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One for Column A

Kathleen B. Wynn is Senior Vice President and Product Manager for Chesapeake’s T-Recs® Enterprise Software and the author of “One for Column A” published in the July/August 2008 issue of AFP Exchange.

Automating Reconciliation for the Entire Balance Sheet

Automating reconciliation used to be an activity limited to Treasury departments, and typically focused on cash accounts. With the advent of Sarbanes-Oxley and other corporate governance standards, automating cash account reconciliation is no longer sufficient. Corporations must implement a repeatable process for reconciling the entire balance sheet. This is often a big challenge for organizations due to the differing nature of the various balance sheet accounts. What works for cash may not work for Fixed Assets, and what works for Fixed Assets may not work for prepaid accounts. What is the best approach to take to meet regulatory requirements, leverage existing processing, and not reinvent the wheel? The good news is that this path has been traveled by many organizations, and there are well defined guidelines and solutions out there for the taking.

Reconciliation is nothing new. Corporations have been required to reconcile activity, both cash and non-cash, for years. Reconciliation almost always starts out as a manual process, involving the proverbial little old lady and lots of different colored highlighters. When the number of accounts, or the volume of activity within the accounts, grows beyond what can be done manually, the move to spreadsheets is a logical one.

Many organizations go to the next level and either build or buy an automated reconciliation system. With this type of solution in place, manual labor and costs are reduced, the focus can be placed on exceptions, and life is good. But the focus of automating reconciliation has been traditionally limited to cash activity. After all, cash is king.

Reconciliation for non-cash activity never seems to have moved beyond the manual or spreadsheet stage. Because so many departments in a company affect non-cash asset and liability accounts, the processes put in place to perform non-cash reconciliations are typically disparate. One department may use a paper process; another department may use spreadsheets. Even when spreadsheets are used by multiple departments, each department creates their own format. Standardization is not the norm. Automating in this environment is difficult, at best. Without the requirement to do so, non-cash reconciliation has remained haphazard and inconsistent.

The Effect Of Sarbanes-Oxley

And then came Sarbanes-Oxley (SOX). This legislation now requires financial controls be put in place for the entire balance sheet, cash and non-cash alike. The “Control Activities” layer of the “Internal Control Framework Over Financial Reporting” created by the Committee Of Sponsoring Organizations specifically cites reconciliation as a required task.

But simply reconciling accounts is not enough for compliance. Some of the other control activities include verification and authorization of the reconciliations. Furthermore, segregation of duties must be enforced at each step. Detailed audit trails of every action taken must be created. Metrics reporting becomes imperative to identify risks, and to prove the financial controls are working. Suddenly, publicly held companies are tasked with putting processes in place to address these requirements. What’s a Corporate Governance Compliance Officer to do?

What Makes Non-Cash Reconciliation So Different?

The first logical step seems to be to extend any automation that has been put in place for cash accounts to non-cash accounts. Is this possible? Maybe. First, the differences between cash and non-cash accounts have to be considered.

Cash account reconciliations, whether deposit or disbursement, share common characteristics. They involve two primary sources of data, the General Ledger and the Bank. Typically, larger volumes of data hit both the General Ledger (or Sub-Ledger) and the Bank on a daily basis. A retailer makes many thousands of deposits every day, and an insurance company disburses thousands of checks every day. This activity must be matched together prior to performing the reconciliation. The reconciliation involves calculating and comparing trial balances (Bank balance adjusted for reconciling GL activity; GL balance adjusted for reconciling Bank activity). Finally, there are usually a lower number of cash accounts, when compared with the total number of accounts on the balance sheet.

Non-cash account reconciliations, on the other hand, generally differ from cash account reconciliations and from each other. Non-cash account reconciliations may involve one, two, or more data sources. There may be very low volumes of activity hitting these accounts, and the activity may occur very infrequently. Prepaid software maintenance accounts, for example, may only incur one entry per month or per year. There may be no matching required at all. Maybe the reconciliation only involves justifying an account balance. Or, because activity is low and infrequent, a company may choose to just compare balances, and only if there is a difference is the detailed activity considered. There may be many thousands of non-cash accounts to be reconciled.

Recognizing these differences, can an existing automated account reconciliation solution that was originally implemented for cash accounts be used for non-cash account reconciliations?

Evaluating Reconciliation Solutions

In trying to answer this question, another question goes hand in hand. Does the existing automated cash account reconciliation meet SOX requirements? Maybe modifications to that solution, or a replacement solution, are needed.

In examining the existing solution, or in looking for a new solution, consider these factors:

Does the solution only match data?

When an organization takes on the task of building a reconciliation solution, the first take is often a simplified one. Reconciliation? That means matching, right? Many in house solutions are just matching engines. The actual reconciliation between the GL and Bank balance is still performed manually, often within a spreadsheet. An automated reconciliation solution needs to do both. It needs to match data, and it needs to produce the reconciliation. This problem is not limited to in house solutions. Many vendor solutions on the market only match data, or only produce the reconciliation. Again, any solution implemented within an organization must both match and reconcile within a single application.

