Distinguish between reserves and provision.

Auditing and Assurance Revision Questions and Answers

Answer
Reserves are amounts appropriated out of profits, which are not intended to meet any liability, contingency, commitment or diminution in the value of assets known to exit at date of the balance sheet. Reserves are appropriations out of profit. Reserves are made up of amounts appropriated out of profits, held for equalizing the dividends of the company from one period to another or for financing the expansion of the company or for generally strengthening the company financially.

Whereas, provisions are amounts charged against revenue to provide for:
 Depreciation, renewal or diminution in the value of assets; or
 A known liability, the amount whereof cannot be determined with substantial accuracy; or
 a claim which is disputed.
Provisions are normally charged to the profit and loss account before arriving at the amount of profit. Provisions are amounts set apart to meet specific liabilities of diminution in assets value. Provisions must be provided for regardless of the fact whether or not any profit has been earned by the concern.

Differences are summarized as below:

1. Reserve is an appropriation of profit whereas provision is a charge against Profit.

2. Reserves are not intended to meet any liability, contingency or diminution in the value of assets. Provisions are made to provide for depreciation, renewal or a known liability or a disputed claim.

3. Reserves cannot be created unless there is a profit except revaluation reserve and capital subsidy. Provisions must be created whether or not there is profit.

4. Reserves are generally optional except in certain situations – Capital Redemption reserve, Debenture Redemption Reserve, Declaration of dividend higher than 10% etc. Provisions are not optional and have to be made as per generally accepted accounting principles.

5. Reserves are shown on the liability side. Provisions for depreciation and provision for doubtful debts are shown as deduction from respective assets. Provision for liability is shown on the liability side.



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