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Hidden Reserve

Hidden Reserves Definitions

Posted on May 5, 2021May 11, 2021 by definitionexplorer

A hidden reserve is simply referred to as a reserve. It is achieved when assets are set too low or liabilities are set too high. As a result, the company’s balance sheet cannot be seen by an outsider.

As a rule, many companies create a hidden reserve in company cars. If the car is bought for 40,000 euros over a period of five years, the company has an operating expense of 40,000 euros. Any profit must be reduced by this amount during this period.

When the 5 years are over, the car still has a book value of around one euro, but it can be sold at a much higher price, so the hidden reserve is offset, but is always a profit-increasing operating income.

The whole point is that a company can exempt its profits from taxation, at least for a certain period of time.

How are hidden reserves formed?

According to gradinmath, a hidden reserve can arise due to various factors. On the one hand, it can be inflation or valuation leeway is exploited. But it can also be a calculation error in a calculation or a depreciation.

The consequence of a hidden reserve is obvious, because profits appear smaller than they actually are. As a result, lower taxes need to be paid, which is a positive benefit for the company. However, such a reserve must not be created in excess, as otherwise a company would violate the clarity of the balance sheet.

In this way, hidden reserves can be created

A hidden reserve, also known as a reserve, can be created by undervaluing existing assets. For this purpose, assets are not given with the actual market price.

On the one hand, this goes with the acquisition costs, which, as already mentioned, can be done with a company car. However, it can also be that the software created by a company is not listed on the balance sheet.

A hidden reserve can also arise from an overvaluation of the liabilities. This is the case when a company has debts, which may consist of liabilities and provisions .

External and internal invoice

According to tax regulations, external as well as internal invoices may contain hidden reserves. On the one hand, they can be recognized when assets are undervalued and liabilities are overvalued.

As a rule, both invoices are not recorded in an accounting, but there is a “silent” folder where the hidden reserves are booked.

Definition: hidden reserve

A hidden reserve cannot be seen in a company’s annual financial statements. This becomes noticeable when debts are paid or an asset is sold. If hidden reserves are formed, the respective company must not miss the existing regulations. However, there are no special laws either, so that companies adhere to existing EU directives.

A hidden reserve is therefore a hidden, but a legitimate reserve of companies, which nevertheless does not have to be shown in detail. The company’s balance sheet plays a major role here.

Hidden reserves are usually formed arbitrarily, because they can arise when a sale is to take place, but the profit only becomes known when the customer has paid his invoice. In every balance sheet there are cost components that can be assessed as hidden reserves.

Different types

  • Hidden discretionary reserve
  • Hidden reserve for estimates
  • Silent compulsory reserve
  • Silent arbitrary reserve

In detail, this means: A hidden valuation reserve results from an actual error in which the value of an asset or an investment was incorrectly assessed. In the case of an arbitrary reserve, the reserve arises from an overvaluation of a provision, for example. Furthermore, hidden reserves are formed through the use of statutory accounting options.

A hidden reserve can also be defined as the equity of a company, because it arises mainly from the withholding of a profit. It can be used as self-financing by a company or to further increase profit.

Hidden reserves will never appear in a balance sheet, because they can also be used for a further investment by the company. Hidden reserves are in no way tied to any purpose, as opposed to, for example, a provision.

Reserves from a profit are shown openly because they can also be used as a company’s reserve. The reserve also offers the opportunity to legally exploit tax assessment leeway.

The equity

In a balance sheet, open reserves appear on the liabilities side; they are undistributed profits or amounts of money that were otherwise transferred to the company. Hidden reserves do not appear because they cannot be seen in a balance sheet.

Hidden reserves help to save taxes, they can only be stored for a short time and then used again. However, they must be taxed at the time of extraction.

They are also formed when it comes to an assessment of the inventory. For example, when it comes to the fact that possible stocks of goods were invested too low. There is a list of possible approaches here.

This can happen if a company relocates its headquarters abroad or in the event of tax evasion. Furthermore, a hidden reserve is not unusual when assets are transferred to a foreign permanent establishment, provided they belong to the company.

If a hidden reserve is recognized, it is automatically taxable. On the other hand, however, according to Section 6b (1) EStG, a tax-free reserve can be formed if a profit from land, agricultural or forestry business assets is converted into a tax-free reserve.

The passive side

If there is a hidden reserve on the liabilities side, in many cases an overvaluation of foreign currencies is the reason. This can be intentional or just an accident. If goods are sent abroad, the foreign currency can still be calculated differently than on the day the money was received.

Hidden reserves never reveal how a company’s finances are really doing. However, care must be taken to ensure that the hidden reserve does not violate balance sheet clarity, but this only actually occurs when there is a large accumulation of reserves.

A reserve or reserve can be used to save taxes; it should not be recognizable for this purpose. A reserve up to a certain amount of capital is legal, otherwise of course it has to be taxed.

Hidden Reserve

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