Accrual or reserve?

Helena Šulcová

From time to time I hold a discussion with my clients on the topic whether an accounting entry should be accounted as an accrual on the account 389 - Estimated payables or whether it should be considered as a reserve (account 459 – Other reserves).

From the accounting point of view accruals are existing payables which are not supported by all supporting documents as of the balance sheet date and thus their amount is not known precisely. Typical examples of accruals are uninvoiced services and purchases realized by an entity in the last month of the accounting period for which related invoices were not obtained by the date of closing of accounting books.

Whereas reserves are intended to cover liabilities and expenditure the nature of which is clearly defined and which are either likely to be incurred or certain to be incurred as of the balance sheet date but uncertain as to their amount or as to the date on which they will arise.

The key difference is thus a certainty vs. the probability of a payable, uncertainty of the moment of the origin of a payable and in the same moment when speaking about an accrual we should be able to assess the payable amount more precisely.

Except of the uncertainty, whether an item should be accounted as an accrual or a reserve, it often happens that a chart of accounts of an entity is set primarily for the purposes of the monthly managerial reports for the parent company, not strictly according to Czech accounting legislation. Me personally, I experienced a similar situation in the manufacturing company in which I used to worked as CFO. We recognized for the purposes of a monthly reporting revenues as net revenues decreased for reserves for expected price decreases of a current year which would be applied by the client retrospectively and we accounted decreased revenues against a reserve. For the purposes of statutory financial statements, we, of course, made all necessary reclassifications to keep the financial statements in accordance with Czech accounting standards.

I remember huge discussions on the topic whether an accrual or a reserve from the times when a reserve for untaken vacation was a hot topic. Some clients accounted this reserve as a reserve, others as an accrual. One of my ex-bosses kept a pragmatic approach to the matter and told: payable as payable, I do not mind whether clients account it as a reserve or an accrual when they disclose it appropriately in footnotes to financial statements, important is to keep it correctly from the tax point of view.

Me personally I am a pragmatic person as well, so from the accounting point of view I could agree with this pragmatic approach, HOWEVER it is necessary to keep in mind tax difficulties related. If an entity accounts about a payable which has a nature of a reserve as it was an accrual, it has to consider this matter in its Corporate Tax Return and think account a double entry related, ie. an account of Profit and Loss Account. While additions and releases of reserves are accounted on the account 554  - Additions of other reserves (with exceptions of non-standard situations as is my example above) which we do not remember to exclude from taxable expenses, a double entry for an accrual will be an expense or revenue account which are usually a part of tax base and thus entities must not omit to exclude such items from the tax base.

What you should do if you realize after few years that you account about an item which has a nature of a reserve as it about the accrual? For sure you should check with your tax advisors whether you deducted appropriately this „accrual“ from tax expenses/tax revenues. In a case you subsequently identify an unjustifiable reduction of a tax base, I recommend to report it actively and not to wait for the moment when Financial Authority would come for an inspection and identify the issue itself. The true is that when you face up the issue and submit additional tax returns for all related periods, you will have to pay also interests on arrears. However, if it is Financial Authority who identifies the error, you will have to pay in addition to interests from arrears also 20% penalty from the reduced tax.