Provisions are financial items in a company's balance sheet that are recognized for future obligations or losses whose exact amount and/or due date are still uncertain at the time of recognition. They are used to taking account of expected expenses resulting from legal, contractual or constructive obligations today and thus ensure a realistic presentation of the company's financial situation. Provisions can be recognized, for example, for possible litigation costs, guarantees or restoration obligations.
The creation of provisions is mandatory in many cases and is subject to legal and accounting regulations. Here are some important points:
These legal and accounting regulations ensure that companies realistically estimate their future obligations and take them into account accordingly in their balance sheet, which leads to a more transparent and reliable presentation of their financial situation.
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This table provides a clear presentation of the different types of Provisions, examples of their use and the corresponding accounting records.
| Type of Provision | Example | Accounting Record |
|---|---|---|
| Pension provisions | Future payments to retired employees | Pension expense to pension provisions |
| Provisions for taxes | Expected additional tax payments due to an upcoming tax audit | Tax expense to provisions for taxes |
| Provisions for litigation costs | Expected legal fees and court costs in the event of a legal dispute | Litigation costs to provisions for litigation costs |
| Provisions for warranties | Expected costs for repairs or replacement deliveries for products subject to warranty obligations | Warranty expenses to provisions for warranties |
| Environmental provisions | Expected costs for the disposal of chemicals or environmental cleaning | Environmental protection expenses to environmental provisions |
| Restructuring provisions | Costs for severance and termination payments in the event of a planned restructuring | Restructuring expenses to provisions for restructuring |
| Provisions for restoration obligations | Costs for the dismantling of facilities or the recultivation of mining areas | Restoration expenses to provisions for restoration obligations |
| Provisions for maintenance | Planned major maintenance measures for machinery or buildings | Instandhaltungsaufwand an Rückstellungen für Instandhaltung |
By correctly creating, reversing and booking provisions, a company can ensure that its financial reporting is accurate and transparent, which in turn strengthens stakeholder confidence.
Provisions are recognized when a company expects a future obligation whose amount and/or due date is uncertain. The expected expense is recorded in the accounts.
Provisions are reversed when the underlying obligation occurs or no longer exists. The amount of the actual payment is offset against the provision recognized. If the actual obligation is higher or lower than the provision, there is a difference which must also be posted.
Release and payment of the provision (amount matches)
Release and payment of the provision (amount is higher than the provision)
Release and payment of the provision (amount is lower than the provision)
Provisions are booked both when they are created and when they are reversed. The correct accounts and amounts must be used to ensure accurate and comprehensible accounting.
Important aspects when booking provisions:
Important terms relating to Provisions
| Term | Description |
|---|---|
| Provision | Liability for future obligations or losses whose amount and/or due date are uncertain. |
| Pension provision | Provision for future pension payments to employees. |
| Tax provision | Provision for expected tax obligations, e.g. from future tax audits. |
| Provision for litigation costs | Provision for future costs in connection with legal disputes. |
| Provision for warranties | Provision for future costs arising from guarantee and warranty obligations. |
| Environmental provision | Provision for future costs in connection with environmental protection measures or remediation. |
| Restructuring provision | Provision for costs in connection with planned restructurings, such as severance and termination payments. |
| Provision for restoration obligations | Provision for future costs in connection with the dismantling of plants or the recultivation of mining areas. |
| Provision for maintenance | Provision for planned major maintenance work on machinery or buildings. |
| Present value | The present value of a future obligation, discounted at an appropriate interest rate. |
| Discounting | The process of discounting future obligations to their present value. |
| Expense account | Account in which the expense of recognizing a provision is recorded. |
| Income from the reversal of provisions | Income that arises when a provision is reversed and the actual obligation is lower than the provision. |
| Regular review | Process of regularly reviewing and adjusting provisions to ensure that they reflect current expectations and obligations. |
| HGB (Section 249) | German Commercial Code, which regulates the creation and measurement of provisions. |
| IFRS (IAS 37) | International Financial Reporting Standards, which govern the recognition and measurement of provisions. |
This table provides an overview of the most important terms in connection with Provisions and their meaning.
