The Balance Sheet Explained

The Balance Sheet Explained (full video transcript)

Introduction

If you're a business owner and have not studied accounting but want to understand your balance sheet, this video is for you.

As you may know, the balance sheet is one of the primary financial statements used to understand the financial position of a business.

In plain English, it answers three basic questions: what does the business own, what does it owe, and what is left for the owners?

Unlike the income statement, which covers a period of time, the balance sheet is a snapshot taken at a specific date.

In this video, we'll walk through the major sections of the balance sheet and, more importantly, what a small business owner should actually look for when reviewing it.

What the Balance Sheet Tells You

The first thing to understand is that the balance sheet reports the financial position of a business at a specific point in time.

If the report says December thirty-first, the numbers represent the company's financial position as of that date.

And "numbers represent" means the ending balance of all accounts on the balance sheet, on that date.

The balance sheet is divided into three broad categories: assets, liabilities, and owners' equity.

For each of these categories, an extensive number of videos could be produced and textbooks have been written to cover all of the details.

So this video just barely scratches the surface.

But for now, just know that those categories form the basic structure of the balance sheet.

Assets are economic resources controlled by the business.

For a typical small business, that might include cash, customer receivables, inventory, equipment, or other resources expected to provide future economic benefit.

Assets normally carry a debit balance and informally, can be defined as what is owned by the business.

Assets — FASB Definition

Technically, assets are defined by the FASB Conceptual Framework as a present right of an entity to an economic benefit

It's probably easier to just remember assets as what the business owns.

What the Balance Sheet Tells You

Liabilities are obligations of the business and normally carry a credit balance.

Informally, liabilities can be interpreted as what is owed by the business.

Accounts payable, accrued expenses and payroll, taxes payable, debt including credit lines, and bank loans are all common examples.

Liabilities — FASB Definition

For those who want to know, the FASB Conceptual Framework defines liabilities as a present obligation of an entity to transfer an economic benefit.

Or more simply, what the business owes.

What the Balance Sheet Tells You

Equity is the residual interest belonging to the owners after liabilities are deducted from assets.

It is important to understand that equity is an accounting measure. It is not necessarily the market value of the business, and it is definitely not the same thing as cash available to the owner.

Equity normally carries a credit balance.

The Accounting Equation

The entire balance sheet is built around one relationship: assets equal liabilities plus equity.

This is the accounting equation.

Every properly recorded transaction preserves that relationship.

That is why the two sides of the balance sheet remain in balance.

Borrowed money increases both cash and liabilities.

Suppose the company borrows fifty thousand dollars from a bank.

Cash increases by fifty thousand dollars, so assets increase.

But the company also owes the bank fifty thousand dollars, so liabilities increase by the same amount.

Profit generally increases equity because earnings retained in the business become part of the owners' residual interest.

The close process that transfers profit or loss from the income statement to equity is out of scope for this video, but it is one of the major links between the income statement and the balance sheet.

Owner distributions generally move in the opposite direction.

When value is distributed to an owner, equity is reduced even though the distribution itself is not normally an operating expense on the income statement. A distribution normally from cash would decrease or credit assets and decrease or debit equity.

The Operating Cycle

The operating cycle is defined as the average time intervening between the acquisition of materials or services and the final realization of cash.

Think about the normal flow of the business. A company spends money to buy inventory, materials, or services. It then uses those resources to generate revenue, bills the customer, and eventually collects the cash.

That entire process is the operating cycle.

When we talk about whether something belongs in the current section of the balance sheet, the operating cycle helps us make that determination.

When the normal operating cycle is less than one year, a one-year period is used to distinguish current assets from non-current assets.

For most small businesses, that means the current section of the balance sheet will generally include assets expected to be converted to cash, sold, or used within the next twelve months.

When the normal operating cycle exceeds one year, the operating cycle will serve as the proper period for purposes of current asset classification.

Some businesses naturally have longer cycles.

A contractor on a long project, for example, may spend money today and not collect the final amount from the customer until well over a year later. The same thing can happen in manufacturing or other businesses with longer production or billing cycles.

Understanding the operating cycle will make the next section easier to follow as we move into the individual components of the balance sheet.

Understanding Assets

Assets are commonly presented in order of liquidity, beginning with current assets.

