Accounts
Chapter- Provisions & Reserves (Class-XI)
Notes by: SAHIL ARORA
At CJ Bureau Of Commerce & Science
Provision: Provision is an amount set aside by charging (debited) it in the profit and loss account, to
provide for known liability the amount of which cannot be determined accurately because they are not
yet incurred. Examples of Provisions:
• Provision for Depreciation on Assets
• Provision for Bad and Doubtful Debts
• Provision for Discount on Debtors
Features of Provisions
1. Provision is made to meet a known liability.
2. The liability is known but the amount of such liability cannot be determined with reasonable
accuracy.
3. Provision is a charge against profits and as such reduces the profits of the year in which it is
created.
Importance of Provisions
1. To ascertain the true net profits or losses of the business
2. To ascertain the true and fair financial position of the business
3. To provide for anticipated losses or known liabilities in future
Meaning of Reserves
Reserves mean amounts set aside out of profits and other surplus to meet future uncertainties. In other
words, a reserve is meant to meet any unknown liability or loss in the future.
Purpose of Reserves:
Financial Stability: Provides a cushion for future uncertainties.
Investment and Expansion: Helps fund future investments or business expansion.
Dividend Distribution: Ensures steady dividend payments even during lean periods
Types of Reserve:
Revenue Reserve: Created from the profits earned through the day-to-day operations of the business.
1. General Reserve: Set aside for general, unspecified future needs or contingencies.
2. Specific Reserve: Created for a specific purpose, such as expansion or dividend equalisation.
Examples: Investment Fluctuation Reserve, Workmen Compensation Reserve etc
Capital Reserve: Created from capital profits, not meant for distribution as dividends but for future
capital expenditure or to cover capital losses. These reserves are
1. Not of recurring nature.
2. Not readily available for distribution as dividend among the shareholders.
3. These reserves can be utilized for writing off capital losses.
Examples: Profit on the sale of fixed assets, profit on the redemption of debentures, profit prior to
incorporation.
Secret reserve
Secret of refers to the reserves whose existence or amount is not disclosed in the balance sheet. These
reserves are also known as hidden reserve
Creation of Secret/hidden reserves
1. By charging extra depreciation 2. By undervaluing, stock and goodwill, 3. By creating extra provision for
bad debts
Advantages of creating secret reserve
1. More working capital
2. Financial support in unfavourable time
3. Unexpected losses can be met
Disadvantages of creating secret reserve
1. Misleading balance sheet
2. Unfavourable dividend to shareholders
3. Reduce the value of shares
DIFFERENCE BETWEEN PROVISON AND RESERVES
Basis Provision Reserve
It is created to strengthen the financial
1. Meaning It is created to meet a known liability
position of business enterprise
Charge or
2. Provisions are charge against profits Reserve is an appropriation of profit.
Appropriation
The object is to provide for known
It is created to strengthen the but financial
3. Objective liability cannot be calculated
position and to meet unforeseen liability
accurately
Effect on Profit & It is debited to the Profit Hence,
4. Reserve reduces divisible profits.
Loss A/c profit is reduced.
Provisions are to be created even if Reserve is created out of adequate are
5. Creation
there are insufficient profits profits only
Provisions are created by debiting It is created through Profit & Loss
6 Mode of creation
the Profit & loss account Appropriation Account
It cannot be invested outside the Reserve can be invested outside the
7 Investment
business business
Creation of provision is necessary as Its creation is not necessary. It is created as
8 Necessity
per law a matter of prudence
DIFFERENCE BETWEEN REVENUE RESERVES AND CAPITAL RESERVES
Basis for
Revenue Reserve Capital Reserve
Comparison
Meaning Revenue Reserve refers to the sum of Capital Reserve alludes to a fund, that is
money retained in business, so as to created to finance long term project or
meet out future contingencies. write off capital expenses.
Source Revenue profit of the firm are the source Capital profit of the firm are the source
of revenue reserves. of capital reserve.
Aim To meet unforeseen contingencies and To adhere to the statutory requirements
improve entity's financial position. or accounting principles.
Dividend It is freely available for distribution as It is not available for distribution as
dividend. dividend.
