Types of Reserves

The phrase “Reserves” refers to the cumulative account that records the company’s retained earnings over time and forms part of the shareholder’s equity. Typically, the amount in Reserve and excess is subdivided into numerous accounts, which are then designated for specific objectives such as the acquisition of fixed assets, payment towards legal settlements, debt repayment, dividend payments, and so on.

It is produced by debiting the profit and loss account. It has no effect on net profit because it is calculated after profit is determined. As a result, the reserve just decreases the figure of divisible profit. It is the property of the owners and shareholders. If its existence is no longer essential, it can be handed to the shareholders.

What exactly is a Reserve?

A reserve is a portion of profits set aside for a certain purpose. A capital reserve is the most prevalent type of reserve, in which monies are set aside to acquire fixed assets. By establishing a reserve, the board of directors separates cash from the company’s ordinary operating expenses.

There is no genuine requirement for a reserve since money that has been “reserved” are seldom subject to limitations on their usage. Instead, management merely notes its future financial requirements and budgets for them accordingly. As a result, a reserve may be included in the financial statements but not be recognised as a distinct account in the accounting system.

Reserves in the Balance Sheet

In balance sheet reserves are under liabilities that are set aside to cover future commitments. Balance sheet reserves are the funds set aside by insurance firms for future insurance claims or claims that have been filed but have not yet been disclosed to the insurance company or resolved. The amount of balance sheet reserves in case of statutory resereves that must be kept is mandated by law for example in case of insurance businesses, to ensure that they can pay any claims, losses, or benefits promised to claimants specific statutory reserves are to be maintained.

Types of Reserves

Capital Reserve

A capital reserve is a reserve that is formed from capital earnings. It is not derived from profits gained in the usual course of business. The profit obtained from certain capital transactions is used to construct the capital reserve. There is no capital reserve available for distribution to shareholders. The following are some examples of capital profit from which capital reserve is created:  Profit from the disposal of fixed asset, Profit on investment sale, Profit from asset and liability revaluation, Premium on share and debenture issuance

Revenue reserves

Revenue reserves are the portion of open reserves that are produced from the company’s profits. It appears in the profit and loss appropriation account. Revenue reserves are also used to distribute dividends to the shareholders. It provides the following advantages: 

• Business expansion
• Set off unanticipated business losses
• Used to strengthen a company’s financial situation
• To maintain dividend rate stability

Secret Reserve

A hidden reserve is a reserve that is kept to boost the financial situation of the firm without being disclosed in the books. The balance statement does not show a secret reserve, which is a concealed reserve. Internal reserve is another name for secret reserve. It is manufactured by displaying a net profit statistic that is smaller than the actual. Its presence improves the company’s financial condition beyond what the balance sheet shows. It is often maintained by banks, insurance companies, and other financial organisations.

A hidden reserve can be established in one of the following ways:

• By depreciating fixed assets at exorbitant rates
• By underestimating the value of present assets
• By removing the assets from the books entirely

Valuation or Assets Reserves

Valuation reserves are established to compensate for the loss of value of some assets, such as equipment and machinery, accounts receivable, investments, marketable securities, patents, and intangibles with a limited life. These reserves are established with the following goals in mind: To restablish the integrity of investments that have suffered or lost value, This cannot be calculated precisely in order to account for expenditures.

Conclusion 

A reserve is a portion of profits set aside for a certain purpose. A capital reserve is the most prevalent type of reserve, in which monies are set aside to acquire fixed assets. A reserve is a portion of profits set aside for a certain purpose. A capital reserve is the most prevalent type of reserve, in which monies are set aside to acquire fixed assets. The amount of balance sheet reserves that must be kept is mandated by law. A capital reserve is a reserve that is formed from capital earnings. The profit obtained from certain capital transactions is used to construct the capital reserve. Revenue reserves are the portion of open reserves that are produced from the company’s profits. The balance statement does not show a secret reserve, which is a concealed reserve. Some of the bank reserves is also kept in the bank’s vault.