Under U.S. GAAP, current asset classification generally captures cash and other assets expected to be realized, sold, or consumed during the normal operating cycle, subject to the specific guidance that applies to the account.

For many small businesses, the main current assets are cash and cash equivalents, short-term investments, accounts receivable, inventory, and prepaid expenses.

Each tells the owner something different. Cash is immediately available. Receivables still have to be collected. Inventory still has to be sold.

Long-term assets generally include resources expected to benefit the business beyond the current operating cycle.

Restricted cash, long-term receivables and investments, tangible assets (land), Property, machinery, computers, vehicles are common examples, although the accounting for each category is governed by its own applicable GAAP guidance.

Depending on the lease arrangement, the balance sheet may also include a right-of-use asset.

This represents the company's right to use leased property or equipment over the lease term.

So even though the business may not own the underlying asset, the lease can still create an asset on the balance sheet under U.S. GAAP.

Depreciable assets are generally presented net of accumulated depreciation.

Accumulated depreciation is not a pile of cash that has been set aside to replace equipment.

It represents the cumulative depreciation recognized on the related assets over time and is a contra account to Property, Plant, and Equipment.

A contra account is used to reduce or offset the balance of a related account and normally carries a balance opposite to that account.

Because Property, Plant, and Equipment normally carries a debit balance, accumulated depreciation normally carries a credit balance.

As depreciation is recorded each period, Depreciation Expense is debited and Accumulated Depreciation is credited. The expense appears on the income statement, while accumulated depreciation builds on the balance sheet and reduces the carrying amount of the related assets.

This is where depreciation can sometimes become confusing.

Just remember that accumulated depreciation is reported on the balance sheet and represents the total depreciation recorded on the asset over time.

Depreciation Expense, on the other hand, is reported on the income statement and reflects only the depreciation recognized for the current period.

Real or Permanent Accounts

This is the perfect time to segue into a quick discussion about real and nominal accounts.

Balance sheet accounts are traditionally called real or permanent accounts. This means that their balances carry forward from one period to the next. Which makes perfect sense because if a cash account has a balance of one thousand dollars on December 31st, and assuming there are no transactions overnight, that same account will still have a balance of one thousand dollars on January 1st.

So in the case of accumulated depreciation, the same concept applies. The balance is cumulative and carries forward from year to year. Generally, the balance remains on the books until the related assets are disposed of.

Nominal or Temporary Accounts

ncome statement accounts are different and are traditionally called nominal or temporary accounts.

heir balances are closed at the end of the accounting year into the appropriate equity account, such as retained earnings for a corporation.

nd while the income statement and the close process are not in the scope of this video, understanding this distinction is important when we talk about the balance sheet.

here the balance sheet represents the financial position of an entity at a specific point in time, the income statement represents financial performance over a period of time.

o revenue and expense accounts do not carry their balances forward indefinitely. At the end of the year, those temporary accounts are closed to zero so that the next year's income statement starts fresh and measures only the activity of the new period.

Understanding Assets

In any case, to wrap up our discussion on assets, the key point is that a company can report a large amount of total assets and still have a cash problem.

Twenty thousand dollars of cash and three hundred thousand dollars of equipment is very different from having three hundred twenty thousand dollars available to pay next week's bills.

Cash is king, and liquidity is key.

Liabilities and Equity

Liabilities are displayed in the order of expected payment.

Obligations are classified as current if their liquidation is reasonably expected to require the use of existing resources properly classified as current assets or to create other current obligations.

Current liabilities also include obligations that are due on demand or that are callable at any time by the lender and are classified as current regardless of the intent of the entity or lender.

Current liabilities include accounts payable, trade notes payable, accrued expenses, dividends payable, advances and deposits, agency collections and withholdings including payroll liabilities, sales or income taxes payable. Current liabilities also include credit cards, lines of credit, and the current portion of long-term debt and lease obligations.

Non-current liablities are obligations that are not expected to be liquidated within one year or the current operating cycle if longer.

These include notes and bonds payable, related lease obligations, certain financial instruments, contingent obligations, and other non-current liabilities related to pension and post-employment obligations and deferred taxes.

These are well beyond the scope of this video and many small businesses will not carry many of these balances.

But owners should pay particular attention to the portion of long-term debt that becomes due within the next year because that amount can affect near-term liquidity.

