As the end of the year approaches, the end of the accounting period is also coming for a number of companies, and with it the duty to draw up a financial statement.  Let us take a look at selected operations from the financial statement perhaps from a slightly different perspective.

Adjusting entries

The purpose of adjusting entries is to adjust the valuation of assets, so that their value would correspond to the expected economic benefit upon their realisation. In other words, receivables should be valuated by a sum, which will probably be paid, the value of inventory by the sum, for which it will be sold, if this price is lower than their acquisition cost. We should also evaluate fixed assets in the same way, if their utility value is lower than their residual value; or so it is formulated by the Czech accounting standard on adjusting entries (ČÚS 005 – Opravné položky). Utility value also represents the future economic benefit here, generated by the asset. Such benefit in case of a production line may be revenues from products, which it produces during its service life, lowered by production costs over the same period of time.

Statutory adjusting entries for receivables are purely tools of the tax policy of the state and should not substitute for accounting adjusting entries. The correct procedure should be the creation of accounting adjusting entries and a subsequent analysis of which of them are also eligible for taxes. 

Accrued items of reserves?

Strictly from the perspective of the financial statement, we probably would not have to worry about the consequences of confusing accrued items and reserves. Both items are part of outside funds on the side of passives and their accounting is results-based.  But because Czech accounting is perhaps too closely intertwined with the taxes, caution is in place.  Generally speaking, accrued items, unlike reserves, are tax-effective.  Unless related to tax-ineffective costs, though, such as for example an accrued item for representation costs. Reserves, on the other hand, may be tax-effective, but this only refers to an enumerative list of reserves created in keeping with the act on reserves.

What is the difference between an accrued item and a reserve then?  In the case of an accrued item, we are 100% certain the expenditure will occur, we only do not know the precise sum. And we also know to whom we will pay this cost.  Whereas we create reserves for costs, for which we do not have 100% certainty of future expenditure as of the date of the financial statement (we may possibly win a legal dispute), or we do not know, to whom we will pay the cost (such as in the of reserves for repair within the warranty period, when we do not know, which client will make a complaint).

Exchange rate conversions

The law obliges us to recalculate items in foreign currencies with an exchange rate as of the date of the financial statement and to post the ensuing exchange rate difference in the profit and loss account. The aim of this enactment is not mathematical exercise for accountants, but the inclusion of exchange rate risks of the accounting entity into the financial statement.  According to the absolute height of the exchange rate differences, the reader will be able to get an idea about the significance of the influence of exchange rate risk on the results of the accounting entity.  There are accounting entities, though, which carry out most costs and revenues in one foreign currency, for example in the euro. Logically, exchange rate profits or losses arise for them with every payment, while their exchange rate risk is minimal.  To these accounting entities, we recommend using article  58, paragraph 2 of decree no. 500/2002 Sb. in their financial statement (the profit and loss account) and to post only net exchange rate profit or loss, which corresponds to their exchange rate risk.

Time frame

In this context, we would like to point out transactions, when the accounting entity negotiates for example rent for a fixed period of time and the rent differs in the individual years.  If it differs due to the fact that the accounting entity uses a different size of leased premises in the individual years, the cost relating to the rent will differ in the profit and loss account in the individual years.  We will proceed similarly in a situation, when the accounting entity receives a discount from rent due to, for example, reduced transport accessibility of the place of rent.   But be cautious about situations, when the accounting entity is granted a discount from rent as an incentive for entering into the contract of lease (for example the first six months free of charge).  In such a case it is necessary to determine the total sum of rent for the time of the contract and to post it evenly throughout the duration of the contract.  The lease-giver should proceed similarly.

Deferred tax

An to conclude, a few words on deferred tax.  This transaction differs from other accounting transactions in that its height can be accepted neither for a contract, nor for an invoice nor a bank statement.  This is while incorrect posting of deferred tax is the same mistake in a financial statement as incorrect time frame for other costs or revenues.  To determine the deferred tax, a trial balance is not sufficient, but a knowledge of the tax issues is also necessary, or cooperation with whoever is preparing the tax declaration fort the company.  And how to verify accuracy of the calculation of deferred tax?  Using the effective tax rate, which is the proportion of the total tax expense (for the tax due and the deferred tax) to the economic result prior to taxation. If we adjust the economic result prior to taxation for items, which are accounting costs (or revenues), but will never become tax cost or taxable revenue, we should come up with an effective tax rate reaching 19 %, which is the same as the statutory one.  From the practical perspective, when calculating deferred tax, we would recommend taking no account of tax deductions and to include the due tax prior to applied discounts into the calculation of the effective tax rate.

A few words in conclusion

To provide a complete picture, we would like to add that from January 1, 2016 a financial statement of medium and large accounting entities must include cash flow overview and an overview of changes in own equity.  Its structure is clarified by the interpretation of the National Accounting Council I-32. Also, do not forget that the form of state reports has changed and the content requirements of the notes to the financial statement.

And why is a quality financial statement even necessary?  Its aim, as codified in the amended accounting act already, is to inform the user about the financial situation and the financial performance of the accounting entity.  It is thus not a mere supplement of the tax declaration.  Although the tax base is based on the economic result, the aim of accountants should not be to minimise the difference between the economic result and the tax base.  We may then well call the financial statement a tax statement.

We will gladly be available for any questions you may have on this subject.