Provisions And Reserves

Chapter 6 PROVISIONS AND RESERVES

PROVISION: Meaning Provision is made for those items which are related to current year operating activities but the amount of these items is not known. Examples: Provision for Depreciation, Provision for Bad and Doubtful Debts, Provision for Discount on Debtors, Provision for Taxation etc.

Basic Features of ‘Provision’ are: 1. To provide for expected decrease in assets or increase in liabilities on account of the transactions of the current year. For e.g., tax liability is determined at the time of assessment by the income tax authorities at some future date. But as tax liability likely to arise in future is on the income of the current year provision for taxation is created and Dr. to the P&L A/c of the current year. 2. Provision is charged against revenue and other incomes of the current year. It ensures proper matching of revenue and expenses. 3. Provision helps to show assets at their real worth. Provision helps in ascertainment of true profits (or loss) of the enterprise, if provisions are not created the profits are overstated. It helps in depiction of true and fair view of the financial position of the business enterprise. 4. When provision for any item is created, actual expense is charged to provision A/c and not to P&L A/c

Reserves 

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Reserve refers to retention of profit which is not in the form of provision. Reserves means accumulated or undistributed profits. If the provision exceeds the amount which is required to meet the loss or liability, the excess is to be treated as reserve.

Objectives of Reserves  

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To strengthen the financial position of the enterprise. To provide funds for modernization and /or expansion of existing plant or acquisition of a new plant. To equalise the dividends during the periods of inadequate profits. To comply with legal requirements e.g. Debenture Redemption Reserve, Capital Redemption Reserve under the Companies Act,1956. To meet unforeseen abnormal losses.

Types of Reserves 1.

(b)

(c)

REVENUE RESERVE: those reserves which are created out of profits available for distribution by way of dividend. These may be classified as: General Reserve: Reserve which is not created for any specific purpose. E.g. General Reserve, Contingency Reserve. Specific Reserve: Reserve which is created for specific purpose. E.g. Dividend Equalisation Reserve, Debenture Redemption Reserve.

2. CAPITAL RESERVE: those reserves created out of profits of capital nature and not out of operating profits. E.g. Profits prior to incorporation, Premium on issue of Shares and Debentures, Premium on reissue of forfeited shares, Profit on sale of fixed assets, Profit on revaluation of fixed asset Revenue Reserves are free for distribution by way of dividend whereas amount of capital reserve are not free for distribution by wy of dividend.

Distinction Between Provision and Reserve Basis of Distinction

Provision

Reserve

1. Purpose

It is created for some specific purpose and can be used for that particular purpose

2. Charge v/s Appropriation

It is a charge against the It is an appropriation out of profit and is required to be profit and can be created created irrespective of the only if profits have been amount of profit. earned.

3. Disclosure in Usually a provision is Balance Sheet shown by way of deduction from the amount of the items for which it is created.

It need not necessarily be created for a particular purpose. E.g. General Reserve

Reserve is shown as a separate item under the head ‘Reserves and Surplus’ on the liabilities oside of the Balance Sheet

4. Investment outside the business

There is no question of investment of amount of provisions

5. Utilisation for It cannot be utilised for Dividends distribution by way of dividends

The amount of Reserve can be invested outside the business It can be utilised for distribution by way of dividends