Equity reflects the owners' financial interest in the company.

Depending on the legal structure, it may include contributed capital, retained earnings or accumulated earnings, and distributions or withdrawals.

One of the most common misconceptions is that retained earnings represents cash sitting somewhere in the business.

It does not.

A company may have accumulated substantial profits over many years and used that money to buy equipment, repay debt, build inventory, or make distributions. The equity remains part of the accounting history even though the cash may be long gone.

How a Business Owner Should Read the Balance Sheet

For a business owner, the balance sheet becomes much more useful when you stop looking at it as simply a list of account balances and start reading it as a management report.

I would begin with liquidity. In other words, does the business have enough readily available resources to meet the obligations coming due in the near future?

Start with cash, but don't stop there. Look at the other current assets and ask how quickly they can realistically turn into cash.

One hundred thousand dollars of accounts receivable is not the same as one hundred thousand dollars sitting in the bank. The receivables still have to be collected. Inventory still has to be sold. And prepaid expenses, even though they may be classified as current assets, generally aren't going to provide cash to pay next week's payroll.

Then look at the other side of the equation. What bills, payroll obligations, taxes, loan payments, lease payments, and other liabilities are coming due?

That comparison begins to tell you much more about the company's short-term financial position than simply looking at the total assets at the bottom of the page.

Accounts receivable deserves its own review because the total balance by itself can be misleading.

Suppose accounts receivable increased from one hundred thousand dollars to one hundred fifty thousand dollars. At first glance that may look like good news, especially if sales are increasing. But now look at the aging schedule.

If most of that increase is sitting in the current or thirty-day columns, there may not be much concern. If a large portion has moved into sixty, ninety, or more than ninety days past due, the story changes. Sales may be growing, but collections may be slowing down at the same time.

That is why an accounts receivable aging is so useful. It gives you information that you simply cannot get from the balance sheet total alone.

You should also look at who owes the money. A hundred thousand dollars spread among fifty customers creates a very different risk than a hundred thousand dollars owed by one customer.

And from an accounting standpoint, the older and less collectible those receivables become, the more important it is to consider whether the allowance for expected credit losses properly reflects what the company actually expects to collect.

So when you review receivables, don't just ask, "How much are we owed?" Also ask, "How old is it, who owes it, and how much of it are we realistically going to collect?"

Next, take a good look at debt and other significant obligations.

Knowing the total amount the company owes is important, but it is only part of the story.

You also need to know when those amounts are due.

A five-hundred-thousand-dollar loan that does not mature for several years creates a very different short-term cash requirement from a five-hundred-thousand-dollar obligation coming due next month.

For an amortizing loan, part of the balance may be classified as current because that principal is scheduled to be paid during the coming year, while the remaining amount stays in long-term debt.

We'll discuss account reconciliations later, but this is also a good place to compare the accounting records with the lender statements and amortization schedules.

The loan balance should make sense, the current portion should be properly classified, and the required payments should be understood before they become a cash-flow surprise.

The same general thinking applies to significant lease obligations.

And don't overlook loan covenants. A company may have plenty of time remaining before a loan matures, but a covenant violation can affect how that debt is classified and, more importantly from the owner's standpoint, can change the company's relationship with its lender very quickly.

Once you've looked at the individual pieces, working capital gives you a useful high-level view.

Working capital is simply current assets minus current liabilities.

If the company has five hundred thousand dollars of current assets and three hundred fifty thousand dollars of current liabilities, it has positive working capital of one hundred fifty thousand dollars.

That's useful information, but don't stop there.

Ask what that one hundred fifty thousand dollars is actually made of.

If most of the current assets are cash and good receivables that normally collect within thirty days, the company may have fairly strong liquidity.

But suppose most of those assets consist of old receivables, slow-moving inventory, and prepaid expenses. The working-capital calculation could be exactly the same, while the company's ability to pay its bills could be very different.

This is why ratios such as the current ratio or quick ratio can be helpful, but they should never replace actually understanding the accounts behind them.

A ratio can tell you where to look. It cannot tell you the whole story.

Finally, don't review a balance sheet in isolation.

Compare it with prior months, prior years, and, when appropriate, the company's budget or expectations.

The trend is often more informative than the number itself.

