What is the imparity principle?
The imparity principle is one of the fundamental principles in double-entry bookkeeping . It stipulates that merchants must exercise the necessary caution when assessing all business transactions and therefore have to record losses as soon as they can be assumed.
The principles of proper bookkeeping regulate the recording of business transactions and the evaluation of all accounting positions. Anchored in the Commercial Code (HGB), the imparity principle stipulates that losses of a company are to be recorded in the accounts if there is a mere assumption that they could occur. This early identification of financial risks is intended to make business decisions easier for both owners and investors.
The principles of proper accounting
You will not find this basic set of rules formulated in writing anywhere, not a few of them have grown historically. However, the Commercial Code has taken up many principles of proper bookkeeping and incorporated them into corresponding paragraphs. A distinction is made between:
- Correctness and freedom of choice
- Clarity and clarity
- Individual evaluation of the positions
- Completeness of the records
- Increase in value and justification of value on the closing date
- period-based posting
- Business continuity
- Posting on the key date
- Principle of factual and temporal delimitation
- Realization principle
- Imparity principle
The principles of proper bookkeeping in the digital age (GoBD) have been redefined in recent years . They complement the regulations that are already in force with regard to the use of modern media – intelligent accounting software, electronic communication and secure data storage.
Above: the principle of caution
The careful evaluation of all balance sheet items prevents companies from paying off rich. This principle of caution is anchored in Section 252, Paragraph 1, No. 4 of the Commercial Code.
Realization and imparity principle
In § 252 No. 1 Paragraph 4 HGB, both principles of proper accounting are taken into account:
- The realization principle : The company’s profits may only be taken into account in the annual financial statements if they have actually been realized on the balance sheet date.
- the imparity principle : all losses and foreseeable risks that have arisen up to the closing date for the financial statements must be taken into account. This also applies if they only became known between the balance sheet date and the date on which the balance sheet was drawn up.
Further regulations in which the imparity principle can be found
You can also find the principles mentioned in other provisions of the Commercial Code:
Acquisition cost principle (Section 253 (1) HGB)
When an asset is received, the acquisition and production costs of the items at most can be posted. In addition, the costs are to be reduced by the annual depreciation on the balance sheet date .
Lower value principle (Section 253 Paragraphs 3 and 4 HGB)
Individually, the balance sheet date all acquired assets of the plant – and working capital to evaluate. If this results in a permanent decrease in the value of property, plant and equipment, it must be written down to the lower value. This also applies to receivables – you have to write off customer receivables that can no longer be collected and correct doubtful receivables.
In the case of financial assets, such a write-down to the lower value may take place even if the decrease in value is not permanent. For items of current assets, such as inventories, the current market or stock exchange price is used to determine the value and taken into account if it is lower than the booked purchase price.
Passivation obligation for provisions (§ 249 HGB)
Provisions do not only have to be set up for neglected maintenance if they are made up for in a timely manner. In addition, it is also mandatory that expenses-increasing provisions must be made for (still in the amount) uncertain liabilities and for impending losses from pending transactions .
Maximum value principle (§ 256 a HGB)
Assets and liabilities in foreign currencies must be converted into euros on the balance sheet date. If this results in a higher repayment amount, this must be shown in the balance sheet.
What is the imparity principle used for?
German accounting and its laws were designed primarily in the interests of creditors. By enforcing the principle of caution, a realistic picture of the company is created – under worst-case conditions. This approach influences the company’s key business figures and thus also affects its overall assessment:
- When the lowest values for the assets are recorded, the total on the assets side of the balance sheet is reduced . The company is worth less overall .
- Depreciation on the acquisition value of goods or on receivables has the same effect on profits as the recognition of provisions for risks. The business result achieved (i.e. profit or loss ) is in the numerator in the calculation formula for key figures such as return on sales or return on equity – if the operating profit is lower with the same turnover / capital, the return decreases. This key figure is an important yardstick for the company’s potential.
Examples of valuation and accounting
Accounting for an impairment
A machine with an expected useful life of 8 years was accounted for at acquisition costs of 80,000 euros in January. The planned straight-line depreciation is 10,000 euros per year. After the third year of operation, the book value after depreciation is now 50,000 euros, the company discovers major damage to the mechanics. The cause is higher stress and the resulting increased wear than calculated. A fundamental overhaul is no longer worthwhile, the asset must be replaced within the next two years.
The remaining useful life is therefore reduced to 2 years . With a possible total useful life of 5 years, this would have resulted in annual depreciation rates of € 16,000, so the value of the machine after the third year is only € 32,000. The company now has to catch up on this depreciation – and posts an unscheduled depreciation of € 18,000.
Accounting for a loss of value
The company has 1,000 shares in a well-known German energy company in its fixed assets. After years of price increases, the share price fell for the first time on this balance sheet date. These are currently still booked at 100 euros per share, but the current market price is only 75 euros . If the management were forced to sell them on the stock exchange today, they would face a loss of 25,000 (1,000 shares * (100-75 euros)) euros. This impending loss must be shown in the balance sheet, in which the value per share is reduced by a write-off .