Difference Between Provision and Reserve

Both Provision and Reserve play an integral role in the smooth functioning of a firm and helps to maintain its integrity. Owing to their characteristics and utility, they hold an essential place in a company’s balance sheet and are treated with the utmost importance.

Though both terms seem to convey a similar ideology or purpose, one cannot simply use it interchangeably. Read along to find out more about the basic difference between provision and reserve and gain valuable insight into the topics accordingly.


Types of Reserve

In a broader sense, there are three types of reserves. Let’s take a quick look at them below –

  1. Capital Reserve 

Such a reserve is created from capital profits, which does not occur frequently and is not readily available for paying dividends to the shareholders of a company. For instance, profits earned through sale or revaluation of assets, forfeiture of shares, etc. helps to create a capital reserve. Mostly such reserves are created for designated purposes like writing off capital losses, investing in long-term projects or other forms of long-term contingencies. 

  1. Revenue Reserve or General Reserve 

This particular type of reserve is popularly known as retained earnings and is set aside from the earnings generated to a firm’s core operations. The said reserve is used to pay a dividend to the company’s shareholders and for business expansion. 

  1.  Specific Reserve

This type of reserve is mostly created for designated purposes. For instance, reserve for asset replacement and reserve for dividend equalisation are two of the most common examples of the specific reserve. 

Now that you have gained a fair idea about the basic types of reserves let’s find out how it is accounted for in the books of accounts.


Accounting Treatment of Reserve

In the balance sheet, reserves are recorded on the liability column under the header of ‘Reserves and Surplus’. In the event of loss, a company does not create any reverse and does not record it in the balance sheet. 

Test Your Knowledge: Pass a journal entry to create a reserve A/C.

An overview of provision and reserve has provided us with a fair idea about these concepts. Let’s proceed to take a quick look at the fundamental point of difference between these two.

Difference between Provision and Reserve

The Table Below helps to Understand the Basic Provision and Reserve Differences –

Parameter

Provision 

Reserve

Definition

It is a share of the money that is kept aside to account for anticipated financial liabilities.

It is a share of profits that is kept aside to meet unforeseen financial liabilities in a business setup.

Appropriation

Charged against profits.

Share of profit.

Creation

By debiting the P&L Account.

By debiting P&L Appropriation Account

Purpose

Safeguards business against expected financial obligations.

Aids to continue business operations and further safeguards it against unforeseen liabilities.

Allocation 

Profit is not mandatory for allocation.

Profit is mandatory for allocation. 

Impact on PL A/C

It lowers the share of profits meant for distribution as dividend.

It lowers the share of the organisation's net profit.

Treatment in books

For assets: It is recorded as a deduction from the designated asset.

For liabilities: It is recorded in the liability side.

It is recorded on the liability side.

Investment

Cannot be invested beyond business venture.

It can be invested beyond one’s business venture.

Usage

Must be used for the purpose it has been allocated for.

The company can use it for any purpose.

Importance 

As per law, its creation is mandatory.

Its creation is not mandatory.


Learn more about Provision and Reserve in great details and find out how they impact the financial standing of a company by referring to Vedantu’s study solutions online. You can further gain a better insight into this and other similar topics by joining Vedantu’s free online classes.

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FAQ (Frequently Asked Questions)

1. What is Provision?

Provision is an amount that a company keeps aside to meet an expected financial liability in future: examples - Provision for doubtful and bad debts, provision of taxation, provision for depreciation of assets.

2. What are Provision and Reserve?

Provision is a sum of money that has been kept away to meet anticipated financial obligations in future. Creation of provisions is mandatory as per law.

Reserve is a sum of money set aside from the total earnings of a company to meet unforeseen contingencies. Creation of reserve depends on the availability of profits.