Hidden reserves in Swiss accounting – How does it work ?
In Switzerland’s complex accounting landscape, a concept plays a subtle but essential role in the financial health of companies: hidden reserves.
Often unknown to the general public and even some professionals, these reserves are a crucial aspect of a company’s accounting and financial strategy.
So, what exactly are hidden reserves? How do they form, and what is their real significance in business management?
Our accountants at Karpeo explain this concept in a simple and educational manner.
Hidden reserves are a fascinating aspect of corporate accounting, especially in Switzerland where the Code of Obligations (CO) plays a key role in their management.
In practice, a hidden reserve often translates into an undervaluation of assets and an overvaluation of liabilities, in line with the prudence principles dictated by the Swiss Code of Obligations.
Simplified definition of hidden reserves
Imagine your company owns an old painting in its office.
You bought it for a few hundred Swiss Francs, but today, the painter has gained recognition, and the painting is worth thousands of Francs.
In accounting, its value hasn’t changed, but in reality, its market value has significantly increased. This is the principle of hidden reserves.
In Switzerland, according to the CO, companies must evaluate their assets at their acquisition cost. The difference between this cost and the current market value constitutes a hidden reserve.
Arbitrary and forced reserves
In addition to hidden reserves, there are concepts of arbitrary and forced reserves:
- Arbitrary reserves are voluntarily created by companies for reasons such as taxation (one can think of the hidden tax reserve of 1/3 on the book value of inventories or the one related to customer receivables of 5% or 10%).
- Forced reserves, on the other hand, are those that companies are legally obliged to maintain, according to the directives of the CO, to ensure their financial stability.
Concrete example
Take, for example, a Swiss company that bought a building several years ago. At that time, the building was worth one million Swiss Francs, but with the evolution of the real estate market, its current market value could be much higher.
However, in the company’s books, the building is still valued at one million Francs.
The difference between this book value and the current market value is a hidden reserve.
Hidden reserves are not just numbers on a balance sheet; they play a crucial role in a company’s strategy and financial stability.
Financial and strategic security
Hidden reserves act like a sort of “hidden treasure” for companies.
They offer significant financial leeway, which can be crucial during times of crisis or when sudden investment opportunities arise.
For example, if the company decides to sell its building whose value has increased, it realizes a profit that was not visible in its accounts before. This profit can be reinvested in the company to stimulate its growth or can serve as a cushion in times of financial difficulties.
Perception by investors and partners
Hidden reserves are also an important indicator for investors and business partners. They reflect the financial health of the company and its ability to generate value.
A balance sheet showing significant hidden reserves can attract additional investments and strengthen the confidence of partners and creditors, as it means that the company’s assets are more substantial than they appear.
Implication of the Code of Obligations
The Swiss Code of Obligations plays a vital role in how hidden reserves are managed. It imposes a prudent and transparent approach, ensuring that companies do not overestimate their assets.
This regulation aims to ensure a faithful and realistic representation of the company’s financial situation, thus protecting the interests of shareholders, investors, and other stakeholders.
The way hidden reserves are accounted for and managed is crucial for ensuring the accuracy and reliability of a company’s financial statements.
Accounting principles
In Switzerland, the Code of Obligations stipulates that assets must be recorded at their acquisition or production cost.
This means that even if the market value of an asset, like a building, increases, this increase is not reflected in the accounting books until the asset is sold.
This prudent approach prevents the overvaluation of assets and ensures a true representation of the company’s financial situation.
Prudent management and hidden reserves
Managing hidden reserves requires a thoughtful strategy. Companies must balance the need to accurately reflect their financial situation while maintaining some flexibility to manage these reserves.
The decision to realize these reserves, for instance by selling an asset whose value has increased, can have significant implications on the company’s financial and tax strategy.
Indeed, hidden reserves play a key role in corporate taxation in Switzerland as it is possible to increase or decrease their value in order to decrease or increase the taxable income of a company.
Impact on financial planning
The presence of hidden reserves can influence a company’s financial planning. Knowing about these reserves, managers can plan future investments or expansions knowing they have additional resources not reflected in the current balance sheet. This can be particularly useful in times of economic turbulence or when pursuing new market opportunities.
Legal obligations and transparency
The management of hidden reserves in Switzerland is governed by strict legal obligations, mainly dictated by the Code of Obligations, aiming to ensure transparency and reliability of financial information.
Publication of hidden reserves in the annex
According to Article 959c of the Swiss Code of Obligations, companies are required to provide detailed information about their financial situation, including the amount of the dissolution of hidden reserves, in their accounting annexes.
This transparency obligation ensures that shareholders, investors, and other stakeholders have a clear and complete view of the company’s financial health. Indeed, the dissolution of hidden reserves positively impacts the company’s profit. This is particularly crucial when a company is in a situation of capital loss or over-indebtedness.
Therefore, companies must disclose the dissolution of hidden reserves, offering a more accurate picture of their actual annual results.
Impact on financial transparency
The disclosure of hidden reserves plays a crucial role in financial transparency. It allows stakeholders to better understand the real value and potential of the company, beyond what is immediately visible in the balance sheet.
This practice strengthens confidence in the Swiss market and contributes to more informed investment decisions.
Importance of compliance
Compliance with the rules of the Code of Obligations regarding hidden reserves is essential not only to abide by the law but also to maintain the company’s reputation.
Transparent and responsible management of hidden reserves is a sign of good corporate governance and can play a decisive role in attracting investments and maintaining strong relationships with business partners.
Conclusion
Hidden reserves represent a complex but fundamental aspect of accounting and financial management in Swiss companies. As hidden wealth, they provide significant financial flexibility and security, while playing a strategic role in long-term planning.
Prudent management and transparent disclosure of hidden reserves, guided by the Swiss Code of Obligations, are essential to ensure investor confidence, market stability, and the sustainability of businesses.
