True-up: Overview, definition, and example
What is a true-up?
A true-up is a process used to reconcile and adjust financial figures to reflect the actual amounts that should be paid or received, based on final data or circumstances. This adjustment typically occurs after an estimate or provisional figure has been used earlier in a contract or agreement. True-ups are common in financial arrangements, such as contracts, leases, and accounting, where initial amounts are estimated but need to be corrected once actual information becomes available.
For example, in a business contract, the parties may estimate certain costs or payments, but later, when the actual costs are determined, a true-up will occur to correct the initial estimates and align the figures with reality.
Why is a true-up important?
A true-up is important because it ensures accuracy and fairness in financial agreements. It allows for adjustments to be made when there are discrepancies between estimated and actual amounts, ensuring that all parties are treated fairly. This process helps prevent overpayments or underpayments and allows businesses to maintain accurate financial records.
For businesses, true-ups are crucial for maintaining transparency and trust between parties, especially when dealing with things like revenue-sharing agreements, utility costs, or taxes that may fluctuate over time.
Understanding true-up through an example
Imagine a company enters into a lease agreement where the rent is based on an estimate of the building’s annual operating expenses. After the year ends, the landlord conducts a true-up to calculate the actual operating expenses. If the actual expenses were higher than estimated, the tenant may need to pay the difference. Conversely, if the actual expenses were lower, the tenant may receive a refund or credit.
In another example, a utility company charges customers based on estimated energy usage throughout the year. At the end of the year, the company performs a true-up to compare the estimated usage with the actual meter readings. If a customer used more energy than estimated, they might owe additional charges; if they used less, they would receive a credit or refund.
Example of true-up clause
Here’s how a true-up clause might look in a contract:
“At the end of each fiscal year, the parties shall conduct a true-up to reconcile the estimated amounts paid under this agreement with the actual amounts incurred. Any discrepancies will be settled within 30 days, with either a refund or an additional payment due, as applicable.”
Conclusion
A true-up is a process that adjusts financial estimates to reflect actual figures, ensuring fairness and accuracy in transactions or contracts. It is commonly used to correct discrepancies between estimated and actual costs or payments. For businesses, true-ups help maintain transparency and ensure that all parties are financially aligned.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.