Prudence principle (voorzichtigheidsbeginsel)
Basic principle of Dutch GAAP: profits are recognised only when realised, while losses and risks that arose before the end of the financial year are taken into account if they become known before the annual accounts are prepared (art. 2:384(2) DCC).
What does prudence principle (voorzichtigheidsbeginsel) mean?
Basic principle of Dutch GAAP: profits are recognised only when realised, while losses and risks that arose before the end of the financial year are taken into account if they become known before the annual accounts are prepared (art. 2:384(2) DCC).
The law requires prudence when applying the accounting policies. Obligations originating before the end of the financial year are processed if they became known before preparation; foreseeable obligations and possible losses may then be taken into account. This does not justify arbitrary hidden reserves.
How does it work?
art. 2:384(2) DCC contains four rules. Prudence is exercised when applying the accounting policies. Profit counts only if it has been realised on the balance sheet date. Obligations originating before the end of the financial year are taken into account if they became known before preparation. Foreseeable obligations and possible losses with such an origin may then be taken into account.
The principle therefore works asymmetrically, but it concerns only obligations and losses that already have a cause in the financial year. Assets and liabilities are also valued separately (art. 2:385(1) DCC), so that a windfall on one item does not hide a loss on another. In the figures it returns as a write-down of assets (art. 2:387 DCC) and as a provision (art. 2:374(1) DCC).
Example
A BV has at 31 December a receivable of € 8,000 from a customer who has not paid since October. On 20 February, before preparation, the customer is declared bankrupt. The cause lay before the balance sheet date and is known before preparation: the receivable is written down in full in the old year, cost € 8,000. The same BV has a building that according to a valuation is worth € 40,000 more than its book value. That increase is not realised: the result falls by € 8,000 and the surplus value compensates nothing.
In the annual accounts
Valuation on the balance sheet and cost in the P&L; notes for material items.
Difference from the realisation principle
The realisation principle is one half of the prudence principle: take profit only when it is realised. Prudence also includes the other half: take obligations and losses into account as soon as they are known. Realisation says when income may be recognised, prudence additionally says when a cost must be.
Common mistakes
- Making extra provisions without support
- Taking all future profit in advance
What to watch for
- Between the balance sheet date and the preparation date, check whether customers have run into payment problems and whether claims have been reported.
- Support every write-down and provision per item; a round amount for safety is a hidden reserve.
- The principle applies in every size class. Micro and small entities that apply tax bases (art. 2:395a(7) and 2:396(6) DCC) follow the tax determination of profit for this.
Legal basis and sources
art. 2:384(2) DCC
Frequently asked questions
May you form an extra provision out of prudence?
Only on a statutory ground: a clearly described obligation, or a future expenditure originating before the end of the financial year (art. 2:374(1) DCC).
Does the principle also apply to losses arising after the balance sheet date?
No. A fire in February you explain if it is significant, but you do not process it in the old year: the cause lies after the balance sheet date.
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Preparing Dutch annual accounts?
Your first set of annual accounts is free, for every size class. Create an account and prepare the annual accounts of your Dutch company under Title 9 of Book 2 of the Dutch Civil Code.
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