If cash has been falling for six months, receivables have been climbing, accounts payable is getting older, and the line of credit keeps increasing, those individual balances are beginning to tell a story about the business.

Likewise, if receivables are growing because sales are growing, collections remain strong, debt is declining, and cash is building, that tells a very different story.

And this is also why the financial statements need to be read together.

The balance sheet tells you where the business stands at a particular point in time.

The income statement tells you how the business performed over a period of time and helps explain changes in equity.

And the statement of cash flows explains how operating, investing, and financing activity affected cash.

No single financial statement gives you the entire picture.

In the next video in this series, we'll move from financial position to financial performance and take a closer look at the income statement.

Account Reconciliations

A discussion about the balance sheet would not be complete without talking about Account Reconciliation, which is really just the methodology used to "Prove the Balance".

Formally, an account reconciliation is the process of substantiating a general ledger balance by comparing it to independent or authoritative supporting data, investigating differences, and resolving or properly documenting those differences.

The important point here is that the balance being reconciled is the cumulative ending balance in the general ledger as of the reconciliation date.

Recall from our earlier discussion that balance sheet accounts are permanent, or traditionally called real accounts. Their balances carry forward from one accounting period to the next.

Because of that, the reconciliation must address the entire ending balance, not simply the activity that occurred during the current month.

The objective is to show that the cumulative balance reported in the general ledger is supported as of the reconciliation date.

Independent Support — Current Assets and Liabilities

The next couple of slides will provide some examples of independent support. Of course, this is not an exhaustive list and will vary by business but the following are the most prevalent.

For cash, the most common supporting document is the bank statement.

The bank statement gives us an external record of the account balance and activity, which can then be compared with the general ledger through the bank reconciliation process.

The goal is not simply to make the numbers match. Outstanding checks, deposits in transit, bank fees, errors, and other reconciling items should be identified and understood.

Accounts receivable is usually supported by the detailed accounts receivable aging or customer subledger.

The total of that detailed report should agree to the accounts receivable control account in the general ledger.

And the aging gives us something the general ledger balance alone cannot provide. It shows which customers owe the money and how long those balances have been outstanding.

That becomes especially important when evaluating whether older receivables are still collectible.

Accounts payable works much the same way.

The accounts payable aging or vendor subledger provides the detail behind the general ledger balance and should reconcile back to it.

This also gives management a chance to identify old unpaid invoices, duplicate bills, unapplied vendor credits, or other items that may need attention.

Again, the balance sheet gives us the total. The supporting schedule tells us what makes up that total.

Credit card liabilities are generally reconciled to the actual credit card statement.

The statement provides third-party support for the amount owed and helps confirm that charges, payments, credits, fees, and interest have all been recorded properly.

This is particularly important because credit card accounts often contain a high volume of transactions and can easily accumulate small recording differences over time.

Debt balances should be supported by lender statements or, when appropriate, a reliable amortization schedule that agrees with the underlying loan terms.

The reconciliation should confirm not only the total amount owed, but also whether principal and interest have been recorded correctly and whether the current portion of long-term debt has been properly classified.

A loan balance can look reasonable in the general ledger and still be wrong if payments were posted incorrectly or if interest was recorded as principal.

Independent Support — Other Balance Sheet Accounts

Inventory should be reconciled to the detailed inventory records maintained by the business, such as the inventory subledger, perpetual inventory system, or physical inventory count records.

The total of those records should agree to the inventory balance in the general ledger.

For businesses that maintain significant inventory, physical counts are also an important control because they help confirm that the quantities recorded in the accounting system actually exist.

Differences can arise from shrinkage, damaged or obsolete inventory, receiving or shipping errors, incorrect unit costs, or transactions that were not properly recorded.

So, just like accounts receivable or fixed assets, the general ledger gives us the total inventory balance, while the supporting records explain what makes up that balance.

Fixed assets are generally supported by a fixed asset register.

That register should provide the detail behind the balance sheet accounts, including the assets owned by the company, their original cost, acquisition dates, accumulated depreciation, and net book value.

The register should reconcile to both the fixed asset accounts and accumulated depreciation in the general ledger.

It should also be reviewed for assets that have been sold, scrapped, or otherwise disposed of but may still be sitting on the books.

Payroll liabilities should be reconciled to payroll system reports and, where applicable, filed payroll tax returns.

