Accounting has evolved to be complex for providing comprehensive insights to the user of financial statements. The objective of improving financial reporting is to enhance the true representation of the financial and operational information presented in the financial statement. So, the process to enhance user experience requires the business accountant to present financial information that is true and reliable in all aspects.
In this article, we cover the true up in accounting. This includes the key definition, when do companies need the true up its accounting records as well as the examples. So let get started!
What is True Up in Accounting?
The term true-up means the concept of leveling, balancing, or aligning something. In accounting, reconciling and matching two or more accounts is known as the true-up process; the reason is that it enhances the credibility and trueness of the account balance.
In the process of true-up, reconciliation of accounts is performed by making adjustments in the accounting record. The journal entries passed to make adjustments in accounts are called adjustment/true-up journal entries. These adjusting entries are made once the accounts for the periods are closed. The truing-up procedure is also used to settle the differences among actual and estimated figures.
When does a company need to true up its accounting records?
The truing up of an entity’s financial record is performed at the end of a financial period. Some of the situations that need adjustments and truing up are described below.
Companies use the operational budgets to estimate the expenses, and these budgets are a quantitative estimation of the resources, revenues, and expenses. Forecasting and budgeting, both techniques are used to determine the allocation of resources for the future period.
Accounting standards allow the companies to estimate their expected revenues and expenses for the upcoming period. However, the budgeted values may differ from actual values. So, to align the information true-up of accounting records is necessary. Adjusting entries are passed to adjust the budgeting variances. Budgets variances can be favorable or unfavorable. That’s why true-up entries are made to reach adjusted figures.
For example, the value of absorbed overheads is used to prepare the Income statement by using absorption costing principles. But if the actual value of overheads for the period is lower or greater than the absorbed value, we adjust the figures by using under-absorbed or over-absorbed calculations.
Let’s understand the concept of timing difference with the help of an example. Utility bills are received once the utilities have been consumed. While preparing the financial statements for the year, we need the utility expense for the last month of the year to post the figures in relevant accounts and reach the value of utility expense for the whole year. This utility expense value is reported in the income statement. But we have not yet received the bill for this month. So, the entities are allowed to estimate the values by using the consumption pattern in previous months. These estimated figures are posted to the related expense accounts. When the actual bills are received, they can either be more or less than our estimate.
So the difference among both values is adjusted by using true accounting entries. These adjustments are important for a true presentation of the financial position and profitability of a company.
Errors or omissions in data
Errors and Omissions can occur while recording, sorting, and posting the balances or figures from one account to another account. There is a high probability of errors and omissions in data, and an audit is performed at the period end to identify such errors and omissions.
To reach accurate financial figures, it is necessary to adjust all the errors and omissions identified during the audit. To tackle omitted information, journal entries are made to record missing information. In addition to this, other problems such as mismatching balances, inaccurate values, understatement, or overstatement of amounts can also be adjusted with the help of true-up entries.
Sometimes, it is difficult to reach accurate expenses figures because of unexpected events, and it would be difficult to calculate certain values with complete accuracy. So, under those circumstances, true up entries are made to reach the correct figures at the end of the period.
Matching concept and accrual’s basis in accounting
Truing up financial records and figures is an important concept to meet the objectives and requirements of fair financial reporting. The matching concept of accounting states that the revenues and expenses for a period should be matched. It means that expenses should be recorded in the same period when the revenue was generated by incurring those expenses. The accrual basis of accounting is based on the matching concept.
Let’s understand this concept with the help of an example. If wages are paid to laborers at the start of an upcoming month, e.g., January, it doesn’t mean that this is an expense of January. If such wages figures are charged as an expense of January instead of December, it will overstate the profit for December. At the same time, January’s profit will be understated. So, in such a situation, the true profitability objective is violated. That’s why it is necessary to true-up financial statements to meet the requirements of the financial reporting framework.
True up (adjustments) Entries
Here are some examples of true-up accounting entries for scenarios described previously in this article.
Example I – Budgeting
The company has estimated that budgeted overhead expense amounts to $5,000 for the year ended 2020. Later on, it was figured out that the actual overhead expense for the period was $5,500. So, there is a difference of $500 between actual and estimated. A journal entry has to be made to settle the difference between the two figures. This difference of amounts shows that the overhead expense was understated by $500. To report exact figures in the financial statements, a true-up entry has to be made to meet the requirements of fair financial reporting. This $500 is required to be adjusted in the profit and loss statement for the year 2020.
Example II- Timing Difference
The timing difference concept can be explained with the help of Electricity bills. HCL Company has estimated that the Electricity bill for December will be around $10,000. However, in January, the actual bill was received, and it was of amount $9,200. It means that HL has charged more. So in this scenario, the overstatement of electricity expense has resulted in understating the profit. So, we have to adjust it. The entry will be:
Hence, we true up accounting records, update budgeted/estimated figures to enhance the reliability of the financial information presented in the financial statement. It increases the reliability of the balance for the user of the financial statement.
Accounting has evolved with time to enhance utility for the user of financial statements. It’s more than posting debit and credit in the accounting record. Today’s accounting operations have evolved to be complex and require applying concepts like accrual, budgeting, and matching, etc. So, the business needs to ensure all the balances presented in the financial statement are reliable and have been updated in all true aspects.
Likewise, the business needs to apply to true-up concept on the budget variances, time difference, errors, omissions, and quantification errors.
So, if there is a difference between the estimated and budgeted amount, it’s adjusted to reflect true/actual value. Similarly, the timing difference of recording and receipt of bills needs to be updated to present the true value of the account balances.
Likewise, at the time of closing, an accountant might face some problems with the figures. For instance, the debit and credit of the trial balance may not be equal. Hence, there is a need to make corrections in the accounting record and present true balances for the financial statement. This helps to enhance the element of reliability on the financial information.
Frequently asked questions
Why is true-up important in accounting?
True up in accounting is important to enhance the reliability of the financial statement—the financial statement users base their decisions on the balances produced by an accountant. Hence, figures and balances presented in the financial statement must be matched and reconciled with each other.
Are there instructions about true-up in any accounting standard?
Accounting standards do not use the term true-up, and however, these accounting standards aim to produce reliable and quality financial information. Hence, accounting standards direct accountants and company management to produce financial statements using true balances and information.
How is deferred tax an example of true-up?
Deferred tax arises due to temporary differences between accounting and tax base. So, an accountant needs to closely study the impact of movement on temporary differences before closing the business’s financial statement.
How can auditors help in accounting true-up?
Auditors review accounting records and financial statements before forming any opinion and issuing reports on a set of financial statements. So, during the performance of audit procedures, they may encounter some omissions/mistakes in the financial statement. Hence, they request management to make certain changes and true up the accounts.
For instance, the auditors may find calculation errors in the depreciation and request management to pass correcting journal entries in the accounting system.