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DIFFERENCE BETWEEN PROVISIONS AND RESERVES

Posted on November 10, 2019 By commerceiets No Comments on DIFFERENCE BETWEEN PROVISIONS AND RESERVES

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  • DIFFERENCE BETWEEN PROVISIONS AND RESERVES
      • PROVISIONS
      • RESERVES
      • DIFFERENCE BETWEEN PROVISIONS AND RESERVES

DIFFERENCE BETWEEN PROVISIONS AND RESERVES

Before understanding the difference between Provisions and Reserves, the two concepts must be understood:

PROVISIONS

Provisions meaning states the amount set aside by charging to the Profit and Loss Account, to provide for any known liability, the amount of which cannot be determined with accuracy.

ACCORDING TO COMPANIES ACT 2013:

“Provision usually means an amount written off or retained by the way of providing depreciation, renewals or dimunitions in the value of the assets or retained by the way of providing any known liability, of which the amount cannot be determined with the substantial accuracy.”

RESERVES

It refers to the amount set aside out of profits of the business to strengthen its financial position or to meet future contingencies or losses. Reserves Accounting aims to provide the firm with sufficient finance to safeguard itself for upcoming adverse situations.

Usually the firm does not distribute the whole amount of profits. It retains the amount of profits to use it for upcoming contingent losses and future projects. The creation of reserves are

  • For redeeming liabilities
  • To replace the depreciable assets
  • For declaring uniform rate of dividend throughout the years.

Reserves are created only in that year in which the firm earns sufficient profit. It means no reserves can be created in the year firm suffers losses.

ACCORDING TO WILLIAM PICKLES

“Reserves mean the amount set aside out of profits and surpluses which are not earmarked in any way to meet any particular liability, known to exist on the date of the balance sheet.”

DIFFERENCE BETWEEN PROVISIONS AND RESERVES

BASIS OF DIFFERENCE PROVISIONS RESERVES
Nature It is a charge against profit It is an appropriation of profit
Purpose It is created to meet known liability It is created to strengthen the financial position and to meet an unknown liability.
Utilization for dividend It cannot be used for distribution by the way of dividend It can be used for distribution as dividend.
Effect on profit Provision is debited to Profit and Loss a/c. So, it reduces the profit. Reserve is an appropriation of profit. So, it reduces the divisible profit.
Investment It’s amount is not invested in outside business.. It’s amount is invested outside the business.
Legal necessity It is made due to legal necessity It is creates as a matter of prudence.
Presentation in balance sheet It is shown either as liability under the head ‘Current liabilities” or as a deduction from the asset. It is shown on the liability side of the Balance Sheet under the head ‘ Reserve and Surplus’
Sufficiency Its amount must be sufficient to meet the loss or liability. Its amount is generally determined by management on the basis of the amount of profits earned.
Impact on working capital It cannot increase the working capital- it is utilized for meeting the specific loss or liability. It increases the working capital thereby strengthens the financial position of a business concern.
Owner’s Claim The owner of the business cannot have any claim over it, since it is created for meeting specific loss or liability. The owner can claim it, since it is created out of profit.
Utilization It is utilized for the specific purpose for which it has been created. It can be utilized for the purpose whatsoever.
Adequacy Auditor must check its adequacy. Auditor is not required to check its adequacy.
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FINANCIAL ACCOUNTING, KEY DIFFERENCES Tags:PROVISIONS

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