Every business needs some form of backup to run the business operations in case of an uncertain event or emergency. This backup is known as a reserve in accounting.
Reserves can be classified into revenue and capital reserves. Revenue reserves are further divided into two types which are: 1. General reserve and 2. Specific reserve.
General reserve is referred to as the reserve fund that is created by keeping aside a part of profit earned by the business during the course of an accounting period for fulfilling various business needs like meeting contingencies, offsetting future losses, enhancing the working capital, paying dividends to the shareholders, etc.
General reserves are created without any specific purpose and can be used for the business in various ways. It is also known as free reserve, which means that the creation of a general reserve is not mandatory for the business, but a company can create a general reserve only when there is sufficient profit earned by the business.
However, if the articles of association of a company has a clause of transferring a certain portion of its profit to the general reserve account before distributing the profit among shareholders, then the company has to set aside a portion of the profit under the General Reserve Account.
General reserves are shown on the liabilities side of the balance sheet under the head of reserves and surplus.
Objectives of General Reserve
Following are the objectives of creating a general reserve:
1. To create an additional source of working capital for the business.
2. To create a fund for meeting unknown contingencies, liabilities.
3. To equalise the dividend rate in case of the absence of a dividend equalisation reserve account.
4. Improving the liquidity of the business
Advantages of General Reserve
Following are some of the advantages of general reserve:
1. It acts as an additional source of working capital for the business, thereby improving the financial position of the business.
2. It helps in overcoming any future losses that may arise during the course of business operations.
3. It helps in providing funds for the purchase of new assets without any need of borrowing from other sources.
Disadvantages of General Reserve
Following are some of the disadvantages of the general reserve:
1. It does not help determine the true financial position of the business as it will cover for any liabilities or contingencies.
2. As this reserve is created without any specific purpose, mismanagement of funds may occur.
3. It reduces the rate of dividend as the reserve is created out of the profits earned by the business.
This concludes the topic of General Reserve, which is an important topic of Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S