Provisions and Reserves Class 11 Accountancy

Difference between Provisions and Reserves

Basis	Provision	Reserve
Nature	Charge against profits.	Appropriation of profits.
Purpose	For providing a known liability or loss, amount of which is uncertain.	For strengthening the financial position of the business.
Compulsion	Compulsory In compliance of prudence concept	Optional at the discretion of the management However, some reserves are mandatory under law like debenture redemption reserve
Utilisation	Can not be utilised for distribution of dividends.	Can be utilised for distribution of dividends.
Presentation	Shown either as deduction from the concerned asset for which it is created shown on the liabilities side	Shown on the liabilities side.
Effect on taxable profits	It reduces taxable profits.	It has no effect on taxable profits.

Types of Reserves 

1. General Reserve - reserve which is created without any specified purpose and can be freely utilised for any purpose. 

2. Specific Reserve - reserve which is created for a specific purpose and can be utilised only for that purpose. Examples include:

• Workmen compensation fund
• Investment fluctuation fund
• Debenture redemption reserve

Types of Reserves as per nature of profits out of which they are created:

1. Revenue Reserves - Reserves which are created out of revenue profits. 

Revenue profits arise out of normal business operations.

Can be used for distribution of dividends. 

Examples include general reserve, workmen compensation fund, investment fluctuation fund etc.

2. Capital Reserves - Reserves which are created out of capital profits. 

Capital profits do not arise out of normal business operations. 

Not available for distribution of dividends. 

Examples include profit on sale of fixed assets, premium on issue of shares/debentures, profit on revaluation of assets and liabilities etc. 

Secret Reserves

Secret Reserve: created by increasing the value of liabilities and decreasing the value of assets. 

Methods of creating secret reserves:

Secret Reserves can be created by:

i. undervaluation of stock

ii. creating excess provision for doubtful debts

iii. charging higher depreciation

 

Objectives of creating secret reserves:

i. To reduce tax liability.

ii. To ensure a strong financial position.

iii. To hide profitability of the business from competitors