What’s True-Up Adjustment?
Several principles dictate how companies account for various transactions. These principles allow them to record those transactions under the accepted standards. Usually, companies conform to several accounting principles. These apply to all companies and organizations that prepare and present financial statements. One of these includes the matching principle in accounting, which is crucial to expenses and revenues.
The matching principle requires companies to record expenses with their corresponding revenues. This principle is crucial in accounting to help companies record those expenses in the correct period. Usually, it involves identifying those expenses first. Once companies can determine them, they must establish the revenues they help contribute. Lastly, they must record both in the same period.
In most cases, companies record expenses in the same period as they occur. The value for these expenses comes from the underlying transactions. Sometimes, however, companies may not have this value. On top of that, some expenses may not occur in the same period. Nonetheless, they may relate to that period even before they occur. Recording these transactions falls under a true-up adjustment in accounting.
What is a True-Up Adjustment?
Companies must record true-up adjustments for several reasons. They include entries made in the accounting system to adjust for year-end transactions or events. Usually, these adjustments occur once a company closes its accounts. As mentioned, companies may have used estimates to record some expenses in the past. Therefore, true-up adjustments may also involve correcting or updating those estimates.
True-up adjustments are crucial under two accounting principles. The first includes the matching principle, where these adjustments are significantly critical. As mentioned, companies use these true-up entries to match expenses to their revenues. Therefore, the true-up concept can be critical in achieving the criteria set by the matching principle. In the absence of these adjustments, companies cannot report a true view of their financial performance.
On top of that, true-up adjustments also relate to the accrual principle in accounting. Under this principle, companies must record expenses in the period when they occur. It does not consider the cash or payment aspects of those transactions. This principle also relates to the matching principle mentioned above. True-up adjustments allow companies to record expenses in the same period as they occur. However, they may require estimations.
What are the Reasons Companies Need True-Up Adjustments?
Companies use true-up adjustments for several reasons. Usually, these include new information that can provide details on a transaction. Based on that information, companies can update or adjust the previous estimates. These adjustments are crucial in correcting a mismatch between two transactions. Some of the reasons why companies need true-up adjustments include the following.
Budgeting involves calculating the future revenues and expenses of a company. Usually, companies create various types of budgets. Through these tools, they can estimate their recurring expenses. In most cases, companies prepare them before a financial year begins. Sometimes, companies must use those estimates to record a transaction. These cases may occur when a figure is not available for that transaction.
However, once companies have the actual amount for that transaction, they must correct the first entry. Usually, this occurs when the value becomes available after closing the financial year. Once companies have that value, they must use a true-up adjustment to update that amount. By doing so, they can match the account with the actual value.
Errors and omissions
True-up adjustments are also crucial in correcting any errors in the financial statements. Some companies may record transactions with an erroneous amount. In some cases, it may also involve recording those figures in the wrong accounts. With true-up entries, companies can adjust those accounts for the correct amounts. This way, the financial statements will reflect accurate numbers.
On top of that, true-up adjustments can also be crucial in helping companies record omissions. An omission occurs when a company does not record a transaction in the accounts. It relates to errors, although it excludes any journal entries. With a true-up entry, companies can record those missed amounts. Sometimes, companies may also omit some aspects of a transaction. True-up adjustments can also help rectify that.
Quantification relates to expenses that do not have an accurate amount. The IFRS suggests that some transactions may not have it. Usually, unexpected events can impact the quantification of those amounts. Companies can rectify that by adjusting for the actual values once those events are over. Before that, however, they may use estimated figures to record those transactions.
In some cases, companies may also wait for the actual amounts to become available. Either way, companies can account for those transactions with true-up entries. In that regard, it is similar to rectifying omissions. However, in this case, these omissions are not unintentional. Once the actual amounts are available, companies can record them using true-up journal entries.
Timing differences are the final aspect that true-up adjustments cover. These differences are similar to the budgeting aspect mentioned above. However, they do not occur due to a variation in budgeted and actual accounts. Instead, companies use estimates in various areas. For example, they can measure their expected utility expenses based on past patterns. However, those figures usually do not reflect the actual expenses incurred.
When companies make estimations, they use them to update the accounts temporarily. Once the actual figures are available, they must adjust the financial statements to reflect them. With timing differences, this process occurs more often. However, true-up adjustments can help companies rectify those estimates. With these adjustments, companies can record the actual accounts for each transaction.
Example of True-up Adjustments
Examples of true-up adjustments exist in all aspects of a company’s transactions. As mentioned, companies use true-up adjustments to rectify various errors or variances. Therefore, the example for those entries may differ based on the reason for those variances. Nonetheless, companies can use true-up adjustments to rectify them.
For example, a company, ABC Co., records its utility expenses based on estimations. The company uses its previous data to forecast those expenses. Once it estimates the amount, it records it in the financial statements. Based on the historical usage data, ABC Co. believes its utility expense for the next month will be $10,000. Therefore, the company records it as follows.
After the month-end, ABC Co. receives its utility bill. This bill states the actual expense to be $12,000. Since the company has already recorded the utility expense, it must rectify it using true-up entries. ABC Co. uses the following entries to adjust the above transaction for the actual amount.
The above true-up adjustment is an example of a timing difference. ABC Co. uses true-up adjustments to reflect an accurate figure in the utility expense account.
True-up adjustments are entries used by companies to balance or match various balances. Companies may have several reasons to use these adjustments. Usually, the need occurs due to budgeting, errors and omissions, quantification, and timing differences. True-up adjustments allow companies to present accurate information on the financial statements.