General Reserve

What is the General Reserve?

General Reserve is the amount kept aside from the profit earned by the company during its normal course of the operation to meet future needs. I.e., like contingencies, strengthening the company’s financial position, increasing working capital, paying dividends to the shareholders, offsetting specific future losses, etc. General Reserve is considered to be part of the profit and loss appropriation accountAppropriation AccountAn appropriation account shows how the firm's net profit is divided, i.e., how much goes to pay income taxes, how much goes to shareholders as a dividend, and how much goes to retained earnings. The partnership firm, the Limited Liability Company (LLC), and the government are primarily prepare it.read more.

Generally, it is used to meet future uncertainties like future losses of the business, future litigations, etc. and there is no prescribed percentage for the creation of reserves. It is on the company’s discretion how much reserve it wants to accumulate. In case of losses, reserves are not created by the company. They are shown in the head ‘reserves and surplus’ on the liabilities side of the balance sheet.

Example of General Reserve

Company Mobile Web ltd. is doing the business of mobiles. During the financial year 2018 – 19, it earned a profit of $100,000 from its normal course of the operation. It is decided by the management of the company to keep aside 10 % of the profits earned during the financial year for meeting future liabilities and not for any specific purpose. Which reserve the company is creating and where it will be shown in the balance sheet of the companyBalance Sheet Of The CompanyA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more?

In the above case, the company kept aside 10 % of the profits, i.e., $ 10,000 ($100,000 * 10%) earned from its normal course of the operation during the financial year without any specific purpose. So this is an example the company has made. This general reserve will be considered as part of the profit and loss appropriation account of the company. It will be shown under the head ‘reserves and surplus’ on the liabilities side of the balance sheet of the company.

General-Reserve

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Source: General Reserve (wallstreetmojo.com)

Advantages of General Reserve Accounting

Some of the advantages are as follows:

Disadvantages of General Reserve

Some of the disadvantages are as follows:

Important Points

The different vital points are as follows:

  • It is the reserve created by the company without any specific purpose using the profit generated during the period and is kept aside by the company for meeting future liabilities.
  • The company can utilize the general reserves for various purposes, such as settling any of the unknown future contingencies, for strengthening the company’s financial position, increasing working capital, paying dividends to the shareholders, offsetting some of the specific future losses, etc.
  • As the amount of general reserve is accumulated to meet the future obligations of the company, so it helps in improving the financial position by helping the company to meet the uncertain financial contingencies.
  • There is no prescribed percentage mentioned anywhere for the creation of the general reserves by the company, and it is on the company’s discretion that how much reserve it wants to accumulate.
  • The company creates them only in case it earns the profit during the period, and in case if there arise the losses in the business, then the reserves are not created by the company.

Conclusion

It is the free reserves that the company can utilize for any purpose it requires after fulfilling certain types of conditions. E.g., settling any of the unknown future contingencies, for strengthening the company’s financial position, increasing working capital, paying dividends to the shareholders, offsetting some of the specific future losses, etc. They provide resources and the funds required for the expansion of business activities and meeting with the future obligations of the company, thereby improving the financial position. There is no prescribed percentage mentioned anywhere for the creation of the general reserves by the company. It is on the company’s discretion on how much reserve it wants to accumulate.

Recommended Articles

This article has been a guide to what is a general reserve and its meaning. Here we discuss the example of the general reserve accounting along with advantages and disadvantages. You can learn more about accounting from the following articles –

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