What is Reserve in Accounting
Reserve is an amount of profit or other gains of an enterprise not yet distributed to its owners i.e. shareholders. Setting up a reserve is an accounting allocation of undistributed profit or gains.
Reserves belong to shareholders and are part of total shareholder equity. Reserves should be distinguished from the provision. The provisions are charged in the calculation of profit and represent a reduction in the value of an asset for the recognition of estimated liabilities. Neither reserves nor provisions are amounts of cash.
Types of Reserves
Reserves are classified as follows:
Capital reserves are those which are not generally available for distribution as a dividend to the members (shareholder) of the company they arise mainly out of the following:
• Capital profits for example profit on the sale of fixed asset
• Upward revaluation of fixed assets
• Capital receipts for example premium on issue of shares or debenture
• Non-trading income during the period prior to incorporation
• Capital reserves may or may not involve any receipts of cash.
The amount of retained profit that is available for distribution as a dividend to the members (shareholders) of the company they are treated by which chaining profits the example of revenue reserves is the credit balance of profit and loss account, general reserve, etc.
General reserves are not created for any particular purpose. They are created for safeguarding the business against and foreseen losses in the future with a view to planning for further development of the business.
Secret reserves are reserves that are not known to the members (shareholder) of the company. Secret reserves are created by a simple method of showing profit at a figure much lower than the actual profit as follows:
• Writing of excessive depreciation
• Undervaluation of inventory
• Showing a contingent liability as an actual liability, etc
Reserves in the Balance sheet
Reserves in the Balance sheet are entered as liabilities and reflect funds set aside to pay future commitments. For an insurance company, balance sheet reserves are the funds set aside by insurance companies for future insurance premiums or claims that have been filed but have not yet been disclosed to or settled by the insurance company.
The amount of balance sheet reserves that must be held is regulated by law. Claim reserves are another name for balance sheet reserves.
Difference Between Reserve and Provision:
A reserve is a portion of profits set aside for a particular reason. A capital reserve is the most common type of reserve, in which funds are put aside to buy fixed assets. By establishing a reserve, the board of directors separates assets from the company’s general operating expenses.
There’s no real requirement for a reserve since there are rarely any legal restrictions on the utilize of reserves that have been “reserved.” Instead, the administration basically makes note of its future cash needs, and budgets for them suitably. In this manner, a reserve can be referred to in budgetary articulations but not even reported in a separate account within the bookkeeping system.
A provision is the percentage of an expenditure or decrease in the value of an asset that an organization chooses to reflect in its accounting system, before having precise details on the actual amount of the expense or asset reduction. For example, a company regularly tracks provisions for bad debts, sales allowances, and inventory obsolescence. Severance payments, asset impairments, and reorganization charges are less common provisions.
In a summary, a reserve is a profit appropriation for a given reason, while a provision is a charge for an expected cost.
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