We drew inspiration to write this article from an interesting judgment of the Supreme Administrative Court from April 2022 on accounting for returnable containers and a change in an accounting method.
What are returnable containers?
Returnable containers are intended for repeat use for the same purpose. They are considered environmentally friendly and economically beneficial. These are mainly beverage bottles, beer and other barrels, crates, pallets, containers, cable reels, and others.
Possible approaches to accounting for returnable containers
Accounting regulation generally allows containers to be recognised as fixed assets or inventory. Specifically, under Section 9 (1) (e) of Regulation No. 500/2002 Coll., “C.I.1 Material” item includes packaging and packaging materials, provided they are not recognised as fixed assets or goods. The reporting entity is required to choose such an accounting method in order for the financial statements to give as true and fair of a view of reality as possible.
Recognition of returnable containers as fixed assets
According to Section 7 (3) (b) of the Regulation, the balance sheet item “B.II.2 Tangible movable assets and sets of tangible movable assets” includes tangible movable assets and sets of tangible movable assets with a separate technical-economic function, with a useful life of more than one year, and starting from the valuation amount set by the reporting entity in compliance with duties set by legislation, which is mainly following the principle of materiality and the true and fair view of the assets.
Reporting entities are required to prepare a depreciation plan, based on which assets are depreciated over their use but only up to their valuation amount in accounting (Section 28 (6) of the Accounting Act). The costs thus reflect the current wear and impairment of returnable containers over their useful life.
Returnable containers recorded on account 022 – Fixed assets are recorded on the prepayment accounts when sold to the market and circulated in the so-called closed system of reusable packaging within which the ownership of the returnable packaging is not transferred with the goods. In other words, reusable packaging is permanently owned by the supplier who repeatedly places it on the market.
The benefit of this system consists in the actual legal obligation of the reporting entity to accept the returned packaging and return the related deposit received to the customer or consumer being recorded in the Company’s accounting.
Recognition of returnable containers as inventory
Tangible movable assets and sets of tangible movable assets with a separate technical-economic function and a useful life of more than one year and not reported under “B.II.2 Tangible movable assets and sets of tangible movable assets” are considered low-value tangible assets recognised by the reporting entity as inventories and reported either under “C.I.1. Material” or “C.I.3.2. Goods” (Sections 9 and 49 of the Regulation and Czech Accounting Standard No. 015 – Inventories).
This accounting method is used in the open system of reusable packaging within which the ownership of the returnable packaging is transferred to the customer with the goods.
The characteristic feature of this system is that the reporting entity does not own or economically control the returnable containers on the market. The customer is thus entitled, but not obliged, to return the returnable container to the reporting entity. The sale (return) of returnable containers is recognised on the profit or loss account (accounts 542, 642) along with the entry of disposal of returnable containers from stock or containers returned from the market in the amount of the refundable deposit in account 112. The price variation (the difference between the actual price of the returnable container and its value net of VAT) is recognised as cost or cost reduction when the container is acquired without being put into circulation.
Within this method of accounting for returnable containers, costs and revenues are overstated due to the “repeated purchases and sales” of inventories. Another disadvantage is that the reporting entity does not account for its duty to accept returned packaging.
A brief summary of the dispute
Plzeňský Prazdroj, a.s., (the “Company”) has changed its method of accounting for POSM (Point of Sales Materials) and returnable bottles. Until 31 March 2014, the Company reported returnable bottles as inventories and accounted for the sale (return/purchase) of returnable bottles on the profit and loss account (accounts 542, 642) while simultaneously accounting for the disposal of bottles from stock or bottles returned from the market in the amount of the refundable deposit.
From 1 April 2014, without changing the contractual (commercial) terms within the supplier-customer relationships, the Company changed the accounting method used for returnable bottles, which are newly reported on the account of fixed assets instead of the inventory account. The Company then accounted for this change as a change in accounting method, which is reflected retrospectively. Thus, the Company included in the tax-deductible expenses of the given year a portion of expenses (costs) incurred for the acquisition of marketing items and bottles, which would otherwise have been applied in the expenses of prior taxable periods if the Company had accounted for the marketing items and bottles as tangible fixed assets from the beginning.
The Specialised Tax Office did not agree with this approach and assessed corporate income tax for the taxable period from 1 April 2014 to 31 March 2015 in November 2016 as from its perspective, the Company did not meet the conditions for the change in the accounting method. The Company appealed, though not successfully. Subsequently, the Company filed a claim with the Regional Court in Pilsen, which dismissed the claim and sided with the tax administrator. The Company then brought an application for annulment of the effective trial decision of the Regional Court with the Supreme Administrative Court, which vacated the Regional Court’s decision in April 2022 and returned the case to it for further proceedings. As such, we will have to wait for the final decision.
However, the judgment is remarkable as it deals with the actual definition of a change in accounting method and its impact on the taxpayer’s tax base. According to the Supreme Administrative Court, a change in accounting method is a situation where a reporting entity starts to recognise, valuate or disclose individual features of the financial statements in a different way than before. According to the Court, the change in method thus does not arise from new information or a new actual state; the reporting entity only records the same economic reality in another way due to the change in its methodology. Methods can be changed only if they improve the explanatory power of the financial statements. This reasoning of the Supreme Administrative Court complies with the National Accounting Board’s Interpretation I-29 Corrections of Errors, Changes in Accounting Estimates, and Changes in Accounting Methods.
Owing to the fact that the Supreme Administrative Court is of the opinion that the Regional Court did not approach the case from this perspective and, above all, did not consider whether or not the Company had changed its economic reality, the dispute was not decided. We will further follow the development of this case and will continue to inform you as the change in accounting method is a fundamental element of accounting and must be assessed correctly, because it may have significant impacts on the tax base.