Topic: Provision and Reserves.

 Meaning of Provision:
Provision means setting aside a part of the profit for meeting a liability in future, the amount of which is not known
accurately at the time of finalization of financial statements. E.g., are Provision for Legal Damages, Provision for Depreciation,
Provision for Taxation, Provision for Doubtful Debts, Provision for Discount on Debtors etc.
 Objective of providing Provision:
1. To meet depreciation, renewal or diminution in the value of asset.
2. To meet expected contingency.
3. To meet known liability.
 Importance of Provision: The importance of creation of provision is as under:
1. Funds for replacement of asset.
2. Funds for diminution in the value of assets.
3. Uniform charge on income statements.
4. In compliance of principle of prudence.

 Meaning of Reserves:
Reserve means an appropriation of profits to strengthen the liquid resources of the business enterprise and not for
meeting any liability, contingency or any other commitment of the business. In other words, reserve means the amount set aside
out of profit and other surpluses until it is needed for some particulars purpose. All reserves appear on the liability side of the
Balance Sheet.

 Importance of Reserves: The importance of reserves is as under:

1. Strengthening the financial position of business.
2. Source of internal financing.
3. Enhancing the reputation of business.
4. Keeping working capital intact.

 Types of Reserves:
Broadly, there are two types of reserves (1) Revenue Reserves and (2) Capital Reserves.
(1) Revenue Reserves: Revenue reserves are created out of retaining profits. They are usually available for distribution as
profit in the future. Revenue reserves may be further classified into: (a) General Reserves, (b) Specific Reserves and (c)
Secret Reserve.
(a) General Reserves: These reserves are that amount of profits which are set aside to meet some future contingencies and
not created for any specific purpose. These are generally retained for strengthening the financial position of the business
and to provide additional working capital for the business when needed.
(b) Specific Reserves: These reserves are created for some purpose and are utilized for these purposes only. These
reserves are generally earmarked against some particular asset and are expressed as reserve fund.
(c) Secret Reserve: Secret reserve is a reserve that does not appear in the balance sheet. It can be created in the year of
higher profits and can be merged with the profits during that year. Secret reserves can be created for undervaluing of
stock, making excessive provisions than the required, charging capital expenditure to revenue etc.
(2) Capital Reserves: are the reserves created out of capital profit and are not generally distributed as profits. These reserves
can be utilized for writing-off capital losses. These reserves are not available for shareholders as dividend. These reserves
may or may not involve any receipts of cash. E.g., Profit on sale of fixed assets, profit on revaluation of fixed assets, profit on
redemption of debentures, profit prior for incorporation etc.

 Distinction between Provisions and Reserves.

Sl.No Provisions
1 A provision is charge against profit.
2 The creation of provisions has nothing to do with the
amount of net profit.
3 Provisions are created for future liabilities and charges
or for valuation adjustments of assets.
4 Provisions are created for some specific purposes.
5 Provisions cannot be distributed as profits.
Reserves
A reserve is an appropriation of profit.
The creation of reserve depends on the amount of profits
earned by the business.
Reserves are created for safeguarding the business
against unforeseen losses.
Reserves are created mostly for general purposes.
Reserves, other than capital reserves, can be distributed
as profits .

 Distinction between Revenue Reserve and Capital Reserve.

Sl.No Revenue Reserve Capital Reserve
1 It is created out of revenue profits. It is created out of capital profits.
2 It can be general or specific. It is always specific.
3 It may be distributed as profits. It is not generally distributed as profits.
4 It is created by retaining profits. It is not created by retaining profits.

 Distinction between General Reserve and Specific Reserve.

Sl.No General Reserve Specific Reserve
1 It is created foe general purpose. It is created for specific purpose.
2 It is created to meet some future contingencies. It is created for some specific purpose.
3 It is utilize to meet any unknown liability. It can be utilized only for the purpose for which they
were created.
4 In case of need, it can be utilized for paying dividend. Usually, dividend cannot be paid out of the specific
reserves.
----------------------