Bonus provision

What it means

A bonus provision is a provision for annual bonuses and rewards to staff and management that relate to the past year but are paid after it ends. It includes the related employer contributions. It is made so that the expense falls in the year in which the employees actually earned the bonus.

It applies the matching principle: if a company assesses the year's results only in February and pays bonuses then, the cost belongs to the previous year. Without the provision, last year's profit would be overstated and the following year's understated.

The provision is made at an estimated amount where payment is probable, for example under an internal policy, a contract or a management decision. Together with the provision for untaken leave, it is among the most common provisions in annual financial statements.

How it works in practice

At the annual closing, the accountant obtains management's estimate of bonuses for the year, for example based on targets met, and adds employer contributions. The provision is booked to personnel costs and used when the bonuses are paid the following year.

If the amount actually paid differs from the provision, the difference goes to expenses or income in the year of payment. Comparing estimates with actual payouts each year helps refine future estimates.

For tax purposes, creating this provision is not deductible in the year it is made. The expense becomes deductible only when the bonuses are actually paid or accounted for under the rules for payroll expenses. The provision is added back when calculating the tax base.

What to watch out for

A provision must not be created without a real basis merely to reduce profit. There must be an obligation or a reasonable expectation of payment, and the amount must be sensibly estimated. The auditor will check what the estimate rests on.

If the bonuses are ultimately not paid, the provision must be released to income. Keeping old provisions without justification distorts the accounts and raises questions in an audit.