Reserve Accounting

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Reserve Accounting Meaning

Reserve accounting represents the company’s accumulated profits, which have been earned over the years, authorized by the board of directors. Unless specifically mentioned, these can be utilized without any legal restrictions for purchasing fixed assets, settlement of legal obligations, payment of statutory bonuses, and long-term debts.

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To meet the uncertainties and contingencies of the business, the creation of reserves is mandatory. It helps the business to survive in a situation when all the odds are against it. But there should be proper monitoring of the funds. It has been noticed that top management had diverted the funds for their use.

Reserve Accounting Explained

Reserve accounting signifies figures that indicate resources preserved to be utilized for specific purposes. These are gains that can help accomplish various tasks and requirements, including the purchase of assets and the improvement of financial situations.

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Also known as retained earnings, these funds constitute extra finance to serve general purposes to boost business processes. In accounting, these extra funds retained after covering all expenditures and liabilities are a debit for the retained earnings account and credited to the reserve account.

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Types

The following are the types of reserves in accounting.

Reserve accounting can be further categorized into several components, depending on the organization’s requirements. The most common examples of reserves are

Many legislations mandate it, equivalent to a certain percentage of the share capitalThe Share CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side.read more.

#2 – Securities Premium

When the company receives the amount over the nominal value of the share, then the excess is termed as securities premiumSecurities PremiumShare premium is the difference between the issue price and the par value of the stock and is also known as securities premium. The shares are said to be issued at a premium when the issue price of the share is greater than its face value or par value. This premium is then credited to the share premium account of the company.read more.

It can be utilized only for certain specific purposes. E.g., issuance of fully bonus shares to the members, buyback of shares, writing offWriting OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more expenses incurred before the incorporation of the company.

Example

Suppose the par value of the sharePar Value Of The SharePar value of shares is the minimum share value determined by the company issuing such shares to the public. Companies will not sell such shares to the public for less than the decided value.read more is $10, and due to excess demand in the market, the share price shoots to $40. The excess $30 becomes a securities premium, which the companies account for in the following way –

ParticularsDebit Credit
Bank Account                   Dr$40mn 
                   To Share Capital $10mn
                    To Securities Premium $30mn

Explanation of Reserve Accounting Journal Entry  – A shareholder would pay $40 to the company, but as the par value is $10, the rest would be housed in the securities premium account.

#3 – Remuneration Reserve

As the name suggests, this is saved to pay bonuses to employees or management.

#4 – Translation Reserve

It is applicable when the entities have an operation in multiple countries. At the financial year-end, consolidated accounts must be prepared, translating different reporting currencies into one functional currencyFunctional CurrencyThe term functional currency represents the currency of the location in which business operates primarily, earns a significant portion of revenue, and incurs the cost to generate such profits. In short, it is the home currency of that country where the corporate headquarter is situated.read more. The exchange difference that arises is parked in this reserve.

#5 – Hedging Reserve

Companies generate this reserve after taking certain positions to protect themselves against volatility in certain input costs.

The list provided above is not exhaustive. There are multiple purposes for which the company can create reserves, which depend on the legal and social requirements.

Example

The following is an example of reserve accounting with journal entries.

The company is in the existing business of industrial chemical industries and now wants to expand its territory into agricultural products.

It would require a separate setup, and the estimated building cost is $10 million.

ParticularsDebit Credit
Retained Earnings               Dr$10mn 
                           To Building Fund $10mn

The actual building cost turns out to be $ 9 million.

ParticularsDebit Credit
Building                 Dr$9mn 
                           To Bank $9mn

After the completion of the building, we need to reverse the first entry created for the building fund. It is since the fulfillment of the assigned purpose using the funds.

ParticularsDebit Credit
Building Fund                 Dr$10mn 
                   To Retained Earnings $10mn

Advantages

The following are the advantages of reserve accounting –

Disadvantages

The following are the disadvantages of reserve accounting –

Reserve Accounting Vs Provisions Accounting

For a layman, reserve, and provision would look similar, but they are two different aspects to an accountant. Understanding the difference between provision and reserve is important for concept clarity. Provisions and reserves both reduce profits, but in a different senses. The former is a charge against the profit, but the latter is an increase in the capital employedCapital EmployedCapital employed indicates the company's investment in the business, i.e., the total amount of funds used for expansion or acquisition and the entire value of assets engaged in business operations. "Capital Employed = Total Assets - Current Liabilities" or "Capital Employed = Non-Current Assets + Working Capital."read more.

Diff-Provision-Reserve

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Provisions meet the liability, but the amount is uncertain. Finally, reserves are the funds set aside, not to cover liabilities but to meet the fund requirements of the business in the future.

Reserve-Accounting-provision

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This article has been a guide to what is Reserve Accounting. Here we explain its types, examples, advantages, disadvantages, and vs provisions accounting. You can learn more about accounting from the following articles –

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