase a car but do not report the car as an asset then you have an error on your statement of cash flows.
Why Is Reconciliation Important for Individuals?
1. Tax Returns
Businesses report all their income earned throughout the year as well as any expenditures that helped generate that income in tax returns (such as charitable donations).
Individuals like to get their taxes done by professionals because they lack the financial knowledge required to accurately complete them themselves.
One of the easiest mistakes to make is to list expenses that were not incurred during the year when those expenses are not dealt with in tax returns (for example, if you spent $400 on your dinner and then listed a deduction of $200 on your tax return in 2015, then you have made an error).
2. Medical/Dental Expenses
You may receive cash back from a medical or dental plan or insurance company as a form of reimbursement. If you do not write it off in your taxes then you have made an error.
It is important to note that federal taxes only apply to employers' contributions and individuals must make these contributions themselves if they are part of a workplace health plan.
3. Retirement Plans
You may contribute money as part of a workplace or individual retirement plans, such as a 401(k) or other IRA (individual retirement account). If you do not list the money in your taxes then you have made an error. Many individuals do not know how to report their contributions on tax returns.
Conclusion
In conclusion, reconciliation is an important step in the accounting process because it ensures that all financial records are accurate and up-to-date.
By reconciling your accounts regularly, you can avoid any discrepancies that may arise and keep your business finances healthy.
Have you tried reconciling your accounts? If not, give it a try and see how much smoother your bookkeeping process becomes.
