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Reserve and Provision. RESERVE After going through this chapter you should be able to After going through this chapter you should be able to Understanding.

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Presentation on theme: "Reserve and Provision. RESERVE After going through this chapter you should be able to After going through this chapter you should be able to Understanding."— Presentation transcript:

1 Reserve and Provision

2 RESERVE After going through this chapter you should be able to After going through this chapter you should be able to Understanding the meaning of reserve. Understanding the classification of reserve. Understanding the difference between capital and revenue reserve. Understanding the meaning of provision. Difference between reserve and provision.

3 MEANING  All liabilities in future both known as well as unknown, it is desirable that some portion of the profit is kept in the business itself in the form of reserve and provisions. The term reserve and provisions are used in different senses in accounting.

4 Reserve Reserve means that part of the profit of the business which has been kept for future use or contingency.

5 According to the company act 1956: Reserve means an amount set aside out of profits which are not designed to meet any liability, contingency. it is not a charge against profits and is not meant to cover any existing liability or depreciation in the value of assets.

6 Features of reserve - It created out of net profit It is also known retained earning Creation of reserve is not a legal necessity. It is recorded on the liabilities side of the balance sheet. When the amount of reserve is invested in outside securities, it is known as reserve fund.

7 Importance of reserves.  Helpful in strengthening the financial position of the business:- it is acts as a sources of internal financing for the purpose of expansion business, like ploughing back of profit  Helpful in meeting the unforeseen loss- any abnormal loss arises in future. .

8 Conti.. Helpful in equalizing dividend over the period- goodwill of the company depends upon maintaining a uniform rate of dividend over the year. To achieve this dividend equalization reserve is created to equalise the rate of dividend

9 Classification of reserves: Reserve may be classified as… Reserve Revenue Reserve Capital Reserve

10 Revenue reserve The profits earned by a business through its routine activities is calculated at the end of the year through profit and loss account. the portion of such profit which is not distributed among the owners but kept apart, known as reserve fund

11 Types of revenue reserve (a) General reserve: (b) Specific reserve (c) Secret reserve

12 General reserve. Which is created without any specific purpose but strengthening the financial position of the business. It is created only when sufficient profit are their in an enterprise

13 Specific Reserve The reserve which is created for particular or specific purpose, is known as specific reserve For example: (a) dividend equalization reserve (b) investment fluctuation reserve (c) debenture redemption reserve (d) reserve for replacement of assets

14 Secret Reserve A secret reserve is a reserve which is not disclosed in the balance sheet. Its also called hidden reserve. Generally, banking & insurance companies create secret reserve with a view to strengthen the financial position..

15 Secret reserve Example: by charging capital expenditure by depreciation on fixed assets by creating provision for bad debt & other contingencies

16 Capital reserve The reserve created out of capital profits are known as capital reserve, such reserve are not available for distribution as cash dividend among the shareholders Example: (a) profit on sale of fixed assets (b) profit on revaluation of fixed assets (c) profit prior to incorporation of the company (d) profit on redemption of debenture

17 provision According to company act 1956 the term provision’ refer as.. the amount retained by way of providing for any known liabilities, of which the amount cannot be determined with substantial accuracy

18 provision Provision is an amount charged against profit to provide for depreciation, renewal of assets or to meet a liability. example: (a) provision for bad debts (b) provision for discount on debtors (c) provision for taxation (d) provision for depreciation

19 Features of provision It is a charge against profit. It is made to meet a known liability It is not available for distribution among shareholders. Note: if the provision exceeds the required amount, the excess is treated as reserve.

20 Difference between Reserve & Provision Reserve Provision It is created to meet an unknown liability It is created to meet a known liability Reserve is an appropriation of profit Provision is a charge against profits it is shown on the liabilities side under the head ‘reserve and surplus’ Either shown on assets side by way of deduction from the particular assets or as a distinct item on the liabilities side.

21 Conti.. Creation of reserve is discretionary Creation of provision is a legal necessity It may be invested outside of business It is never invested outside of business Dividend can be paid out of it Dividend cannot be paid out of it

22 t

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