Reserves in Accounting
When a company earns profit at the end of a financial year, certain portion of it is retained in the business to meet future contingencies, growth prospects etc. This amount of money kept aside is termed as Reserves. They help in fortifying the financial position of a company and can be used for various purposes such as expansion, stable dividend repayments, legal requirements, meeting contingencies, improving financial situation, investments etc. It is also referred to as retained earnings.
Examples of Reserves – General reserve, Reserve for Dividends Equalization, Reserve for Expansion, Reserve for Increased Cost of Replacement etc.
There are mainly 2 different types Capital Reserves &, Revenue Reserves.
Reserves in Financial Statements
It is shown on the liability side of a balance sheet under the head “Reserves and Surplus” along with capital, if a company faces losses then no reserves are made.
Capital reserve is created out of capital profits & are usually not distributed as dividends to shareholders. It can not be created out of profits earned from core operations of a company.
- Profit earned before a company’s incorporation
- Premium earned on issue of shares & debentures
- Profit on re-issuance of forfeited shares
- Profit set aside for redemption of preference shares or debentures
- Profit on sale of fixed assets
- Surplus on revaluation of assets and liabilities
- Capital redemption reserve
Revenue reserves are created out of profits earned from operations of a company. It is reflected in profit and loss appropriation account. Revenue reserve can be used for the following:
- Dividend to shareholders
- Expansion of business
- Stabilize the dividend rate
Revenue reserves are divided into two types & both of them are kept aside as appropriation of profits.
- General Reserves – As the name suggests, they are created out of profits & kept aside for general purpose and financial strengthening of the company, it doesn’t have any special purpose to fulfill and can be used for any viable reason in future. Top reasons include meeting contingencies and expansions that can’t be foreseen.
- Specific Reserves – This reserve however is created keeping a specific reason in mind and can only be used for its designated purpose. Examples include Dividend Equalization Reserve, Debenture Redemption Reserve, Contingency Reserves, Capital Redemption Reserve etc.