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
In accounting, surplus earning are debited, and reserves are recorded, the same amount is then credited to the reserve account. Once the entry that caused the sanctuary to create is complete, the entry is reversed by shifting the balance back to the retained earnings account. In the balance sheet, the reserve account is recorded under ‘Reserve and Surplus’ liabilities.
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.