How to Check if the Balance Sheet Is Correct

A correct balance sheet is the foundation of a company’s financial story, providing a clear snapshot of its assets, liabilities, and equity. To trust that story, you need to be certain the numbers are accurate. This guide provides a detailed process for verifying a balance sheet, covering everything from the fundamental accounting equation to reconciling specific accounts. We'll walk you through the practical steps professionals use to confirm a balance sheet is correct and reliable.

The Golden Rule: Checking the Accounting Equation

Before you look at any single account, start with the most fundamental check of all: the accounting equation. This principle lies at the heart of double-entry bookkeeping and is the first indicator of a properly stated balance sheet.

Total Assets = Total Liabilities + Shareholder's Equity

In simple terms, everything the company owns (assets) must be financed by either what it owes (liabilities) or what the owners have invested (equity). If these two sides do not equal each other, the balance sheet does not balance, and there is a fundamental error somewhere in the accounting records. While modern accounting software like QuickBooks or Xero is designed to prevent this from happening by enforcing double-entry rules, errors can still creep in through manual journal entries, data migration problems, or incorrect formula setups in spreadsheets. Verifying this equation is your quick, high-level first pass—if it’s wrong, you don’t need to go any further until it's fixed.

Step 1: Reconcile Cash and Cash Equivalents

Cash is often described as the lifeblood of a business, making it one of the most important accounts to verify. The cash balance reported on your balance sheet should directly correspond to your actual bank account balances, adjusted for any timing differences.

• Perform a Bank Reconciliation: Compare the cash balance on the balance sheet with the ending balance on the company’s bank statements for the same period. Any discrepancies should be resolved in the bank reconciliation.
• Account for Reconciling Items: Common reconciling items include outstanding checks (checks written by the company that haven't cleared the bank yet) and deposits in transit (cash received and recorded by the company but not yet processed by the bank). These items explain the difference between the book balance and the bank balance.
• Check All Accounts: Remember to perform this process for all cash accounts, including checking, savings, money market accounts, and any petty cash funds. The total of all reconciled cash balances should equal the cash figure reported on the balance sheet.

An unreconciled or incorrect cash balance is a major red flag, as it can indicate recording errors, unrecorded transactions, or even potential fraud.

Step 2: Confirm Accounts Receivable and Allowance for Doubtful Accounts

Accounts Receivable (A/R) represents the money owed to your company by customers for goods or services already delivered. Verifying this balance involves more than just checking a single number; it requires assessing its collectability.

• Tie A/R to the Sub-ledger: The total A/R balance on the balance sheet must equal the sum of all individual customer balances in the A/R aging sub-ledger. This report breaks down receivables by how long they’ve been outstanding (e.g., 0-30 days, 31-60 days, 61-90 days, etc.).
• Review the A/R Aging Report: Analyze the aging report for large, past-due amounts. These could indicate collection problems. Contacting customers with significantly overdue balances can confirm the debt and identify potential disputes that need to be addressed.
• Assess the Allowance for Doubtful Accounts: Not all receivables will be collected. The allowance for doubtful accounts is a contra-asset account that estimates the portion of A/R that is likely to be uncollectible. Your allowance should be reasonable. Check if it's based on a logical policy, such as a percentage of total A/R or an aging method that applies different percentages to different aging buckets. An inadequate allowance overstates your company's true assets.

Step 3: Scrutinize Inventory

For merchandisers and manufacturers, inventory is often the largest current asset. Its accuracy is vital for both the balance sheet and the income statement, as inventory values directly affect the cost of goods sold (COGS).

• Verify Physical Quantities: The inventory quantity recorded in the accounting system should match what is physically on hand. This is confirmed through a full physical inventory count (usually at year-end) or ongoing cycle counts. Investigate and resolve any significant discrepancies.
• Check the Valuation Method: Ensure inventory is valued correctly and consistently using an approved method like First-In, First-Out (FIFO), Last-In, First-Out (LIFO), or weighted-average cost. Switching methods can significantly alter reported asset values and net income, and it requires specific disclosures.
• Evaluate Obsolescence: Write down the value of any inventory that is obsolete, slow-moving, or damaged. Keeping unsaleable goods on the books at full cost overstates assets and profitability. A proper inventory reserve or allowance for obsolescence should be established and regularly reviewed.

