VIDYA BHARTI EDUCATIONAL INSTITUTIONS

RESERVES http://vidyabharti.in/

RESERVES MEANINGReserves are the amounts set aside out of profits. It is an appropriation of profits or accumulated profits to strengthen the financial position of the business. It is not a charge against profits. Reserves are not meant to cover any liability or depreciation in the value of assets. Examples are General Reserve, Reserve for Expansion ,Reserve for Equalisation of Dividends, Reserve for Increased Costs of Replacement, etc.

When the amount equal to the reserve is invested in outside securities, the reserve will be named Reserve Fund.

But if there are no specific investments it will not be called a Reserve Fund but merely a ‘Reserve’.

General reserve, Reserve for expansion and Dividend Equalisation Reserve are shown in the Profit and Loss Appropriation Account and not in the Profit and Loss Account.

RESERVES important note

Reserves are important in a business to strengthen the financial position of the enterprise.

The reserves enable the enterprise to face difficult financial period that may arise in the future by using reserves which are cost free source of internal financing.

RESERVES importance

1.Expansion2.Better financial position3.Redemption of liabilities4.Meeting unforeseen

contingencies5.Making dividends uniform

from year to year 6.Meeting legal

requirements

RESERVES may be created for

1.Revenue Reserves

2.Capital Reserves

3.General Reserve And Specific Reserve

Types of RESERVES

Any reserve which is available for distribution as dividend to the shareholders is called Revenue Reserve

Examples› General Reserves,› Dividend Equalisation Reserve,

› Debenture Redemption Reserve and

› Investment Fluctuation Reserve, etc.

Revenue RESERVES

Any reserve which is created out of capital profits or is not available for distribution as dividend to the shareholders is called Capital Reserve.

Examples› Profit prior to incorporation,› Premium on issue of shares or debentures,› Profits on redemption of debentures,› Profit on forfeiture of shares,› Profit on sale of fixed assets,› Capital redemption reserve and› Profit on revaluation of fixed assets and

liabilities

Capital RESERVES

REVENUE RESERVES CAPITAL RESERVESIt is created out of business profits.

It is created out of capital profits.

DISTINCTION BETWEEN REVENUE AND CAPITAL RESERVES

Revenue Reserves Capital ReservesIt can be used for distribution of dividends without the any precondition.

It can be used for distribution of dividends only if the company satisfies certain conditions prescribed by the Companies Act.

DISTINCTION BETWEEN REVENUE AND CAPITAL RESERVES

Revenue Reserves Capital ReservesIt is created for

strengthening the financial position and

meeting the unforeseen contingencies or some

specific purpose.

It is created for meeting capital losses

or to be used for purposes specified by the Companies Act.

DISTINCTION BETWEEN REVENUE AND CAPITAL RESERVES

It is the amount set aside out of profits for no specific purpose.

It is available for any future contingency or expansion of business.

Such reserve strengthens the financial position of the business.

It is to be noted that General Reserve and Contingency Reserve generally mean the same thing.

GENERAL RESERVE

It is that reserve which is created for a specific purpose and can be utilised only for that purpose.

ExamplesDividend Equalisation Reserve,

Debenture Redemption Fund, Capital Redemption Reserve, Development Rebate Reserve, etc.

Dividend Equalisation Reserve is a specific reserve because it is created to maintain a steady rate of dividend flow.

SPECIFIC RESERVE

If reserves are invested in outside securities and such securities are earmarked for a particular purpose denoted by the reserve, the reserve will be called ‘Reserve Fund’. A company will invest the funds outside only if:

(i) ready cash is necessary on a certain date, or

(ii) the funds cannot be profitably invested in the business itself.

RESERVE FUND

Reserves are shown on the liabilities side of a Balance Sheet

Reserves are liability and belongs to the proprietor.

NATURE OF RESERVES

A secret reserve is a reserve the existence and/or the amount of which is not disclosed in the Balance Sheet.

It is also called a Hidden Reserve or Internal Reserve. It can be said that there is a surplus of assets over liabilities and that the surplus is not disclosed or shown by the Balance Sheet.

Such reserves are created by showing the assets at a lower amount and liabilities at a higher amount.

SECRET RESERVE

Under the provisions of the Companies Act, 1956, no company (other than a banking company or insurance company) is allowed to maintain a secret reserve.

Secret reserves are created in concerns like banking companies, insurance companies, etc., where public confidence is required for its working life.

1. By charging excessive depreciation,2. By undervaluing stock-in-trade and

goodwill,3. By creating excessive provision for

bad debts and other contingencies,4. By charging capital expenditure to

the Profit and Loss Account,5. By suppressing sales,6. By showing a contingent liability as

a real liability and7. By grouping free reserves as

creditors.

SECRET RESERVE CAN BE CREATED

1. It increases the working capital of the concern and also strengthens its financial position.

2. It discourages competition by not disclosing the total profit made by a concern.

3. It enables the directors to tide over unfavourable time. As and when profit reduces, the directors can maintain the rate of dividend by utilising it.

4. Heavy losses of an exceptional nature can be met without disclosing the fact in the published statements and without disturbing the normal business profit.

ADVANTAGES OF SECRET RESERVE

1. The Balance Sheet will not disclose a true and fair position of the affairs of the business.

2. Losses arising from bad and inefficient management are not disclosed to the shareholders.

3. Sometimes the directors make use of such reserves for their personal benefits.

DISADVANTAGES OF A SECRET RESERVE

4. Value of shares goes down in the market.

5. The shareholders do not get their due share of profit from the business.

6. The creation of secret reserve is not allowed under the Companies Act, 1956 as it requires a full disclosure of all material facts and financial position.

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