Provisions and reserves

provisions and reserves

What Is A Provision?

Provision is an amount that is set aside to cover future uncertain, but probable expenses/losses or obligations that belong to the current accounting period. Provision is a charge against the income of current accounting period and ensures proper matching of income and expenses which helps in ascertaining the true profit or loss of the company for the period. There are specific expenses/losses or obligations that may arise in future but whose amount cannot be determined exactly. So a certain estimated amount is kept aside for them which is called as provision. Some of the examples of provisions are:-
– Provision for doubtful debts
– Provision for discount on debtors
– Provision for depreciation
– Provision for preference dividend
– Provision for taxation

What Is A Reserve?

Reserve is a part of profits of the company which is set aside and retained in the business for purposes such as expansion, working capital, issuing bonus shares,etc or some other specific purpose. Reserve is an appropriation of profits. There are two types of reserves:-
(1) Revenue reserve:-
Revenue reserve is created out of the profit earned by the company from its normal trading/operating activities. Revenue reserve can be used for general purposes such as expansion of business, increasing working capital,etc or for some specific purposes such as redemption of debentures, dividend equalization, etc.
(2) Capital reserve:-
Capital reserve is created out of the profit earned from activities such as sale of assets, revaluation of assets, issue of shares at premium,etc which are not the normal trading/operating activities of the company. Capital reserve can be used for purposes such as issue of bonus shares, writing off preliminary expenses, etc.

Difference Between Provision And Reserve:-

Provision Reserve
It is a probable loss or obligation. It is a portion of profit.
It is a charge against profit as it is deducted from the income. It is an appropriation of profit as it is allocated to various heads.
It must be created irrespective of profit or loss. It can be created only if profits are earned.
True profit or loss cannot be ascertained without creating provision. True profit or loss can be ascertained even without creating reserve.
Profit or loss is affected by provision. Profit decreases after creating provision. Profit or loss is not affected by reserve. It is created after ascertaining profit.
The amount of provision does not belong to the owners i.e. shareholders. The amount of reserve belongs to the owners i.e. shareholders.
Provision is either shown on the assets side of balance sheet by way of deduction from the items for which it is created for e.g. provision for doubtful debts from debtors or on the liabilities side of balance sheet for e.g. provision for taxation. Reserve is shown on the liabilities side of balance sheet as Reserves and Surplus after share capital.

 

Leave a Reply

Your email address will not be published. Required fields are marked *