Step 4: Audit Fixed Assets and Depreciation

Fixed assets, or Property, Plant, and Equipment (PP&E), are long-term assets like buildings, machinery, and vehicles. The balance sheet reports them at their net book value (NBV).

• Reconcile the Fixed Asset Sub-ledger: The total NBV on the balance sheet should agree with the total from the detailed fixed asset sub-ledger. This sub-ledger should list each asset, its original cost, acquisition date, and accumulated depreciation.
• Review Additions and Disposals: Verify that new assets purchased during the period have been added to the sub-ledger at cost. Similarly, ensure that assets sold or retired have been removed, with the corresponding cost and accumulated depreciation taken off the books. Any gain or loss on disposal should be correctly recorded on the income statement.
• Check Depreciation Calculations: Confirm that depreciation has been calculated correctly and consistently for the period based on the company's depreciation policy (e.g., straight-line, declining balance). The depreciation expense on the income statement should correspond to the increase in accumulated depreciation on the balance sheet, excluding the effects of asset disposals.

Step 5: Verify Accounts Payable

Just as you check who owes you, you must also meticulously check who you owe. Accounts Payable (A/P) represents the short-term obligations to vendors and suppliers.

• Tie A/P to the Sub-ledger: Like Accounts Receivable, the A/P balance on the balance sheet must match the total of the A/P aging report or sub-ledger. This ensures that the summary figure is supported by detailed invoice-level data.
• Search for Unrecorded Liabilities: A common error is failing to record invoices received around the end of the accounting period. Review invoices received after the balance sheet date to see if they relate to goods or services received before the period ended. If so, they need to be accrued.
• Compare to Vendor Statements: Reconciling your A/P records with statements received from major vendors is a great way to catch discrepancies, such as missed invoices or unrecorded payments.

Step 6: Confirm Debt Arrangements and Other Liabilities

Beyond A/P, businesses often have other liabilities like bank loans, notes payable, and accrued expenses. These must be presented correctly.

• Reconcile Loan Balances: Check the balances of all short-term and long-term debt against loan statements or amortization schedules from the lenders. Ensure the principal and accrued interest are correctly stated.
• Review Current vs. Non-Current Portions: The portion of long-term debt due within the next 12 months must be classified separately as a current liability. Misclassifying this can distort key liquidity ratios like the current ratio.
• Analyze Accrued Expenses: Accrued expenses are costs that have been incurred but not yet paid (e.g., wages, utilities, taxes). Review these balances for reasonableness and make sure that all necessary accruals for the period have been made.

Step 7: Reconcile Retained Earnings

The retained earnings account links the income statement to the balance sheet. A "roll-forward" is a classic check to ensure this link is intact.

Beginning Retained Earnings + Net Income (or - Net Loss) - Dividends Paid = Ending Retained Earnings

Obtain the retained earnings balance from the prior period’s balance sheet. Add the current period’s net income from the income statement, and subtract any dividends paid to shareholders. The result must equal the retained earnings balance on the current balance sheet. If it doesn't, it often points to an error in how net income was closed out or how shareholder distributions were recorded.

Final Thoughts

Verifying a balance sheet is a systematic process of reconciliation and review, ensuring every number is supported and every account tells an accurate story. From the foundational accounting equation to the details of each major account, these checks confirm that the financial statements provide a reliable base for making informed business decisions.

While these checks help confirm numbers, complex questions often arise regarding the proper accounting or tax treatment for specific transactions—like determining the correct depreciable life for a unique asset or classifying a complex debt instrument. Having instant access to authoritative guidance is key. Our platform, Feather AI, provides citation-backed answers to your toughest tax and accounting questions in seconds, so you can resolve issues and have complete confidence in your financial reporting.