Does the solution provide exception management?

Anyone familiar with reconciliation understands that the real work involves researching the transactions that did not match. Reporting on exception items is a start, but the best systems provide automated exception management. Automated alerts, escalation procedures, and creation of journal entries are just a few of the features a good automated reconciliation system will include. This is a more critical requirement for cash accounts, but is still an important consideration for certain types of non-cash accounts.

Does the solution provide different reconciliation templates?

Different types of reconciliations require different reconciliation formats. A cash account reconciliation requires a comparison of adjusted GL and Bank balances. A GL to Sub-Ledger reconciliation requires a similar two-way comparison. A prepaid account reconciliation requires a format that shows the detailed activity justifies the GL balance. To speed the process for low volume, but high in number accounts, a format that simply compares balances makes more sense. The final automated reconciliation solution chosen should provide various reconciliation templates, and should allow for customization at the reconciliation level. Selection of fields, subtotal flexibility, sort order, and other display options is critical in using one system for the entire balance sheet.

Does the solution provide a review and approval process?

Again, many in house and vendor solutions, especially if implemented pre-SOX, only match and/or reconcile data. SOX now requires that a review and approval process be put in place. Very few organizations have taken the step to add a review and approval process to their in house solution. Some vendor solutions now offer these capabilities. When evaluating review and approval capabilities, ensure that the system offers flexibility in customizing the workflow process to your specific needs. Many solutions provide only pre-defined processes, with no accommodation for differing requirements. The ideal solution will also offer automated alerts for reconciliations that are due, overdue, or ready to be approved. A good review and approval workflow will enforce segregation of duties, ensuring that the reviewer and approver are not the same person. Creation of detailed audit trails every step of the way is crucial. Finally, for those high number of non-cash accounts, look for automatic and mass approval capabilities, as well as roll-up capabilities, so only the reconciliations that fall outside of pre-defined parameters have to be individually reviewed and approved.

Does the solution provide metrics dashboards and reporting?

Metrics reporting is critical for SOX compliance. The better solutions will provide both summary reporting, to highlight potential areas of material weakness, and detailed reporting, to attest to the effectiveness of the financial controls. Management and auditors should be able to access graphical metrics dashboards at any time, to ensure targets are being met, and the reconciliation process is on track. These capabilities are even more valuable if they enable data to be grouped in any user defined manner. The CFO should be able to view metrics by cost center, for example, while the audit staff should be able to view metrics by individual user.

Does the solution support multi-currency and multi-language?

For global organizations, being able to reconcile in any currency and across currencies is a must. If your organization has operations in multiple countries, look for a solution that can easily display screens and reports in any language, particularly languages that require multi-byte characters, such as Japanese.

If your existing cash account reconciliation system provides these features, it should support the reconciliation of both cash and non-cash accounts, while ensuring compliance with SOX and other corporate governance requirements. If your existing solution falls short, these are the areas to focus on when designing any in-house solution, or when evaluating vendor solutions.

Implementation Strategies

Once a good solution is identified, the next challenge is to implement the solution for the non-cash accounts. Ideally, a single standardized process can be defined for all accounts, cash and no-cash. In reality, this is often not possible. A single process may be able to be put in place for all the cash accounts, but the non-cash accounts often different significantly. So, a strategy of identifying sub-groupings of non-cash accounts is often the next best approach.

Look for common characteristics among sub-groups of non-cash accounts. For example, how many of the GL to Sub-Ledger reconciliations have very low volumes of activity? These may qualify for a high level reconciliation approach: compare the GL balance to the Sub-Ledger balance initially, and only if there is a difference, move to a detailed level. The GL to Sub-Ledger reconciliations that require a detailed process often can use the same process that is being used for the cash accounts. After all, a GL to Sub-Ledger reconciliation and a GL to Bank reconciliation are both types of reconciliations that involve reconciling a GL account to an independent source. Another grouping may only involve justification of a GL balance. Many organizations are able to categorize their non-cash account reconciliations into three or four sub-groupings. This approach yields a major benefit: cross training. Once a staff member is trained on one sub-group process, they are able to reconcile any other account in the same sub-grouping.

Once the processes are established, the accounts need to be added to the identified solution. A key element of long term success involves being able to automate the addition of accounts to the reconciliation solution. This allows accounts to be automatically added to the reconciliation solution as the accounts are added to the General Ledger. Ensure that a control is in place to identify any accounts on the General Ledger that have not been assigned to the reconciliation process. This is a critical audit requirement.

Another strategy to cut down on manual labor is to automate the verification of reconciliations meeting baseline criteria. For example, if an account has had no activity since the last reconciliation was performed, and the account has no reconciliation activity over ninety days old, the reconciliation solution should be set up to automatically approve the reconciliation. This allows your staff to focus on only the reconciliations that require manual review.

Automating reconciliation for the entire balance sheet is not something that should be avoided. Current regulatory requirements demand financial controls involving reconciliation, so any work undertaken to automate the process will only pay off in the long run. It will not necessarily be a quick process, but it does not have to be a painful one.