Reserves and Surplus

Reserves and Surplus Meaning

Reserves and Surplus are all the cumulative amount of retained earnings recorded as a part of the Shareholders Equity and are earmarked by the company for specific purposes like buying of fixed assets, payment for legal settlements, debts repayments or payment of dividends etc.

Types of Reserves and Surplus on Balance Sheet

#1 – General Reserve

A general reserve is also known as a revenue reserveRevenue ReserveRevenue Reserve, also known as Retained Earnings, is a reserve type created out of profits that a business generates from its operating activities over a given period. It is used to expand the business operations or to handle contingencies in the long run. read more. The amount kept separately by an entity from its profits for the future purpose is known as revenue reserves. It is simply the retained earnings of an entity kept aside from the entity’s profits for meeting certain or uncertain obligations.

#2 – Capital Reserve

Capital ReserveCapital ReserveCapital reserve is a reserve that is formed from the company's profits earned from its non-operating activities during a period of time and is retained for the purpose of financing the company's long-term projects or writing off its capital expenses in the future.read more refers to a part of the profit which is kept by an entity for a specific purpose, like providing for financing long-term projects or writing off any capital expenses. This reserve, created from any capital profit of an entity that is earned from profit other than the company’s core operations.

#3 – Capital Redemption Reserve

Capital Redemption Reserve is created out of the undistributed profits that are general reserve or the Profit and loss account on the redemption of preference shares or during buyback of own sharesBuyback Of Own SharesShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.read more to reduce the share capital.

#4 – Dividend Reserve

Dividend reserve is the amount that is kept in a separate account for ensuring that a similar amount of the dividend is declared every year.

Reserves and-Surplus

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Example of Reserves and Surplus

Let’s take the example of a Corporation named Computer Web Inc., which is doing the business of computers and laptops. The earnings of the corporation from its normal course of the operation during the financial year 2017–18 were $ 500,000. It is decided by the management of the company to keep aside 8 % of the profits earned during the financial year for meeting future liabilities, i.e., for General Reserve and corporation has issued sharesIssued SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet.read more for which they have received premium amounting to $ 25,000.

Also, the amount present in capital redemption reserve and dividend reserve amounted to $ 14,000 and $ 19,000 respectively during the same period. Now we need to calculate the total amount of reserves and surplus, which is the sum of the general reserve, share premium account, capital redemption reserve, and dividend reserve.

Solution:

Reserves and Surplus Example

Total Amount of Reserves and Surplus = $40,000 ($500,000 * 8%) +$25,000 +$14000 + $19,000 = $98,000

Advantages

Disadvantages

Important Points about Reserves and Surplus

  • The utilization of the reserves and surplus includes purposes such as dividend distribution, meeting future obligations, overcoming losses, managing working capital requirements, fulfilling funds requirement for expansion of business, etc.
  • It is required for the company to maintain reserves sometimes in cash to manage the reduction in revenues and slow-paying customers. Generally, the maintenance of cash reserves depends upon the type of business of the company.

Conclusion

Reserve and surplus created by the company are the reserves which company can utilize for the purpose according to nature or the type of such reserve and surplus. Generally, these reserves are created by the company to settle any of the future contingencies. E.g., for strengthening and increasing the company’s financial position in the market, paying off the dividends to all the shareholders of the company, increasing working capital in the company, etc., after fulfilling all the conditions required for that reserve. Sometimes reserve and surplus are maintained in cash to manage the reduction in revenues and slow-paying customers.

This article has been a guide to what is Reserves and Surplus and its meaning. Here we discuss different types of reserves and surplus on the Balance Sheet along with an example. We also discuss the advantages and disadvantages. You can learn more from the following articles –

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Comments

  1. Roshani divakar meshram says

    Thanks .it is really

    helpful

    • Dheeraj Vaidya says

      Thanks for your kind words!

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