These accounts can include employee withholdings, employer payroll taxes, benefit deductions, and other amounts that have been accrued but not yet paid.

Because many of these balances represent money owed to employees, taxing authorities, or benefit providers, unexplained differences should not be allowed to accumulate from one period to the next.

Sales tax payable should be supported by the underlying sales tax reports and the returns filed with the taxing authorities.

The balance in the general ledger should represent amounts that have been collected from customers but have not yet been remitted.

If the accounting records, sales reports, and filed returns do not agree, the difference needs to be investigated.

This is a good example of why simply looking at the general ledger balance is not enough. The liability should be tied back to the activity that created it.

Lease obligations should be reconciled to the schedules used to account for the leases, whether those schedules come from dedicated lease accounting software or another controlled calculation.

Those schedules support both the lease liability and the related right-of-use asset.

They should reflect the lease terms, payment schedule, interest or discounting calculations, and the division between current and long-term portions of the liability.

As with debt, the important point is that the balance in the general ledger should agree to a detailed schedule that explains exactly how that amount was determined.

Monthly Rollforwards

Let's spend a couple of minutes talking about something that is often mistaken for a balance sheet reconciliation but, by itself, does not meet the objective of one.

That is the monthly rollforward.

A rollforward explains how an account moved from its beginning balance to its ending balance.

It may show additions, reductions, adjustments, or even every transaction recorded during the month.

That information can certainly be useful.

The problem occurs when the rollforward is treated as the reconciliation itself.

A rollforward tells us what changed during the current period.

It does not, by itself, substantiate the entire ending balance against a bank statement, aging schedule, subledger, lender statement, fixed asset register, or other independent or authoritative support.

And that can leave a business at risk.

Look at the example on the slide. We begin with a balance of two hundred twenty thousand dollars. We then explain the activity during the month and arrive at an ending balance of two hundred forty-five thousand dollars.

The rollforward explains the movement between those two numbers.

But what has substantiated the original two hundred twenty thousand dollar beginning balance?

That is where the real risk can exist.

If that beginning balance has simply been carried forward month after month without ever being reconciled to supporting documentation, we may have no idea what is buried inside it.

Maybe it contains an old error.

Maybe an expense that should have been recorded on the income statement was incorrectly posted to an asset account.

If that mistake is never identified, the asset can remain overstated month after month and potentially year after year simply

because each new reconciliation begins with the previous month's ending balance.

A properly performed reconciliation forces us to substantiate the entire ending balance. If an old error is discovered, the accounting records then have to be corrected based on the nature of the error and the period in which it originated.

And depending on the size of that error, the effect on the financial statements could be significant or even material.

So if you're a business owner and your balance sheet reconciliations consist only of monthly rollforwards, that deserves immediate attention.

The rollforward can still be part of the reconciliation process.

But it should not replace the process of substantiating the full ending balance and resolving unsupported or unexplained amounts.

If opening balances have been carried forward without proper support, those accounts should be reviewed carefully before management relies on the financial statements.

Risk-Based Reconciliations

Not every balance sheet account carries the same level of risk, so a good reconciliation policy should not treat every account exactly the same.

A practical approach is to classify accounts as high, medium, or low risk.

That classification should consider more than just the dollar balance. Materiality matters, but so do transaction volume, complexity, the amount of judgment involved, exposure to fraud or misuse, and whether the account has a history of errors.

Cash is a good example. Even if the balance is not especially large, cash is highly liquid, usually has significant transaction activity, and is more susceptible to error or misuse. That would generally support a higher-risk classification.

Once the risk level is established, that risk should help determine how often the account is reconciled.

Higher-risk accounts are generally reconciled more frequently, often monthly.

Lower-risk accounts with little activity, limited judgment, and a stable history may be appropriate for quarterly reconciliation.

The important point is that the frequency should reflect the risk of the account, not simply follow the same schedule for every balance on the general ledger.

And for certain high-volume accounts, such as cash clearing or payment settlement accounts, even monthly reconciliation may not be frequent enough.

With account reconciliation software readily available, it is not uncommon to see certain high-risk accounts, particularly large volume cash accounts, with a daily reconciliation requirement.

Timing and tolerances are also part of a strong reconciliation policy.

