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Reserve and Provision

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Reserve

Reserve is a part of profit set aside to meet the future contingencies. It is created for meeting the unexpected future liabilities and losses. Similarly, it may also be created to meet the anticipated future loss and distribute dividends uniformly over the future period of time. It simply reduces the distributable profit. Capital reserves, revenue reserves, secret reserve, etc. are examples of reserves.

Features

The followings are the features/ characteristics of reserves:

  1. It is created to meet the expected liability, strengthen the financial condition, equalization of dividends etc.
  2. It is created by debiting the profit and loss appropriation account.
  3. It is created only when there is profit in the business.
  4. It can be distributed as the dividend to shareholders.
  5. Creation of reserve depends on the financial policy of business and analysis of the management.
  6. It is usually shown on the liability side of the balance sheet.

Objectives

Reserve may by created for the following purposes:

  1. To expand business through internal sources.
  2. To strengthen the financial position of a business.
  3. To distribute the dividend uniformly over the years.
  4. To ease the replacement of fixed assets which have become obsolete or useless.

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Provision

A provision is an amount set aside by debiting the profit and loss account for the specific purpose. It is maintained to meet known loss or liability the amount of which is not certain. A provision is always created for the specific purpose. It is not meant for the distribution of shareholders. The provision, in fact, reduces the figure of the business profit and not the figure of divisible profit.

Generally, a business maintains different types of provisions with some specific purposes. They are:

  • Provision for bad and doubtful debts
  • Provision for repairs and renewals
  • Provision for taxation
  • Provision for discount on debtors

Objectives

Some of the important objectives of maintaining provision are as follows:

  • For meeting anticipated losses and liabilities such as provision for bad and doubtful debts, provision for debtors and provision for taxation.
  • For meeting known losses and liabilities such as provision for repairs and renewals.
  • For presenting correct financial statements
  • For reporting true profit and loss and financial position



  • A provision is the amount set aside by debiting the profit and loss account for the specific purpose. 
  • Reserve is a part of profit set aside to meet the future contingencies. Capital reserves, revenue reserves, secret reserve, etc. are examples of reserves.
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Very Short Questions

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  • Which one of them is not the objective of provision?

    To expand business through internal sources.
    To strengthen the financial position of a business.
    All the options are correct
    To ease the replacement of fixed assets which have become obsolete or useless.
  • Which one of them is the characteristic of reserve?

    It can be distributed as dividend to shareholders.
    It is created only when there is profit in the business.
    It is created by debiting the profit and loss appropriation account.
    All the options are correct
  • Which one of them is the objective of reserve?

    All the options are correct
    To expand business through internal sources.
    To distribute the dividend uniformly over the years.
    To strengthen the financial position of a business.
  • Which one of them is the objective of provision?

    For presenting correct financial statements
    For meeting known losses and liabilities such as provision for repairs and renewals.
    For reporting true profit and loss and financial position
    All the options are correct
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