Reserve and Surplus

Reserves and surplus are the totals of the earnings that are maintained and then reported as a part of the equity of shareholders and set aside by the business for particular objectives. For example, paying legal settlements, purchasing fixed assets, paying dividends, repaying debts, etc.

Reserves

Reserve always contains a credit balance in the financial accounting. It also refers to a part of the shareholders’ equity, including their contra-asset for the uncollectible accounts and liability for the estimated claims. Moreover, it can be present in any part of the shareholders’ equity except the basic share or contributed capital. In non-profit accounting, an operating reserve is said to be the unrestricted cash present to make a business survive. The nonprofit boards generally have a particular target for maintaining the various months of a percentage of the business’s annual income, known as the business the operating reserve ratio.

Types of Reserves

Here are the 2 types of reserves:

• • Revenue Reserve
  • Capital Reserve

Revenue Reserves are those which are been created out of the profits of the company and that could be distributed as dividends in the future as per situations.

Capital Reserve – A capital reserve is that part of the profit generated by the business which is kept aside by the management for a particular reason. Such as deferring capital expenses, financing long-term initiatives, etc. This reserve is made with any capital profit a business gains from sources other than its primary business.

Under Revenue Reserve, we have General Reserve, Specific and Secret Reserves and under Specific Reserves, we can put some reserves specifically created for a particular purpose such as  Capital Redemption Reserve, Dividend Reserve, etc.

General Reserve – The general reserve is also commonly known as the revenue reserve. These are the funds that are kept safe by the business to use in the future if needed. It is the retained earnings of the corporation. These earnings are set aside from the profit generated from the revenue so that it can help fulfil specific requirements that can be uncertain and unclear at the same time.

Capital Redemption Reserve – While redeeming the preference stocks or buying back of own stocks to reduce the share capital, this reserve is made with the undistributed earnings in the P&L account or the general reserve.

Dividend Reserve – It is considered as an equal amount to the dividend which is annually announced for securing the money maintained in a particular account.

Surplus

It is considered the residual amount of the resources left after a specific period of usage. Moreover, in accounting, a surplus is the amount of retained earnings recorded on the balance sheet of a business entity. However, a surplus is good for the business as it has additional resources that can be useful in the future when needed. When we talk about manufacturing, a surplus is some extra quantity of goods that were manufactured but could not be sold to anyone, so in this case of manufacturing, a surplus can be a bad thing to have.

Advantages of Reserve and Surplus

Here are some essential benefits of the reserve as well as the surplus:

Internal Financing

When it comes to internal financing in any business, reserves are considered the most essential and useful source. When the business needs funds for some commercial operations or to fulfil its need for satisfying its obligations, the primary and the very easy source of funds is the general reserve generated by the company.

Working Capital Requirements

A business can easily survive on its own when it needs some working capital with the help of the generated general reserve. It assists in boosting the business’s working capital when the business runs short of funds.

Liabilities

Having reserves as well as surplus has some more advantages. When the business has to pay off its present liabilities in the future, it can be easily done with the help of the reserves and surplus.

Dividend Distribution

Most of the funds required for the dividend distribution are taken from the reserves. Moreover, it helps save the similarity of the dividend distribution rate by providing the required amount to maintain the uniformity of the dividend rate when there is a shortfall of the funds available for distribution.

Disadvantages of Reserve and Surplus

Here are some disadvantages of the reserves and surplus:

At The Time of Losses

Suppose a business is facing losses, and the losses are adjusted against the reserves of the business. In that case, the accounts will be manipulated to not let the real picture of the profitability of the business presentation to the readers of the financial statements.

Misuse of Funds

Due to the widespread usage, the funds collected in reserve can be misused by the business’s management team.

Extra Reserves

The process of generating extra reserves can be a reason for the decline in dividend payouts to the investors in the business.

Conclusion

The reserve and surplus study material concludes that reserves and surpluses are often maintained when dealing with reducing income and slow-paying customers. However, the reserves and the surpluses have different advantages and disadvantages at the same time. Therefore, these should be managed responsibly as they can also be risky. This is all from the reserve and surplus topic.