Secret reserve definition

What is a Secret Reserve?

A secret reserve is the amount by which the assets of an organization are understated or its liabilities are overstated. An entity might establish a secret reserve for competitive reasons, to hide from other businesses that it is in a better financial position than appears in its financial statements . However, a secret reserve means that the information provided to shareholders is false and misleading.

A side effect of the secret reserve concept is that both reported income and taxable income are reduced.

How to Create a Secret Reserve

There are several ways to establish a secret reserve, such as the following:

Accelerate the depreciation of fixed assets . Depending on the depreciation method used, this can double the amount of depreciation expense recognition in the first few years of an asset’s useful life.
Write off assets entirely . This approach can be quite a stretch from an accounting standpoint, if there is any possibility that an asset will be used again at some point in the future.
Undervalue the market value of assets . This is outright fraud, since it represents an intentional reduction in the reported value of an asset.
Create excessively large reserves . This is a conservative treatment, since it means that the large reserves were created with up-front write-offs.