Provisions are an integral part of the balance sheet and are reported on the liabilities side under liabilities. They represent a form of liability that is formed for uncertain obligations. Here is an overview of how provisions are presented in the balance sheet:
Assets:
Equity and Liabilities:
| Assets | Liabilities | ||
|---|---|---|---|
| Fixed assets | € 100,000 | Equity | € 150,000 |
| Current assets | € 80,000 | Provisions: | |
| Prepaid expenses | € 20,000 | Pension provisions | € 10,000 |
| Tax provisions: | Tax provisions | € 5,000 | |
| Other provisions | € 8,000 | ||
| Liabilities: | |||
| Current liabilities | € 20,000 | ||
| Long-term liabilities | € 7,000 | ||
| Total assets | € 200,000 | Total liabilities | € 200,000 |
Provisions are an indicator of a company's forward-looking financial planning. They show that the company is taking possible future obligations into account and is preparing for them. This increases the transparency and reliability of financial reporting and contributes to the financial stability of the company. Provisions have a direct impact on the company's profit, as they are recognized as an expense in the P&L statement and thus reduce the reported profit.
What exactly is a Balance Sheet in this context?
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To the article on Balance SheetProvisions are created for various reasons to ensure the financial health and transparency of a company.
The following diagram provides an overview of the reasons for provisions.
By creating provisions, a company can not only meet legal and accounting requirements, but also improve its long-term financial stability and transparency.
Companies must take into account future financial obligations arising from legal requirements or contractual agreements, such as pension obligations or environmental protection measures.
Provisions help to present the actual financial situation of a company more realistically by taking future costs and losses into account in the current balance sheet.
The creation of provisions prevents future expenses from suddenly and unexpectedly burdening the balance sheet, which could lead to distortions.
Provisions enable a company to make financial resources available for future obligations at an early stage, thereby ensuring liquidity and financial stability.
In some cases, provisions can be tax deductible, which leads to a reduction in the company's tax burden.
Provisions offer companies better planning security, as they can anticipate future financial burdens and plan accordingly.
What is Liquidity in this context?
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Zum Artikel zu LiquiditätThis table summarizes the main differences between Reserves and Provisions.
| Criterion | Reserves | Provisions |
|---|---|---|
| Definition | Part of equity from retained earnings | Liabilities for uncertain future obligations or losses |
| Purpose | Financial stability, provision for investments or times of crisis | Coverage of expected expenses, exact amount and maturity uncertain |
| Recognition | Equity (liabilities side of the balance sheet) | Liabilities (equity and liabilities side of the balance sheet) |
| Creation | Voluntary or required by law | Mandatory if future expenses are expected |
| Example | Legal reserve, statutory reserve, free reserve | Pension provisions, tax provisions, provisions for litigation costs |
| Use | Reinvestments, dividend distributions, risk provisioning | Fulfillment of specific future obligations |
| Time of recognition | Subsequent, from profits already generated | When the expected obligation arises |
| Impact on profit | No direct impact on profit | Reduce profit in the year of recognition |
| Legal basis | German Commercial Code (HGB), articles of association | German Commercial Code (HGB), International Financial Reporting Standards (IFRS) |
| Flexibility | High flexibility of use | Earmarked, specific for certain obligations |
Non-current provisions are special types of provisions that are recognized for obligations that fall due more than one year in the future. They differ from current provisions, which are due within one year. Here are some important aspects of long-term provisions:
The measurement of non-current provisions is more complex than that of current provisions, as it requires the consideration of time value factors:
Non-current provisions are reported in the balance sheet under non-current liabilities. They must be presented separately from current liabilities in order to enable a clear distinction to be made between the different maturities of the obligations.
Both the German Commercial Code (HGB) and the International Financial Reporting Standards (IFRS) contain specific regulations on the recognition and measurement of non-current provisions. These regulations ensure that provisions are reported realistically and reliably in the balance sheet.
By recognizing long-term provisions, companies can ensure that they are financially prepared for long-term obligations and guarantee their long-term financial stability.
Under tax law, no provisions may be recognized for impending losses from pending transactions, for deferred maintenance and for expenses incurred in future financial years.
You calculate the discounting of provisions by multiplying the future amount by a discount factor. The discount factor is calculated using the formula 1/(1 + r)^n, where r is the discount rate and n is the number of years until maturity.
Non-current provisions whose fulfillment is more than one year in the future must be discounted.
Provisions reduce taxable profit by being recognized as an expense in the income statement.
Provisions for contingent liabilities, impending losses from pending transactions and deferred maintenance, which must be made up within three months, are mandatory.
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