Undisclosed reserves and provisions allow companies extra support by offering security for when times get tough.
As a result of the precautionary principle and the different informational needs of senior management and the general public, in practice, there is an internal closing and an external closing of the fiscal year:
- The purpose of the external closing is to inform creditors, shareholders and the general public. It is based on the assessment instructions focused on protecting creditors and therefore shows, in general, a profit and financial situation that is worse than the reality.
- The internal closing serves as a basis for decision-making and as an instrument for control. It is therefore relatively precise and provides accurate values insofar as possible.
Equity capital is therefore lower on the external balance sheet than on the internal balance sheet. The difference between the amount of equity capital announced on the external balance sheet and the actual amount of equity capital is called “undisclosed reserves”. Undisclosed reserves may arise, for example, through provisions or the depreciation of goods.
When undisclosed reserves are released, it means that expenses are too low (in other words, yield is too high) on the external balance sheet and, as a result, profit is too high.
The Swiss Code of Obligations authorizes undisclosed reserves with almost no limit because they bolster companies in several ways:
- Since profit declines, a smaller share of the profit can be distributed. The profit retained is at the disposal of the company as equity capital for financing investments or eliminating debt (self-financing).
- Undisclosed reserves from good years may be released in bad years, which favors a balanced dividend policy.
- Undisclosed reserves offer security for a rainy day. By releasing undisclosed reserves, losses can be avoided, boosting the company's image and credit capacity. So that creditors and employees are not misled as to how things really are, Swiss corporations (sociétés anonymes) are required to disclose the release of undisclosed reserves in the appendix if the undisclosed reserves had a clear impact on net income. Use of an auditor can also prevent this type of "oversight".
Unlike undisclosed reserves, disclosed reserves appear on the external balance sheet and are therefore visible to outside persons. They are made up of potential reserves and legal reserves.
Provisions are a form of disclosed reserves—in other words, voluntary. They are a sort of advance savings to help avoid payment difficulties in the event of unforeseen problems. Provisions are always linked to an actual risk:
- The subsequent collection, for example, of AVS or VAT when revenue or payroll has been underestimated, is a frequent risk.
- The requirement of a guarantee or potential procedural risks should also be covered by provisions.
Overall, the tax authorities grant a 2% deduction on revenue subject to a guarantee.