The question of provisions or accrued expenses arises most often when preparing annual reports. Both items are liabilities recorded on the company’s income statement, but they differ in several respects. However, if a given company prepares its annual report in accordance with German accounting standards, they must consider further discrepancies.
Distribution of costs affecting more than one financial year
One accounting principle in Hungary clearly states that costs affecting more than one year must be divided proportionately between the financial years to which they relate. In practice, a significant number of accrued expenses comprise trade payable invoices received after the reporting date. An important characteristic of accrued costs and expenses is the fact that their amount is known and approved by the company. Under German standards, such accrued expenses are treated as other liabilities; therefore, they must be reclassified in the reports and statements. Items recognised as accrued expenses are acknowledged by default when assessing corporate tax, unless they cannot be recognised as such because of the type of expense involved.
When are provisions obligatory?
Companies are required to allocate provisions for their contingent liabilities, and for any other significant, anticipated and periodically recurring costs that are expected to arise, but where the amount or exact time they will be incurred is uncertain. German standards define the criteria for provisions in similar ways; there is no difference to Hungarian accounting rules in this respect. There are a number of differences, however, as to which expenses have to be provided for under Hungarian or German regulations. For instance, while annual taxes payable are recognised as liabilities according to Hungarian standards, German accounting standards require provisioning for the unpaid amount of such taxes. There are further discrepancies between Hungarian and German rules as regards the release of provisions. According to Hungarian standards, provisions must always be released against other income. The German standards, however, differentiate between three cases, based on whether the amount of the actually incurred expense is the same, higher or lower than the amount of the provision. If the expense is equal to the provision, the release of the provision is recognised against liabilities, without affecting revenues and expenses. If the amount of the allocated provision is higher or lower than the expense, the difference must be booked on a separate general ledger account.
What should be done in the case of group reports?
When preparing a consolidated report, such differences must be compensated for by reclassifications in the income statement. Under Hungarian standards, provisions do not affect taxes, as the tax base must be adjusted with the provision. As provisioning does not entail any tax base adjustment under German regulations, the German tax authority closely examines the legitimacy of provisions if they differ from the expense incurred, since they might indicate a reclassification of profit and loss accounts between multiple years.
The importance of understanding legal regulations
The above comparison relates mainly to costs and expenses; however, it is also important to know that accruals/deferrals and provisions must be allocated not only for costs and expenses, but also for revenues and other special cases when preparing both Hungarian and German annual reports and financial statements as regulated by the Accounting Act.
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