True up in accounting is important to present fair and transparent financial information. It’s about tracking, reconciling, and correcting account balances to ensure fair and fine financial statement are presented to the users.
Accounting has evolved to be complex and super technical in terms of logical understanding and presentation. Although, well-developed accounting operations lead to greater automation and accuracy. However, still, there is a need to pass some manual entries in the accounting system to make it more reliable, relevant, and in line with user expectations. This process of correcting an accounting record is referred to as true up in accounting. Let’s have a detailed understanding of true up accounting concept.
Alos read, price level accounting.
True up meaning in accounting with example
True up in accounting means,
- Identification of the balance to be corrected.
- Correction of the account balance.
- Reconciliation with other figures.
Identification of uncorrected balance is the first step to true up financial statement. For instance, cash and bank balance in the financial statement may be subject to certain corrections at the end of the accounting period. So, there is a need to pass adjusting manual entries.
Correction is about manual action to pass adjusting entry in the accounting record. For instance, there may be a need to record bank charges as these are usually discovered once a bank statement is received.
Reconciliation means tracing the account balance with other balances. Reconciling a bank statement with the accounting-related cash record is an example of the same.
To be conclusive, true up means to ensure a balance of two or more accounts is reconciled. It helps to enhance the reliability and relevancy of the financial statement.
Generally, the process of true-up is performed at the time of closing when all of the normal accounting entries have been posted in the accounting record. The process involves posting of adjusting journal entries to adjust and correct two or more balances. Hence, it aims to achieve higher accuracy for financial statement users.
It’s important to note that accounting standards do not normally use the term true-up. However, they do require that the accounting balance and accounting record are accurate and free of errors.
When does the business need to true up?
Following are some of the circumstances when a business needs to true up its accounting record.
- Closing variance in the accounting record – Sometimes, the business needs to use estimated figures. However, actual figures are different. Hence, there is a need to adjust the accounting record after discovering actual figures. For instance, suppose the business has entered in the accounting system, manufacturing overhead amounting to $3 per unit. However, actual invoices indicate that real overhead amounts to $5 per unit. It means there is a need to adjust and increase the cost by $2 per product unit. So, the journal entry required to adjust the balance is called true-up journal entry.
- Error and omissions in the accounting record – Sometimes, there are human errors and omissions in the accounting record. These errors and omissions may be leading to material misstatements. Hence, there is a need to correct balance/true-up. Although, enhanced automation and less dependency on manual aspects have brought accuracy to the next level. Still, there is a probability of errors and omissions. In fact, it can be a frustrating experience when your trial balance’s debit and credit are not equal, and you’ve been looking for the error. Likewise, some adjustments are proposed by auditors. Hence, business needs to true up things.
- Quantification and estimates – Sometimes, the business needs to record liabilities/expenses that cannot be quantified with higher accuracy. For instance, IFRS and GAAP require recognition of the pension provision, and it’s not possible to estimate such provisions with a hundred percent accuracy.
- Delayed invoice receipt – In line with the accrual accounting concept, the business might need to record expenses on the basis of estimates. It’s due to the fact that expense needs to be recorded irrespective of the fact that invoice has been received or not as utility has been consumed. Hence, the business needs to develop some estimates. However, an amount needs to be adjusted/true-up once the actual bill is received.
Journal entries for true up accounting
Example-1 (variance adjustment)
Suppose you had recorded $2 as the cost of manufacturing overhead at a production of units 10,000. So, absorbed amount is $20,000 ($2×10,000). However, actual billing reveals that manufacturing overhead amounts to $18,000. It means there was over absorption amounting to $2,000 ($20,000-$18,000).
Hence, the business needs to true up accounts and that can be done with the following journal entry.
|Cost of goods sold||XXX|
The debit impact of the transaction is the removal of credit balance in the manufacturing overhead as it remains underapplied. On the contrary, credit impact is the reduction of expenses that leads to an increase in profit at the end of an accounting period.
Example-2 (Errors and Omissions) – true up in accounting
Suppose the trial balance of your business does not balance by $200, and there is a suspense account on the credit side. Upon investigation, you come to know that error was due to omitted credit impact of insurance prepaid journal entry, although expense was correctly recorded. However, the prepaid asset was not reduced. Let’s pass adjusting/true-up entry for the same.
The debit impact of the transaction is the closing of the suspense account, as we have identified where the problem falls. On the other hand, the credit impact of the transaction is a reduction of prepaid insurance assets, which was omitted at the time of passing an original journal entry.
Example-3 (Quantification and estimates)
Suppose your business has quantified gratuity expense amounting to $7,000. However, a report from experts suggests that the current obligation should stand at $7,200. Hence, there is a need to charge $200 in the income statement and increase obligations which can be done with the following journal entry.
|Profit and loss (pension expense)||XXX|
|Gratuity obligation payable||XXX|
The debit impact of the transaction is recording for the expense. On the contrary, credit impact is recording of liability under gratuity.
Example-4 (Delayed invoice receipt)
Suppose there is year-end closing and you have not received the electricity bill as of now. However, you need to timely close accounts. So, there is a need to estimate electricity expenses and post them in the accounting record. However, there is a higher probability of difference in the estimate and actual amount that needs to correct with a journal entry later.
True up in accounting means reconciling two or more balances to ensure the accuracy of the financial record. It helps to enhance the credibility and reliability of financial statements for the users.
The process of truing up is carried out at the time of closing accounting books. Further, there may be different reasons and logic for these reconciliations. These logics include adjustments for the variance, omissions, errors, quantification, adjusting estimates, etc.