Difference Between Reserve and Provision

Reserve and Provision are two common terms often discussed in business. These terms sound similar but are created for different reasons in a business organisation. Both these terms are important for maintaining the integrity of a business.

According to business experts, it is a good idea to save some part of the profit as reserves for the unforeseen future, hence companies create a reserve to meet those events.

Meaning of Reserve

Reserve is the term which refers to a sum or percentage of profit that a company retains or keeps aside at the end of a financial year towards meeting future contingencies that may occur. It is also used to strengthen the business.

Stabilises the financial position of a company by being used for expansion of assets, dividend payments and investments.

There are two types of reserves in an organisation

  1. Capital Reserve
  2. Revenue Reserve

A capital reserve is created from the capital profits and is not available for distribution to shareholders in the form of dividends. Therefore, it cannot be created from the profits earned from the core operations of a company.

Revenue reserve is created from the profits earned from the core operations of a company or organisation. A profit and loss appropriation account needs to be made for creating Revenue reserve.

Revenue reserve is also known as Retained earnings. It can be used for the following purposes.

  1. Paying dividend to shareholders
  2. Expanding the business
  3. Stabilising the dividend rate

Meaning of Provision

Provision refers to an amount that is kept aside from a company’s profit in order to cover probable expenses arising in future or a possible reduction in the value of an asset.

Provisions are important for a business as they address certain expenses in business and payments made for them. Provisions should not be regarded as savings as these are created to meet expenses for an anticipated liability in future.

It appears in the income statement in the form of expenses and is recorded as a current liability in the balance sheet.

Let us look at some of the key differences between Reserve and Provision in the table below:

Reserve Provision
Definition
The portion of profit kept aside for unforeseen obligations of a business A portion of money from the business set aside for meeting known liabilities or expenses
Method of Creation
Created by debiting Profit and Loss appropriation account Created by debiting Profit and Loss Account
Purpose
It provides capital for running the business and safeguards against expenses from unforeseen contingencies It secures business from expenses arising from known liabilities
Allocation
Presence of profit is required for allocation of reserve. Presence of profit not necessary for allocation
Dividend Payment
Paid from reserves Cannot be paid
Impact on Profit
Reduces net profit of the organisation Reduces profits for dividend distribution
Appears in
Always shown on the liability side Appears as a deduction from the concerned asset, in case of an asset,  in case of liabilities, it is shown in the liabilities side
Utilisation
Can be used for any given purpose Needs to be used for the specific purpose it is allocated for

This article will help you develop a clear view of the differences between Revenue and Provision, two terms which are very important for the business aspect of an organisation. It will also help budding Commerce students grasp the concept well. For more such knowledge filled articles, stay tuned to BYJU’S.

 

1 Comment

  1. Very useful 👍 thanks 😊

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