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(C) Reserve Account: For Example, A Business Wants To Reserve Funds For A Future Building Construction
(C) Reserve Account: For Example, A Business Wants To Reserve Funds For A Future Building Construction
A reserve is profits that have been appropriated for a particular purpose. Reserves are
sometimes set up to purchase fixed assets, pay an expected legal settlement, pay
bonuses, pay off debt, pay for repairs and maintenance, and so forth. This is done to
keep funds from being used for other purposes, such as paying dividends or buying
back shares. The board of directors is authorized to create a reserve. A reserve is
something of an anachronism, because there are no legal restrictions on the use of
funds that have been designated as being reserved. Thus, funds designated as a
reserve can actually be used for any purpose.
Reserve accounting is quite simple - just debit the retained earnings account for the
amount to be segregated in a reserve account, and credit the reserve account for the
same amount. When the activity has been completed that caused the reserve to be
created, just reverse the entry to shift the balance back to the retained earnings
account.
For example, a business wants to reserve funds for a future building construction
project, and so credits a Building Reserve fund for $5 million and debits retained
earnings for the same amount. The building is then constructed at a cost of $4.9 million,
which is accounted for as a debit to the fixed assets account and a credit to cash. Once
the building is completed, the original reserve entry is reversed, with $5 million debited
to the Building Reserve fund and $5 million credited to the retained earnings account.
A reserve line item does not necessarily have to be presented separately in the balance
sheet; it may be aggregated into the retained earnings line item.