Friday, 5 July 2013

Provision and Reserves

Reserves

 Reserve is the part of the capital of a company, other than the share capital, largely arising from retained profit or from the issue of share capital at more than its nominal value. Reserves are distinguished from Provision in that for the latter there is a known diminution in value of an asset or a known liability, whereas reserves are surpluses not yet distributed and, in some cases (e.g., share premium account or capital redemption reserve), not distributable. The directors of a company may choose to earmark part of these funds for a special purpose.(e.g., a Reserve for obsolescence of plant). However, reserves should not be seen as specific sums of money put aside for special purposes as they are represented by the general net assets of the company. Reserves are subdivided into Retained earnings(revenue reserves), which are available to be distributed to the shareholders by way of dividends, and capital reserves, which for various reasons are not distributable as dividends, although they may be converted into permanent share capital by way of a bonus issue.

Provision

Provision is an amount set aside out of profits in the accounts of an organisation for a known liability(even though the specific amount might not be known) or for the diminution in value of an asset. Common examples include Provision for Bad debts, Provision for depreciation and also provision for accrued liabilities.

Reserve and Provision may be shown on the Liabilities side of the Balance sheet or it may be deducted from the concerned asset on the assets side of the balance sheet(like Provision for bad debts deducted from Debtors)


Differences Between Reserve And Provision 
 The following are the main differences between reserve and provision:

1. Mode Of Creation
Reserve is created against the charge of the profit and loss appropriation account. Provision is created against the charge of the profit and loss account.

2. Objective       
Main objective of reserve is to strengthen the financial position and to meet future unknown losses and liabilities. Objective of provision is to meet known losses and liabilities the amount of which is not certain.

3. Accounting Treatment
Reserve is shown on debit side of profit and loss appropriation account and liabilities side of balance sheet. Provision is shown on debit side of profit and loss account and assets side of balance sheet as deduction from the concerned asset.

4. Relation With Profit
Reserve is created when there is enough profit in the business. Provision is created even if there is loss in the business.

5. Distribution
Reserve can be distributed to shareholders as dividend. Provision can not be distributed as dividend to shareholders.

6. Future Requirement
Reserve is created without considering the future requirement of the business. Provision is created by estimating the future requirement of the business.

7. Impact
Impact of reserve will be on financial position. Impact of provision will be on profit or loss of the business.

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