True Up In Accounting: What Is It?

In its most generic form, a true up means to match, reconcile, tie out two or more balances with the help of an adjustment. In accounting, this adjustment journal entry is called true-up entry.

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’s get started.

What does the term True Up means?

The literal meaning of the term ‘true up’ mentions to make level, balance, or to align something.

But if we learn the term true-up for the accounting procedures, it has almost the same literal meaning. The term true-up means matching or reconciling two or more two accounts’ balances.

Further breaking down of the definition says that the reconciliation or matching is done by making several adjustments in bank accounts.

A payment made post-closing to adjust for any difference between the purchase price, which was determined on a transaction’s closing date and based on estimated financial metrics, and the actual purchase price determined using financial metrics that become known only after the closing date.

Why Is True up Necessary? Matching Principle and Accrual Basis

There are two systems of accounting. One is cash-based accounting while the other one is accrual-based accounting.

If we look in detail, cash-based accounting treats the expenses and revenues based on when the cash is paid or received.

On the other hand, the accrual basis accounting system works on specific accounting principles. The accrual system’s main or basic concept is that expenses and revenues related to a particular financial period should be kept in the same period, irrespective of payments formed and cash received.

The accrual system is primarily based on the matching principle of accounting. The matching principle says that revenues and expenses for a certain period should match.

In other words, expenses related to certain revenues should be recorded in the same period when revenue was given.

In practice, a true up payment is made to the buyer only if the financial metrics of the target are worse than the parties agreed. The mechanism for determining the true up, the payment amount, and the source of the true-up funds are all subject to negotiation.

Reasons

There are many reasons why a mismatch may exist between two balances;

  • Budgeting – Some recurring expenses are estimated at the beginning of the year and booked in each period accordingly. There is always a chance of going over or under the budget.
  • Timing Differences – If a bill or invoice is not received till the end of an accounting period the expense is accrued as per estimate after the actual bill/invoice is received it is then matched with the help of a true-up entry.
  • Errors & Omissions –  With manual intervention, there is always a chance of human errors and misses.
  • Quantification – Not every expense and situation can be quantified and anticipated in advance, for example, an increase in headcount resulting in an additional payment of insurance premium at the end of a year.

True Up Examples

An example would be a payment for insurance services. A company may have subscribed to workers’ compensation insurance with an agent.

The agent quoted $12,000 per annum based on the current size of the company, with the final fee depending on the headcount of the company for that year. The accountants then book an accrued expense amount of $1,000 a month.

At the end of the year, the agent invoices the company $15,000 as the headcount had increased by 30%. A true-up of $3,000 is booked to adjust for the increase. In this case, the accountant could also book true-up in the books every reporting period (i.e. every quarter) if they have revision estimates instead of waiting until year-end when the final invoice is received.

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 2022.

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:

AccountDebitCredit
Electricity payable$800 
Electricity expense $800

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.

Leave a Comment