RESERVE

MEANING OF RESERVE

The entire amount of profit earned is not distributed to the owners. A portion is retain in the the business for known or unknown emergence, contingencies,liabilities etc.Thus ,a reserve means an amount of profit set aside until it is needed for some particular purpose. Generally Reserve Account is specially named to indicate its purpose It is an appropriation of profit and not a charge against profits. It is merely a part of net worth.

Normally a reserve rise from retention of profit (i.e. amount set aside from profits),capital profit (i.e. profit on sale of the balance sheet.

The companies Act,1956, gives a negative definition of  'reserve'. Account to the Act the term 'reserve' shall not include "any amount of written off or retained by way of providing for depreciation, renewals, or diminution in the value of assets or retained by the way of providing for any known liability". 

Thus, a reserve is an allocation of ascertain profit made to strengthen the financial health of a firm or to meet contingencies.

CHARACTERISTICS OF RESERVE

• The amount standing to the credit of reserve represents undistributed profits.
• The general purpose of creating reserves is to strengthen the financial health of the company.
• When any reserve is invested outside it is called Reserve Fund.
• Reserve not maintained for a particular purpose may be utilized for the payment of dividend to  shareholders.

IMPORTANCE OF RESERVE 

To strengthen the financial position of the business - Reserve is the source of internal financing of business extensions and known as ploughing back of profit.

To meet the unforeseen liability or loss - Future is uncertain. If any abnormal situation arises reserve can be used to meet such eventualities.

To provide funds for meeting a specific liability - A specific reserve may be created and invested outside in order to enable the firm to make payment of certain liability on a future date. For example, Debenture redemption fund for the payment of debentures.

To provide uniformity in dividend payment over the years - In order to maintain uniform rate of dividend payment from a year to year a specific reserve known as Dividend Equalization Reserve is created. This reserve helps the management to maintain parity in dividend payment where there is inadequacy of profits.

TYPES OF RESERVE 

 1. Public Reserve :-
         
             The reserve  which are shown in the liabilities side of Balance Sheet are called Published Reserves or Open Reserve.

Published Reserves are two types

• Capital Reserve - Such reserves arises from specific capital transactions. Capital reserve is the reserve which is not available for distribution as dividend through the Profit Loss Account.

                  Profit on revaluation of assets, profit on reissue of forfeited shares, profit earned prior to incorporation etc are the examples of Capital Reserve. Such reserves are utilized for the issue of bonus share to the equity shareholders or for meeting capital losses.

• Revenue Reserve - The reserves which is created by retaining profit are called revenue reserves. These reserves are created by debiting Profit or Loss Account and crediting an appropriate Reserve Account. This reserve is also known as free reserve. Credit balance of Profit and Loss Account, general reserve, dividend equalization reserve etc. are few examples of revenues

          Revenue Reserve may be either specific or general. When a revenue reserve is created for a specific purpose such as to equalize dividends is called Specific Reserve When a Revenue Reserve is created not for a specific purpose it is called General Reserve.General Reserve are created for safeguarding the business against unforeseen losses in future. Specific reserve may be invested in outside securities but the general reserve is not invested.

Reserve Fund denotes reserve which is invested outside the business as ear-marked investment. A reserve fund is usually created to replace a fixed asset at the end of its useful life or to repay a liability on a future date. 

• Secret Reserve - The reserve which is not shown in the balance sheet is called Secret Reserve may be created by a making excessive provision for depreciation, over standing liabilities, undervaluing current assets etc. These reserve are generally created by banking and insurance companies. The creation of secrete reserve is not possible for any public limited companies as under the companies Act the auditor has to certify that its Balance Sheet discloses a true and fair view.