Saying that an account must be reconciled monthly is not very useful if the reconciliation is completed several months late.

The policy should establish a clear due date after the end of the reporting period so that errors are identified while the financial statements are still relevant.

It should also define when a difference has to be investigated.

A small rounding difference may not require the same level of attention as a large unexplained variance, but the threshold should be established in advance rather than decided differently each month.

Taken together, risk classification, reconciliation frequency, due dates, and investigation thresholds help turn account reconciliation from a routine bookkeeping task into a meaningful financial control.

Reconciliation Criterion 1 — Description and Purpose

We'll wrap up this video on the balance sheet by reviewing the seven account reconciliation criteria that should form part of a strong reconciliation process for organizations of any size.

An effective account reconciliation policy should address all seven of these areas consistently.

The first criterion is Description and Purpose.

Every reconciliation should clearly explain what the account represents and why it exists. This should go beyond simply restating the account title or adding a short generic sentence.

The description should identify the specific nature of the account. For example, if the account relates to cash, it should identify the particular bank account being reconciled. This is also a good place to document the account's risk classification and how frequently the reconciliation is required.

For more complex accounts, the description may need additional context. That could include a brief explanation of the underlying process, references to supporting schedules, or even a simple process map or flowchart when that helps explain how the balance is created.

The reconciliation does not need to become a full accounting procedure manual. But the description should be detailed enough that a knowledgeable reviewer can understand what the account is, what activity flows through it, and what the reconciliation is intended to substantiate.

Reconciliation Criterion 2 — General Ledger Balance

The second criterion is the General Ledger Balance.

For balance sheet accounts, what we are reconciling is the full cumulative ending balance as of the reconciliation date, not simply the activity recorded during the current month.

On the slide, I use the phrase Year-to-Date General Ledger Balance because it helps reinforce that we are looking at the entire balance carried forward through the current period.

Technically, though, the more precise description is the ending or cumulative general ledger balance as of the reconciliation date.

That distinction matters because as discussed, a rollforward may explain only the current-period activity, while a proper reconciliation must substantiate the full balance reported in the account.

Reconciliation Criterion 3 — Independent or Authoritative Support

The third criterion is independent or otherwise authoritative support, which we have discussed throughout this video.

By this point, it should be clear that simply exporting a list of transactions from the general ledger does not provide independent support. That report is coming from the same accounting records we are trying to substantiate.

The same principle applies to an adjusting journal entry. Even if the entry has been reviewed and approved, the journal entry itself is not independent evidence of the balance. It may correct the account, but the adjustment should still be supported by underlying documentation or another authoritative source that explains why the entry was necessary.

We've already covered several examples of appropriate supporting documentation, so I won't repeat them here.

The important point is that the reconciliation should rely on evidence that helps substantiate the balance independently of the general ledger itself.

That makes this one of the most important criteria in the entire reconciliation process.

Reconciliation Criterion 4 — Identification, Investigation, and Disposition of Differences

The fourth criterion is the Identification, Investigation, and Disposition of Differences.

Differences between the ending general ledger balance and the independent or authoritative supporting source are generally referred to as open items or reconciling items.

These differences should be clearly identified, investigated, and resolved as quickly as practical.

Not every difference represents an error. Some may be legitimate timing differences, such as outstanding checks or deposits in transit. But every reconciling item should have a clear explanation and an expected resolution.

Open items that remain unresolved for an extended period can indicate a larger process problem. In some cases, they may point to a systemic issue that requires assistance from other areas of the business and can increase the overall risk associated with the account.

And resolving an open item is more than simply posting an adjusting journal entry.

The key part of this criterion is the investigation. The objective is to understand the root cause of the difference and determine the appropriate corrective action.

A good reconciliation does not just make the current month's numbers agree. It should help identify what caused the difference in the first place and, where possible, correct the underlying process so the same problem does not continue to occur in future periods.

For all open items, a clear, documented action plan is needed to ensure timely resolution.

Reconciliation Criterion 5 — Resolution of Open Items

The fifth criterion is the resolution of open items by the subsequent period.

This may be one of the more difficult criteria to meet, and it is intentionally strict.

A quick example helps explain why.

Assume that at January 31, a balance sheet reconciliation identifies two open items.

During February, one of those items is investigated and cleared through the appropriate accounting correction.

