Should I use different accounts for provisions?

accruals
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easily explained

This page was last updated on May 19, 2021

Definition: what are provisions?

In accounting, provisions denote liabilities, their Occurrence and amount uncertain are. If a company expects such a liability, it can set aside an amount, that is, “reserve” an amount to meet future payment obligations.

To be able to set up provisions, two requirements must be met:

  1. The cause of the costs must be in the current fiscal year.
  2. The timing, amount and existence of the utilization of the provisions are uncertain but probable.

What is the difference between provisions and reserves?

In accounting, provisions are not to be confused with reserves. Both are positions on the liabilities side of the balance sheet. The difference, however, is in the intended use:

  • accruals are formed for impending liabilities and thus belong to Borrowed capital. They are booked as an expense, so they reduce the success.
  • Reserves are considered bound Equity and are formed for impending losses. This leads to an increase in equity, but this has no effect on the company's success.
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What types of provisions are there?

Expense provisions and school provisions

When it comes to provisions, a distinction is made primarily between school provisions and expense provisions. The difference is quite simple:

  • Expense provisions are obligations to yourself.
  • School deferrals are obligations to third parties.

Simple examples make it clear when provisions fall into which category:

Example of provisions for expenses

A restaurant business suffers water damage in December. However, due to the Christmas business, the final repair is not planned until the beginning of the next billing year. The catering business creates provisions for this, which already appear in the balance sheet for the current financial year as provisions for neglected maintenance and are booked as expenses. Here there is an obligation to oneself.

Example of school deferrals

One company expects to be sued by a competitor the following year. For this purpose, it can set up provisions for litigation costs in order to be able to cover the court costs. This means that there are liabilities to third parties.

Section 266 (3) B I - III HGB also subdivides provisions into the following categories:

Pension provisions

According to Section 249 (1) HGB, there is a legal one Provision obligation for employersif a binding and direct Pension commitment to employees consists. In order for a company to be able to set up appropriate pension provisions, a written pension commitment must be available on the balance sheet date.

Tax provisions

Taxes and duties that arose in the current financial year, but the amount of which has not yet been finally determined, are declared as tax provisions. It may only for certain taxes Provisions are formed, e.g. B. for:

Other provisions

This type includes both expense and school deferrals. There are also these sub-categories:

  • Provisions for contingent losses
  • Goodwill provisions
  • Provisions for guarantee obligations
  • Litigation provisions
  • Provisions for commission
  • Annual financial statements and audit provisions

Provisions for archiving requirements according to GoBD

You can also set up provisions for archiving in accordance with the GoBD standard! For example, for the acquisition of shelves, the scanning of documents or parts of the rent if the documents to be archived take up a correspondingly large amount of space.

Why are provisions made?

Provisions serve to cover impending liabilities in the following year. Since they are booked as an expense, they reduce the profit at the end of the year and thus the tax burden of a company. In addition, provisions are regulated by law and in some cases even mandatory.

Provisions are made for three reasons:

  1. Protection against impending liabilities
  2. Reduction of profit and tax burden
  3. Legal obligation

When do I have to, when can I set up provisions?

You may only set up provisions if the reasons listed in Section 249 of the German Commercial Code (HGB) apply. In some cases, you are even obliged to create these provisions. In cases that are not mentioned there, it is not permitted to set up provisions. That would at least dilute the balance sheet and possibly even be a criminal offense.

Post provisions

Provisions are fundamental Passive accounts and therefore to book in credit. The booking rate is adapted and supplemented on a case-by-case basis. An example booking record for a provision looks like this:

The term “provisions for uncertain liabilities” is often used when booking. This expresses that the company does set up provisions, but is not yet clear about the specific cases for which these provisions are made.

Release provisions

Provisions must always be reversed as soon as the reason for creating provisions no longer applies.

When reversing provisions, the amount actually incurred depends on the expense. There are three different cases:

  1. The amount of the provision and the payment are the same: The dissolution does not affect profit or loss.
  2. The provisions were larger than the necessary payment: other operating income must be booked.
  3. The provisions were too low, i.e. not sufficient for the payment: Other operating expenses must be recorded.

Example of the reversal of provisions

A restaurateur opens a restaurant under the name BurgerHouse. It is optically designed closely to the nearby BurgerHome. Due to the similar concepts, the operator expects to be sued by the competitor or to be prosecuted in some other form. He therefore creates provisions:

Extraordinary expenses
10.000 €
Provisions for uncertain liabilities
10.000 €

As expected, there will be a process in the following year. There are three conceivable scenarios:

1. Provision = payment

The payment is as high as the anticipated provision.
The booking rate for reversing the provision is:

Provisions for uncertain liabilities
10.000 €
2. Provision> Payout

The matches are less drastic than expected. Ultimately, the BurgerHouse only has to pay an amount of € 7,000.

The booking rate for reversing the provision is:

Provisions for uncertain liabilities
10.000 €
to other operating income
3. Provision

The BurgerHouse will face an even higher penalty than expected. The amount is € 12,000.

The booking rate for reversing the provision is:

Provisions for uncertain liabilities
10.000 €
Out-of-period expenses
2.000 €

Special case: long-term provisions

What are long-term provisions?

Long-term provisions are characterized by a remaining term of more than one year. Section 253 (2) of the German Commercial Code states in more detail:

"Provisions with a remaining term of more than one year are to be discounted at the average market interest rate for the past seven financial years that corresponds to their remaining term."

The concept of discounting provisions means that you have to pay interest on the reserves that relate to expenses in the more distant future.

Here are two examples:

  • Pensions for employees
  • Provisions for warranties that have a term of more than one year

The interest rate is used to reflect rising costs. Using the interest, you can calculate a settlement amount. On this basis, you determine the present value of the provision using the discount rate. You can find the currently valid discount rates online on the Deutsche Bundesbank website. For the calculation, we also recommend using an accounting software or consulting an accountant.

The schedule of provisions: an overview of all provisions

In the so-called provision table, all provision items on the balance sheet and their development are listed. The tabular overview contains information on:

  • Opening balance
  • Closing balance on the balance sheet date
  • Feed
  • resolution
  • Consumption / usage
  • Rebooking
  • Effect from compounding and discounting

Is it compulsory to keep a list of provisions?

In principle, you are not legally obliged to draw up a schedule of provisions. However, Section 285 No. 12 of the German Commercial Code calls for an explanation of the development of other provisions. You can meet this request with an overview in the form of a reserve sheet.

A provision schedule is often necessary to meet commercial law requirements. That is why it should be present in professional accounting software. How exactly you structure the overview is up to you. The arrangement according to the due date and the listing of the above information are popular.

accruals summarized

  • Provisions are liabilities that have a relatively high probability of occurrence Existence and amount but uncertain are.
  • First and foremost, a distinction is made between liability and expense provisions.
  • The commercial code regulates the precise requirements for when provisions are to be formed.
  • An overview of your own provisions can be a Provisions mirror give.
  • Accounting software supports the creation, release and overview of provisions.