Reserve is also known general reserve.
Reserve mean to keep separate something.
In accounting, reserve means amount keep aside out of profit.
It helps to make strong financial position of the business or organization.
Reserve is created out of profit.
If there is loss in particular year, reserve cannot be created.
Revenue reserve is created out of operating profit.
It is undistributed operating profit.
It helps to increase financial position of the business.
It also helps to replace assets by creating sinking fund.
Some revenue reserves are:
Sinking fund (depreciation fund).
Dividend equalization fund etc.
Capital reserve is created out of capital profit.
It is also created from operating profit for specific purpose.
It is not used to distribute shareholders as dividend.
It is used to adjust capital loss.
It is shown in liabilities side of balance sheet.
Capital reserve is created from:
Profit on sales of fixed assets.
Premium on issue of share and debentures.
Profit on share forfeiture etc.
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Secret reserves are those reserves, which are not shown in the books of accounts.
Secret reserves are not shown in balance sheet; therefore, it is called ‘hidden reserves’ or ‘inner reserve’.
These are not created for specific purpose.
These reserves are created in the following methods:
By providing excessive depreciation on assets.
By eliminating the assets altogether.
By undervaluing the assets.
By charging capital expenditure to revenue etc.
A sinking fund is a fund established by business organization for the purpose of reducing debt by repaying or purchasing outstanding loans and securities held against the entity.
It is also used for replacement assets.
Provision is the sum of amount set aside from profit and loss account.
It is created for known liability.
Provision is maintained to cover estimated loss or liabilities.
Provision amount is uncertain.
If previous provision is not sufficient, new provision is created from current year’s profit.
This provision debited to profit and loss account without consider whether the business is in profit or loss.
There are two types of sales in the company.
They are goods sold in cash and goods sold on credit.
If goods are sold on credit, provision is crated.
When business provides credit facility, situation of a bad debts arise.
Provision for bad debts is deducted after bad debts.
These are deducted from debtors (bills receivable, account receivable).
Both bad debts and provision for bad debts are debited in profit and loss account.
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