Reserves Meaning

Reserves Meaning: The amount that is kept out of the profits of an enterprise to meet the future ‘unknown’ or ‘unexpected’ liabilities is known as reserve. The creation of reserves helps in meeting the unforeseen expenses or losses that may occur in the near future. It should be noted that the creation of reserves is not compulsory. Its creation completely depends upon the will of an enterprise. It is an appropriation of profits that is created out of the undistributed profits of the business. It helps in strengthening the financial position of the business. Besides this, the number of reserves can also be utilized for the distribution of profits among its shareholders.

As the creation of reserve is an appropriation of profit so, it does not reduce the profits of the firm. Therefore, the reserves are not debited to the Profit and Loss Account. Rather, it is debited to the Profit and Loss Appropriation Account. Also, the reserves created are shown on the Liabilities side of the Balance Sheet under the head Reserves and Surplus. Sometimes, a business may opt to invest the amount of reserve so created outside its operations. Such investment of reserve is known as Reserve Fund.

In the words of William Pickles, ‘Reserves means the amount set aside out of the profits and other surpluses, which are not earmarked in a way to meet any particular liability, known to exist on the date of Balance Sheet’. As per the American Institute of Accounting views- ‘The use of term reserves be limited to indicate that an undivided part of the asset is being held or retained for general or specific reserve’.

The given below are some examples of reserves.

  • Dividend Equalisation Fund
  • Capital Reserve
  • Debenture Redemption Reserve
  • Workmen Compensation Fund
  • Investment Fluctuation Fund, etc.

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