A reserve is a retained earnings secured by a company to strengthen a company’s financial position, clear debt & credits, buy fixed assets, company expansion, legal requirements, investment and other plans. These are usually done to save the cash from being used in other purposes. Reserve funds do not have any legal restrictions so that the company can use it for any purpose.
Reserves are divided into two types:
- Revenue Reserves
- Capital Reserves
Revenue reserve is a portion of profit owned by the company and is kept aside for the use of other multiple purposes. This reserve is recorded in the profit and loss account and can be used the following way:
- Dividend to shareholder
- Expand the business
- Stabilise the dividend rate
The revenue reserve is further divided into 2 categories:
- General Reserves- It is saving out of the profit share. The only purpose of this reserve is to strengthen the financial position of the company or can be used for many reasons.
- Special Reserve- This reserve is secured for a particular purpose, and the money cannot be used for any other reason.
A capital reserve is taken out of the capital profit and is not shared as a dividend to the shareholder. This reserve cannot be created out of the profit earned from the core operation. Few examples of capital reserves are:
- Cash received by selling current assets
- Premium earned on the issue of share and debentures
- Excess on revaluation of assets and liabilities
Reserve in accounting is used to make the investors aware that a certain part of funds should not be used as dividends or for buying back shares. Reserves are used for settling legal obligations, bonus payment, debt payment and purchasing assets or expanding business.
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The above mentioned is the concept, that is elucidated in detail about ‘What are the Reserves?’ for the Commerce students. To know more, stay tuned to BYJU’S.
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Frequently Asked Questions on Reserves
Is reserve account asset or liability?
Reserve accounts is a liability.
How reserve is created?
The reserve is created out of capital profits.
What are free reserves?
Free reserves are those reserves that doesn’t have a specific purpose and can be withdrawn anytime.
Where is reserve used?
Reserves are mostly used to repay debts, bonuses, purchasing fixed assets or as funds for business expansion.