Difference between Reserve and Provision
Reserve
Reserve is an amount set aside out of the profit to strengthen the financial position of a business to meet future contingencies and losses. It is also called undistributed profit or retained earnings. Sometimes it can be distributed to shareholders as a dividend. So, we can say that reserve is that part of the profit, which is undistributed for the business in the future. An organization maintains reserve only if it has earned profit. Otherwise, reserve is not created. Reserves are recorded on the liabilities side of the balance sheet. It can be invested outside the business to purchase securities from a reserve fund.
Objectives of Reserve
Reserve helps the business in strengthening the financial position of a business. It also helps to meet uncertain and unexpected losses without and reduction in owner’s capital. The reserves may be created for achieving any of the following objectives.
- To strengthen the financial position of a firm.
- To increase the working capital of a firm.
- To meet future contingencies of a firm.
- To replace wasting assets of a firm
- To distribute dividends uniformly.
Provisions
Provision is the amount kept to meet specific losses or liabilities that may be expected but not yet incurred. The provision means providing for possible losses or liabilities. The amount of which can not be determined exactly. Provisions are usually created by debiting the profit and loss account. They are either deducted assets on the balance sheet or shown on the liabilities side under the appropriate heading.
Examples of some provisions are:
- Provision for doubtful debts
- Provision for discount on debtors
- Provision for taxation
- Provision for repairs and renewals
- Provision for depreciation
Objectives of Provisions
The following are the objectives of the provisions
- Provision is created to cover a loss in the value of assets
- Provision is created to meet anticipated losses and liabilities, such as provision for doubtful debts, provision for taxation, etc.
- Provision is created to show correct financial statements and report actual profit and business position.
Difference between Reserve and Provision
|
Reserve |
Provision |
|
Reserve is a part of profit kept aside to meet any unknown loss or
liabilities. |
Provision is an estimated amount. It is created to meet specific
losses or liabilities, but the amount of loss or liability can not be
determined exactly. |
|
It is a portion of the profit earned by the business. It is created
by debiting the profit and loss appropriation account. It is an appropriate
profit. |
It is possible loss. So it is created by debiting profit and loss
accounts. It is charged against profit. |
|
It can be utilized to distribute dividends to shareholders. |
Dividends cannot be paid out of it to its shareholders. |
|
Its amount is generally determined by management on the basis of the
amount of profit earned. |
Its amount must be sufficient to meet the loss or liabilities. |
|
It strengthens the financial position of the business by increasing
working capital. |
It cannot increase working capital. It is utilized for meeting the
specific loss or liability. |
|
It is shown on the liabilities side of the balance sheet as a separate item. |
It is shown on the assets side of a balance sheet as deducting from
the concerned assets. |
|
Reserve amounts can be invested outside the business in the purchase of
securities. |
It cannot be invested outside the business. |
|
An auditor is not required to check adequacy. |
An auditor must check its adequacy. |
Conclusion
Provision and reserve are two accounting terms people sometimes get confused about them. In short, a reserve is an undistributed profit kept to meet future contingencies and losses. It is created by debiting profit and loss appropriation accounts, also known as retained earnings. In comparison, the provision means providing for possible losses or liabilities. It is created to meet specific losses or liabilities which may be expected but not yet incurred. It is charged against profit by debiting the profit and loss account. They are either deducted on assets side of balance sheet or shown on the liabilities under the appropriate heading.