The second item, however, remains unresolved. By the time the February reconciliation is completed, that item is still sitting on the balance sheet with no final resolution.

Under this reconciliation policy, the fifth criterion has not been met, and the account would be considered unreconciled until that aged open item is resolved.

The purpose of this requirement is to prevent reconciling items from simply carrying forward month after month.

In many cases, the solution may already be known, but the adjustment or other corrective action is delayed because of competing priorities, lack of follow-through, or simple procrastination.

This criterion creates a clear expectation that open items should not be allowed to linger indefinitely.

It also gives management or the business owner a very simple way to assess the condition of the balance sheet.

When reviewing reconciliations, management should be able to ask: Are there any aged open items? What are they? How much do they represent? Why are they still outstanding? And when will they be resolved?

Those questions provide a quick measure of whether balance sheet accounts are truly under control or whether unresolved issues are beginning to accumulate.

Reconciliation Criterion 6 — Preparer Signoff

The sixth criterion is the signature and date of the preparer.

With today’s account reconciliation software, this will usually be an electronic signoff rather than a traditional wet signature.

But the signoff means more than simply placing a name and date on the reconciliation.

By signing the reconciliation, the preparer is acknowledging that the work has been completed in good faith, that the balance has been properly supported, and that the reconciliation has been prepared in accordance with company policy and the applicable accounting requirements.

The date of the preparer’s signoff is equally important.

That date provides evidence that the reconciliation was completed within the timeframe established by company policy.

For example, if the policy requires medium-risk accounts to be reconciled by the tenth business day following period-end, then the preparer’s signoff should occur on or before that deadline.

Under this framework, if the reconciliation is completed after the required due date, the sixth criterion has not been met and the account would be considered unreconciled for that period.

Reconciliation Criterion 7 — Reviewer Signoff

The seventh and final criterion is the signature and date of the reviewer.

Just like the preparer signoff, this will usually be completed electronically in today’s accounting systems.

But the reviewer’s role is different.

The reviewer is not simply confirming that the reconciliation exists. By signing and dating the reconciliation, the reviewer is approving the work performed by the preparer and acknowledging that the reconciliation has been reviewed for completeness, accuracy, proper support, and compliance with company policy.

That review should include confirming that the general ledger balance agrees to the supporting documentation, that reconciling items have been properly identified and explained, and that any required follow-up or remediation has been addressed.

The reviewer should also consider whether the reconciliation actually makes sense.

A reconciliation can technically tie and still contain unusual items, unsupported assumptions, or aged differences that deserve further investigation.

Similar to the preparer, the date of the reviewer’s approval is also important because company policy should establish not only when the reconciliation must be prepared, but when it must be reviewed and approved.

For example, a company may require the preparer to complete a medium-risk reconciliation by the tenth business day and require reviewer approval by the twelfth business day.

If the reviewer does not approve the reconciliation within the required timeframe, then under this framework the seventh criterion has not been met.

The preparer is responsible for completing and supporting the reconciliation. The reviewer provides the second level of control by independently evaluating that work and formally approving the account reconciliation for the period.

The Seven Criteria as a Practical Framework

As we conclude this video, it is important to note that these seven criteria are not U.S. GAAP requirements.

They are simply a strong, practical way to run the reconciliation process.

This is the framework Gomez CPA recommends to clients because it creates accountability, improves the quality of the balance sheet, and makes it much harder for old errors and unresolved items to sit on the books month after month.

The details can be adjusted for the size and complexity of the business, but if you put these seven criteria into practice consistently, your balance sheet will be in much better shape.

Sources

The presentation concepts discussed in this video are based primarily on current U.S. GAAP, including FASB Accounting Standards Codification Topic two-ten, Balance Sheet, together with the FASB conceptual framework and the account-specific Codification Topics that apply to individual balance sheet items.

Credits and Disclaimer

All content was created by Gomez CPA. The narration voice of Gilbert Gomez CPA, was generated under license by Eleven Labs. All images were created under license by Open AI. We hope you found the content informative and helpful. To find out more about Gomez CPA visit our website at https://gomezcpa.com. For questions or comments email info@gomezcpa.com. This video is for informational and educational purposes only and does not constitute tax, legal, accounting, or financial advice; viewers should consult a qualified professional regarding their specific facts and circumstances.

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