Valuation of provisions and passive accruals of costs and contingent liabilities according to National Accounting Standard No. 6.

Objective of National Accounting Standard No. 6 (hereinafter referred to as CRS No: 6) has been specified Under point 1.1. This document. It is “determining uniform rules for the recording of reserves in the accounts, the passive settlement of accruals and contingent liabilities, as well as their valuation and the presentation and disclosure criteria in the accounts” . This article will focus primarily on valuation issues; however, before discussing them, it is worth reading the basic definitions.

Definition of liabilities

point 2.1. CRS No 6 contains a definition of commitments that explicitly refers to Article 3(1)(20) Accounting Act. Under this provision, liabilities arising from past events are obligations to perform benefits of a reliable value which will result in the use of the entity's already held or future assets.

CRS No 6 provides examples of such past events, i.e. ‘sale of products and goods, purchase of goods, materials and services, use of employment, create a tax obligation’. For example, the benefits are listed as ‘payment, issue or repair of goods or products, removal of damage’.

Definition of reserves

Under point 2.2. CRS No 6 is presented the definition of reserves in which the reference to the provision of the Accounting Act, this time to Article 3(1)(21).According to the provision, the provisions are liabilities whose maturity or amount is uncertain. According to further explanations included Under point 2.2.

CRS No 6: „The provisions shall be created in accordance with the legal obligation or the usual commercial obligation, that is, where there is a high likelihood that an entity will have to comply with its obligation and the costs or losses required to comply with that obligation are sufficiently significant that their failure to take account of the financial result of the period in which the obligation arises would result in a material distortion of the image of the entity’s financial, financial and financial situation.’[1].

It is worth mentioning at this point that the creation of “the obligations for which the reserve was previously created reduces the reserve.

Non-use of the reserve, in view of the reduction or cessation of the risks justifying its creation, increases to the date at which the remaining operating revenue, financial revenue or extraordinary profits have proved unnecessary, respectively.’[2].

Passive settlements of accrual costs

Under point 2.3. CRS No 6 there is talk of passive accruals of costs. There is a reference to Article 39(2)(2) and Article 39(2a) Accounting Act.

According to first by provision, undertakings shall make passive accruals of costs in the amount of probable liabilities for the current reporting period, arising in particular (...) from the obligation to implement, relating to the day-to-day business, future benefits to employees, including pensions, as well as future benefits to unknown persons whose amount can be reliably estimated, even though the date of establishment of the undertaking is not yet known, including for guarantee and warranty repairs for the products sold for long-term use.

Under Article 39(2a) The Accounting Act goes on to read that the liabilities in question Under section 2 point 2, shall be shown in the balance sheet as a liability reserve. To put it simply, point 2.3. CRS No 6 defines passive accruals of costs as reserves directly linked to operational activities, i.e.

production, sale (and more generally trade) and after-sales phase and overall management. It is also clarified that when in CRS No. 6 it is referred to as passive accruals of accruals of costs, which must be understood to mean passive accruals of accruals of the reserve costs.

Under the above item CRS No. 6 it has also been detailed, which should not be included in passive accruals of costs. These are primarily:

„(a) costs for the execution of pending service contracts, including construction referred to in the CRS 3 „Unfinished construction services’,

(b) obligations resulting from the non-invoiced supplies and services accepted by the entity.

They shall be included in the delivery and service obligations, including where the unit’s determination of the exact quantity and/or the price of the supply/service may require estimates."[3].

Conditional obligation

Conditional liability, according to Article 3(1)(28) The Accounting Act is the obligation to perform benefits which arise on the basis of certain events. point 2.4. CRS No 6 it further specifies that as long as the liabilities are conditional, they are not included in the balance sheet and in the profit and loss account.

Valuation of provisions and passive accruals of costs and contingent liabilities

In Chapter IV of CRS No. 6 the valuation of reserves and passive accruals of costs and contingent liabilities has been discussed.

According to point 4.18. CRS No 6, in view of the likely evolution of the circumstances surrounding the decision to disclose the conditional obligation, ‘the entity should assess the conditional obligations at least on a balance sheet date in order to determine whether the outflow of the measures has become likely.

If it is likely that the outflow of funds will be necessary in relation to the position treated as a contingent liability, a reserve shall be created, showing it in the books and accounts of the period during which the probability change occurred.”[4]

As it was written Under point 4.1. CRS No 6 and under Article 28(1)(9) The accounting act, the entity shall value the reserves at least at the balance sheet date at a reasonable, reliable estimate. This also applies to passive accruals of costs. According to point 4.2.

CRS No 6, ‘the amount to which the reserve is created should be the result of a reliable, rational assessment of measures containing economic benefits necessary to fulfil the current obligation at the balance sheet date or to be transferred to the party third for that day’[5].

The amount of the reserve should reflect the most accurate estimate of the amount required to meet the current obligation at the time of the creation or verification of the reserve, taking into account the risks and uncertainties associated with the business activity of the unit.

The amount of the reserves justifies the choice by the entity concerned of different valuation methods, depending on the circumstances.

From the provisions described above, it deserves special attention point 4.10. CRS No 6. As has been rightly noted, the creation of reserves should take into account changes in the value of money over time (while maintaining the principle of materiality).

The amount of the reserve for future estimated liabilities (by applying the discount rate) should reflect their current value (at the date of creation or verification of the reserve). ‘When applying the discount, the balance sheet value of the reserve shall increase over each period of time.

This increase is recognised as a financial cost in the profit and loss account.

The discount rate to be applied shall be the discount rate established on the basis of the valuation date (day of creation or verification of the reserve) of the market rate of return on highly rated corporate bonds or the market rate of return on government bonds, depending on the choice made by the entity in the accepted accounting policies.

If the market rate of return on government bonds is chosen, an entity may increase the discount rate by a risk-related factor if the provision relates, for example, to financial operations carried out in markets whose risks and, therefore, interest rates are higher than the average interest rate on government bonds.

The maturity of corporate and government bonds should be consistent with the estimated maturity of the use of the reserve.’[6].