INTERPRETATION OF FREE RESERVES DEFINITION AS PER

COMPANIES ACT 2013

AUTHOR :CSDIVYAJAIN

https://taxguru.in/company-law/interpretation-free-reserves-definition-companies-act-2013.html

Introduction: The Companies Act 2013, which governs the corporate framework in India, introduces several
concepts to ensure transparency and protection for shareholders. Among these concepts is the definition of “free
reserves”, a term critical for shareholders and financial analysts. It demarcates which reserves are available for
dividend distribution.

Page Contents

Understanding the Basics: What are Free Reserves?

Examples of Non-Free Reserves:
Examples of Free Reserves:
Free Reserves Vs. Surplus: A Distinctive Analysis

Understanding the Basics: What are Free Reserves?

By definition, free reserves are funds in a company’s balance sheet that are available for distribution as
dividends. Essentially, these are the extra amounts, after deductions, that can be utilized to reward shareholders.

Examples of Non-Free Reserves:

1. Reserves from Asset Revaluation: Any reserves that have arisen due to the revaluation of assets cannot
be considered as free reserves.
2. Unrealized Gains Reserves: These are reserves created by gains that haven’t been realized, thus making
them ineligible as free reserves.
3. Carrying Amount Changes: Reserves arising from adjustments in the carrying amounts of assets or
liabilities do not qualify as free reserves.

Examples of Free Reserves:

1. Capital Reserves: Typically arising from the excess of shares issued over their face value, these reserves
are free for dividend distribution.
2. General Reserves: These are voluntary reserves kept aside for general purposes and can be considered as
free reserves.
3. Profit and Loss Reserves: Accumulated profits from the company’s operations that haven’t been
distributed as dividends yet qualify as free reserves.
Provisos to Consider:

Certain provisos in the definition are noteworthy:

Reserves from unrealized gains, notional gains, or asset revaluation, even if displayed as reserves, are off-
limits for dividend distribution.
Changes in carrying amounts of assets or liabilities recognized in equity, like the surplus in profit and loss
account when assessing the asset or liability at fair value, cannot be considered as free reserves.

Free Reserves Vs. Surplus: A Distinctive Analysis

It’s pivotal to understand the difference between surplus and free reserves. Surplus is a more extensive term that
envelops all the company’s reserves. However, free reserves are specifically those subsets of the surplus which
can be disbursed as dividends to shareholders.

Conclusion: Free reserves, as outlined in the Companies Act 2013, play a pivotal role in safeguarding the
shareholders’ rights. Companies must meticulously analyze their reserves to ascertain the amounts available for
dividend distribution. This understanding ensures transparency and augments trust between the company and its
stakeholders.