Reserve and types of Reserve

4:55 AM imran ali

The term 'reserve' denotes something kept for future use. In accounting sense, it denotes the amount set aside out of profit for the purpose of strengthening the financial position of the business. It is created for meeting unknown liability or loss in the future. Thus, it is not an expenses or loss in real sense.

According to William Pickles,"Reserves mean the amounts set aside out of profits and other surpluses, which are not earmarked in any way to meet any particular liability, known to exist on the date of the balance sheet".

Features of Reserves:
  1. It is created for meeting unknown liability or losses.
  2. It is created out of net profits.
  3. It is not created compulsorily.
  4. It is a part of undistributed profit, so it is shown in balance sheet until is is used.

Objectives of Reserves:
  • It works as an additional capital for the expansion of business through internal resources.
  • It strengthens the financial position of business.
  • It helps to meet any unknown liabilities, looses or contingencies in the future.
  • It provides funds for the repayment of debentures, preference share capital.
  • It helps to equalize in the rate of dividend in case of company.

Types of Reserves

  1. Capital Reserve
  2. Revenue Reserve
1. Capital Reserve:
Capital reserves are those reserves, which are not created out of operating profit. In other words, these reserves are created out of capital profits. Profit on sale or revaluation on fixed assets is capital profit, which are generally not available for distribution among the shareholders of the company. The following are some examples of capital profits, which are the sources of creating capital profits which are the sources of creating capital reserves.
  • Profit on sale of revaluation of fixed assets.
  • Profit on repayment of debentures.
  • Profit earned through the issue of shares at premium.
  • Profit earned through forfeiture and re-issue of shares.
  • Profit on the purchase of running business etc.
Utilization of Capital Reserves:
  • To meet future capital losses
  • To issue as fully paid bonus shares
  • To strengthen the financial position of the business.
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