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Objectives:

1.
Appreciate the purpose of reserves.
2.
Define reserves
3.
Name the categories of reserves
4.
Describe revenue reserves and name and
outline the types of revenue reserves.
5.
Show the journal entries for revenue reserve
6.
Describe capital reserves and name and
outline each type of capital reserve.
7.
Show the relevant journal entries of capital
reserves

It

is essential to retain part of the profits


within the company for future expansion and
to minimise the borrowing funds in the
future.
Funds can also be set asset aside to maintain
dividends

Reserves

are profits which are retained in


the business for no specific purpose.
Reserves are different from provision, as
provisions are made for a specific purpose
such as provision for bad debts and provision
for depreciation.

There
-

are two categories of reserves, namely


Revenue reserves
Capital reserves

Revenue

reserves are undistributed net


profit. These can be used to pay dividend or
used in any other way the directors consider
appropriate.
Revenue reserves are called various names
such as general reserve, unappropriated
profits, profit and loss appropriation,
accumulated surplus.

Specific

reserves
Specific reserves are revenue reserves which
have been set aside for some specific
purpose such as replacement of fixed assets
or in anticipation of an expansion of the
business.
General reserves
General reserves are other revenue reserves
considered desirable or necessary to
reinforce the financial position of the
company.

Revenue

reserve represent profits made in


the ordinary course of business.
Ordinary course of business means what
the business does on a day to day basis to
earn money.
For example, a commercial banks ordinary
course of business is lending money.
A factorys ordinary course of business is
making semi-finished or finished goods and
selling it.
A supermarket buys and sells various
consumer goods

To

set aside undistributed profits (retained


profits) in a reserve, it is necessary to make
the following journal entries:
Debit profit and loss appropriation
Credit the relevant reserve
In other words, revenue reserves are profits
which are transferred from profit and loss
this is done by
Debiting profit and loss appropriation
Crediting the relevant reserve

Although

later on some of the revenue


reserves can be taken out (debiting) and
added to the profit and loss appropriation
account (crediting) so that more money is
available as dividends.
Caution companies should not retain too
much liquid funds not efficiently utilised
when it could be paid to shareholders as
dividends.

Before

cash dividend is paid out it is critical


for management to analyse the firms
finacial position both in the present and
future to see if they can afford it.
If so, the board of directors will vote before
declaring that dividends will be paid out.
There are three important dates pertaining
to dividend transactions namely,
- Date of declaration
- Date of record
- Date of payment

Couples

Resort board of directors passed a


resolution on 10 January, 2012 (date of
declaration) and declared that payments will
be made by January 24, 2012 (date of
record). As on January 25, 2012, Couples
Resort declared a cash dividend of $1 per
share on 2 million shares payable on January
25, 2012 to all shareholders.

Required:

Journal

Record the transaction in the

Setting

aside profits as revenue reserves (in


the case of ABC Ltd is $100 000) reduces the
amount available to pay out to shareholders
as dividends
In general revenue reserve is essential as it
indicates to shareholders that it will be
unwise to pay out all available profits as
dividends.

Capital

reserves are generally NOT available


for distribution to shareholders as dividends.
Although bonus shares issued to existing
shareholders can be financed from this
source.

Gains

(profits) arising from revaluation of


fixed assets are classified as capital reserves.
Amounts arising from the issue of shares at a
premium
So these profits were not earned during the
ordinary course of business.

Share

premium
Revaluation reserves
Capital redemption reserves

Case

2
Couples Resort revalued its premises and the
result was a $5million increase
Required
Show the journal entry

In this case the premises account is debited to


show the increase in the asset account and the
revaluation reserve is credited because share
holder equity is increasing.

Revaluation

reserve is created when an


asset is revalued to reflect an increase
in its value.

Remember capital reserve is not available for


distribution as dividend or for transfer to the
profit and loss appropriation account to inflate
profits that will be paid out as dividends.

Share

premium account may be used:


In paying up unissued shares as fully paid
bonus shares
To write off:
Preliminary expenses (when forming the
company)
Expenses incurred as a result of the issue of
shares (e.g. legal expenses)
To provide for any premium on the
redemption of shares.

Capital

redemption may be used to finance


the buyback of redeemable shares.
It must protect the creditors by replacing the
shares purchased with profits that would
otherwise be available for paying dividends.

Debit

profit and loss appropriation


Credit capital redemption reserve

See

shares redeemed at part where some


new shares are issued and
See - Shares redeemed at a premium where
shares were not issued at a premium

See

p. 29, Teck