Chapter 6

PROVISIONS AND
RESERVES
 PROVISION: Meaning
Provision is made for those items
which are related to current year
operating activities but the amount
of these items is not known.
Examples: Provision for Depreciation,
Provision for Bad and Doubtful
Debts, Provision for Discount on
Debtors, Provision for Taxation etc.
Basic Features of ‘Provision’ are:
1. To provide for expected decrease in assets or increase in
liabilities on account of the transactions of the current year.
For e.g., tax liability is determined at the time of assessment
by the income tax authorities at some future date. But as
tax liability likely to arise in future is on the income of the
current year provision for taxation is created and Dr. to the
P&L A/c of the current year.
2. Provision is charged against revenue and other incomes of
the current year. It ensures proper matching of revenue and
expenses.
3. Provision helps to show assets at their real worth. Provision
helps in ascertainment of true profits (or loss) of the
enterprise, if provisions are not created the profits are
overstated. It helps in depiction of true and fair view of the
financial position of the business enterprise.
4. When provision for any item is created, actual expense is
charged to provision A/c and not to P&L A/c
 Reserves
 Reserve refers to retention of profit
which is not in the form of provision.
 Reserves means accumulated or
undistributed profits.
 If the provision exceeds the amount
which is required to meet the loss or
liability, the excess is to be treated
as reserve.
 Objectives of Reserves
 To strengthen the financial position of the enterprise.
 To provide funds for modernization and /or expansion
of existing plant or acquisition of a new plant.
 To equalise the dividends during the periods of
inadequate profits.
 To comply with legal requirements e.g. Debenture
Redemption Reserve, Capital Redemption Reserve
under the Companies Act,1956.
 To meet unforeseen abnormal losses.
 Types of Reserves
1. REVENUE RESERVE: those reserves which are
created out of profits available for distribution
by way of dividend. These may be classified as:
(b) General Reserve: Reserve which is not created
for any specific purpose. E.g. General Reserve,
Contingency Reserve.
(c) Specific Reserve: Reserve which is created for
specific purpose. E.g. Dividend Equalisation
Reserve, Debenture Redemption Reserve.
2. CAPITAL RESERVE: those reserves created
out of profits of capital nature and not out of
operating profits. E.g. Profits prior to
incorporation, Premium on issue of Shares
and Debentures, Premium on reissue of
forfeited shares, Profit on sale of fixed
assets, Profit on revaluation of fixed asset

Revenue Reserves are free for distribution by

way of dividend whereas amount of capital
reserve are not free for distribution by wy of
dividend.
 Distinction Between Provision and Reserve
Basis of Provision Reserve
Distinction

1. Purpose It is created for some It need not necessarily be

specific purpose and can created for a particular
be used for that particular purpose. E.g. General
purpose Reserve
2. Charge v/s It is a charge against the It is an appropriation out of
Appropriation profit and is required to be profit and can be created
created irrespective of the only if profits have been
amount of profit. earned.
3. Disclosure in Usually a provision is Reserve is shown as a
Balance Sheet shown by way of separate item under the
deduction from the head ‘Reserves and
amount of the items for Surplus’ on the liabilities
which it is created. oside of the Balance Sheet
4. Investment There is no question of The amount of Reserve
outside the investment of amount of can be invested outside
business provisions the business

5. Utilisation for It cannot be utilised for It can be utilised for

Dividends distribution by way of distribution by way of
dividends dividends