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Provision & Reserves

The document discusses the concepts of provision and reserves in accounting. Provision is an amount set aside to cover known liabilities or losses while reserves are amounts set aside from profits for future contingencies. The document outlines the key features, importance and accounting treatment of provisions as well as types and importance of reserves.

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Nancy Shangle
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40 views4 pages

Provision & Reserves

The document discusses the concepts of provision and reserves in accounting. Provision is an amount set aside to cover known liabilities or losses while reserves are amounts set aside from profits for future contingencies. The document outlines the key features, importance and accounting treatment of provisions as well as types and importance of reserves.

Uploaded by

Nancy Shangle
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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PROVISION & RESERVES

NOTES
CLASS XI: ACCOUNTANCY
Provision is an amount which is set aside by charging it to profit for the
purpose of providing for any known liability or uncertain loss or expense. The
amount of which cannot be determined with certainty is also referred to as
provision.
• Few examples are provision for depreciation, provision for doubtful
debts and provision for discount on bad debtors.
• The main objective of provision is to account all expenses and losses.
Through the creation of provision account, the amount of liability, losses
and expenses are estimated and accounted for the accounting period.
Therefore, the true profit and loss is ascertained, liabilities and assets are
presented with correct values.
FEATURES

• It is an amount kept aside, out of income or profit, to meet the known liability
• It is retention of profit made for the time being and specific reason such as
known depletion in the value of the asset, anticipated loss occurred but the
amount is not ascertained and a liability has been known to have arisen
• At the time accounting, an appropriate amount of anticipated loss in the
value of the asset or the liability is not ascertained
• It is a charge to profit and loss account
IMPORTANCE OF PROVISION

• To meet anticipated losses and liabilities: Provision is created to meet the


anticipated losses and liabilities such as provision for doubtful debts, provision
for discount on debtors and provision for taxation.
• To meet known losses and liabilities: Provision is created to meet known
losses and liabilities such as provision for repairs and renewals.
• To present correct financial statements: To present a true and fair view of
profit and financial statement, the business must maintain provision for known
liabilities and losses. Therefore, provision is necessarily to be created to
ascertain the current income or profit. Also, it is considered as a charge against
revenue or profits.
Accounting Treatment
Provision is a charge against the profit which is debited in the profit and loss
account. In the balance sheet, the amount of provision may be shown on the
asset side by deducting from the relevant asset or on the liability side along
with the current liabilities.
• Treatment on asset side– Provision for doubtful debts is deducted from the
amount of sundry debtors and the provision for depreciation is deducted from
the relevant asset.
• Treatment on liability side– Provision for repairs and charges are shown
along with the current liabilities.

RESERVES AND ITS IMPORTANCE


Reserves Reserve is an amount set aside from the profit other than surplus
which is retained by the business to meet future contingencies. It is an
appropriation of profit and not a charge against profit, and therefore is shown
in the profit and loss appropriation account.

Revenue Reserve: It is an amount set aside out of revenue profits for


distribution of dividends. For example, general reserve, investment fluctuation
fund, capital reserve and workmen compensation fund. It is not a charge
against profit but it is appropriation of profit shown in the profit and loss
account. It is beneficial for the smooth function of the business. The retention
of profit in the form of reserves reduces the amount of profit to distribute
among the business owners. This is further classified in to general reserve and
specific reserve.
o General reserve means a reserve which is not maintained for specific
purpose. It helps to strengthen the financial status of the business. It is also
known as free reserve and contingency reserve.
o Specific reserve means a reserve which is maintained for specific purpose.
For example, dividend equalisation reserve is created to maintain dividend
rate. This reserve amount is utilised to maintain the rate dividend in the year of
low profit. Likewise, the workmen compensation fund is maintained to provide
claims of the workers, investment fluctuation fund is used at times of decline in
the value of investment and debenture redemption reserve is used to provide
funds for redemption of debentures.
CAPITAL RESERVE: It is an amount set aside out of capital profits which is not
available for distribution as dividend among the shareholders. It is used for
writing capital losses/issue of bonus share in a company. Examples of capital
reserves are
• Profit prior to incorporation
• Premium on issue of shares or debentures
• Profit on redemption of debenture
• Profit on forfeiture of share
• Profit on sale of fixed assets
• Capital redemption reserve
• Profit on revaluation of fixed assets and liabilities
IMPORTANCE OF RESERVES
1. It strengthens the financial position of an enterprise
2. It helps meet the purpose of future contingency
3. It assists the expansion of business operation or to bring consistency
in distribution of dividend.
4. It creates reserves for investment allowance reserve

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