Nature of Reserves-Funds or Provisions
- June 28, 2017
- Posted by: marlenedubois
- Category: CPR Training
The amount saved will be set aside for any of the following several purposes:
(a) for meeting future liability or loss;
(b) for strengthening the financial position of the business;
(c) for fulfilling some specific purpose;
(d) for redeeming a liability;
(e) for replacing a wasting asset.
(f) There are two ways in which the amount available for distribution as profit can be reduced:
(1) Indirectly, i.e.. out of gross profit or by debiting profit in addition to loss account.
(2) or, directly. i.e., out of divisible profits by debiting profit in addition to loss appropriation account.
Profit in addition to loss account will be debited only when the object will be either to meet an anticipated or future contingent liability or loss or to replace a wasting asset. In all additional cases, profit in addition to loss appropriation account will be debited.
(3) The sum that will will be set aside mayor may not be invested; in addition to if invested, This specific may be invested inside or outside the business. This specific depends upon the object that will will be sought to be served. This specific will be usual to invest the money outside the business when the object will be to redeem a liability or to replace a wasting asset. Money may be invested outside or inside the business at one’s option, if the object will be to strengthen the financial position of the business.
Meaning of the terms:
1. Fund. If amount equal to the reserve will be invested in outside securities, the reserve will be termed as ‘Reserve Fund’.
2. Reserve. If amount set aside by profit will be not invested in outside securities, This specific will be termed as ‘Reserve’ .
3. Provision. If amount set aside as charge against profits or surplus to meet:
(a) Depreciation for renewal of the asset.
(b) Any known liability, the amount of which cannot be ascertained with accuracy. Provisions are generally, created by debiting the profit in addition to loss account. Provisions are also sometimes termed as ‘Specific Reserves’ by the accountants. Provisions are created even when there are no profits inside the business. Provisions are not surplus. They are not available for distribution amongst the proprietors or shareholders. However, provision in excess of requirement will be a surplus. When any provision becomes redundant, This specific should be credited back to profit in addition to loss appropriation account.
This specific should be noted that will sums set aside to meet known liabilities, the amount of which can be determined with accuracy do not fall within the definition of a provision in addition to should, therefore, be called as accrued liabilities. For example, outstanding rent, interest, etc. are accrued liabilities in addition to not provisions.
Types of Provisions (Specific Reserves)
As already stated, the provisions are of following types:
(i) Provision for doubtful debts ;
(ii) Reserve for discount on debtors;
(iii) Reserve for discount on creditors;
(iv) Reserve for repairs in addition to renewals.
Reserves are retained profits. They are part of the surplus. They are the amount kept aside by profits. There can be no reserves if there are no profits. Reserves are undistributed profits. They are appropriations of profits. While provisions are a pre-profit matters, reserves are a post-profit matters. One cannot talk of creating reserves, without first finding out profits. This specific will be a not bad business policy to create reserves. They strengthen’ the’ financial position of the business. Reserves are created for different purposes. They may be for expansion of business; they may be for equalization of dividends or they may be for redemption of debentures or loans. Again, reserves may be created out of capital profits or out of revenue profits. The reserves created out of capital profits are called capital reserves, whereas, others are called revenue reserves.
Capital reserves are created out of capital profits. Capital profits are not regular trading profits. They are profits on rare transactions. Capital reserves are generally not available for distribution as dividend. They are set aside to strengthen the financial position of the business or to meet capital losses. The following are the examples of capital profits :
(i) Profit on sale of fixed’ assets.
(ii) Profit prior to incorporation.
(iii) Profit on redemption of debentures.
(iv) Premium on issue of shares or debentures.
(v) Profit on forfeiture of shares.
(vii) Profit on acquisition of business.
(viii) Profit which have not been earned inside the regular course of business.
Capital reserves can be utilized inside the following ways:
(a) Issue of bonus shares.
(b) Writing off goodwill.
(c) Writing off preliminary expenses.
(d) Writing off shares/debentures issue expenses.
(e) Writing off losses prior to incorporation.
Revenue reserves are created out of revenue profits. They are available for distribution as dividend. Revenue reserves are of two types-those immediately so available for distribution in addition to those not immediately so available.
(a) General reserve
This specific reserve will be created by setting aside revenue profits. The object will be to strengthen the general financial position of the business. This specific will be not for a specific purpose. This specific will be a free reserve. This specific acts as a safety cushion against all unforeseen contingencies inside the future. This specific will be immediately available for distribution as dividend profit.
(b) Specific reserve
This specific too will be created by setting aside revenue profits. yet This specific will be for a specific purpose. This specific will be not immediately available for distribution. For example, reserve created for redemption of debentures. During the period of liability, This specific reserve will be not available for distribution. This specific becomes a general reserve on the redemption of debentures. Similarly, a reserve may be created for
equalization of dividend.