Types of Reserves in Accounting with Examples
Understanding what are reserves in accounting is essential for Commerce students, whether you are preparing for Class 11/12 accountancy exams, competitive exams, or seeking practical business knowledge. Reserves ensure businesses stay financially strong and meet future obligations or unexpected losses. This topic is vital for exams and real-world finance.
| Type of Reserve | Created From | Main Purpose | Examples |
|---|---|---|---|
| General Reserve | Revenue profits | Strengthen financial position, flexibility in use | General Reserve |
| Capital Reserve | Capital profits (not regular business income) | Special uses (not distributed as dividends) | Share Premium, Profit on Sale of Assets |
| Revenue Reserve | Normal business profits | Dividends, expansion, contingencies | Dividend Equalisation Reserve |
| Specific Reserve | Revenue profits | Set aside for a particular purpose | Debenture Redemption Reserve |
| Legal Reserve | Mandatory by law | Statutory compliance | Capital Redemption Reserve |
| Secret Reserve | Undisclosed profits | Extra hidden safety, rarely shown in books | Undervaluation of assets/liabilities |
What Are Reserves in Accounting?
Reserves in accounting are amounts set aside from business profits to meet future needs, unexpected losses, or obligations. Companies create reserves to maintain financial stability and comply with accounting principles. Reserves help firms prepare for uncertainties and fund future growth. This concept is crucial for exams, interviews, and business decisions.
Types of Reserves in Accounting
There are several types of reserves in accounting, each serving a different purpose in financial management.
- General Reserve
- Capital Reserve
- Revenue Reserve
- Specific Reserve
- Legal Reserve
- Secret Reserve
Difference Between Capital Reserve and Revenue Reserve
A capital reserve is created from capital profits, such as share premium or asset sale gains, and is usually not available for dividend distribution. A revenue reserve is made from operating profits and is mainly used for dividends and business expansion. Learn more about this comparison at Difference Between Capital Reserve and Revenue Reserve.
Purpose and Importance of Reserves
Reserves play a vital role in financial management. They ensure business stability by providing a buffer against losses, funding future growth, and meeting legal requirements. Businesses also use reserves to pay consistent dividends, finance expansion, and navigate uncertain situations. Maintaining adequate reserves is a key principle in accounting and risk management.
- Safety against unforeseen losses
- Funds for expansion and modernization
- Meeting legal or statutory obligations
- Consistent dividend payments
- Strengthening the company’s financial position
Placement of Reserves in the Balance Sheet
Reserves are shown on the liabilities side of the balance sheet under the heading “Reserves and Surplus.” This reflects that the funds are retained from profits, not expenses. Here’s a simplified format:
| Liabilities | Assets | |
|---|---|---|
| Share Capital | XXX | Various Assets |
| Reserves and Surplus | XXX | |
| Secured Loans | XXX | |
| Current Liabilities | XXX | |
For a detailed explanation, visit Surplus in Balance Sheet at Vedantu.
Examples and Journal Entries for Reserves
Let’s look at some typical examples of reserves and their journal entries.
Example 1: Creating a General Reserve
Suppose a company decides to transfer ₹20,000 from profit to a general reserve at year-end.
Journal Entry:
Profit and Loss Appropriation A/c Dr. ₹20,000
To General Reserve A/c ₹20,000
Example 2: Capital Reserve from Asset Sale
If a fixed asset is sold at a profit of ₹5,000, this gain may go to capital reserve.
Journal Entry:
Asset A/c Dr. —
To Capital Reserve A/c ₹5,000
Example 3: Specific Reserve (Debenture Redemption Reserve)
If you make a reserve for redeeming debentures:
Journal Entry:
Profit and Loss Appropriation A/c Dr. ₹10,000
To Debenture Redemption Reserve A/c ₹10,000
For more detailed accounting treatments, visit Accounting Treatment of Reserves and Accumulated Profits or Losses.
Key Related Concepts
Reserves are different from provisions. Provisions are amounts set aside for specific, known liabilities or losses (like bad debts), while reserves are broader financial buffers. To compare, visit Difference Between Provision and Reserve at Vedantu.
Also, check how reserves connect with Profit and Loss Appropriation Account and Retained Earnings for a better grasp of surplus allocation in accounting.
At Vedantu, we simplify Commerce concepts like accounting reserves by offering solved examples, exam strategies, and stepwise solutions from trusted textbooks such as DK Goel and TS Grewal. Dive deeper using Types of Reserves and related resources for structured learning.
In summary, reserves in accounting are essential safeguards and growth tools for any business. Understanding their types—general, capital, revenue, specific, legal, and secret reserves—their uses, and balance sheet placement is vital for school and competitive exams, business practice, and personal financial literacy. Mastering this topic builds strong foundations for further study in commerce and accountancy.
FAQs on What Are Reserves in Accounting?
1. What does reserve mean in accounting?
In accounting, a reserve represents accumulated profits set aside for specific future needs. It acts as a financial buffer for unforeseen events or planned expenditures. Reserves are typically shown as a component of equity on the balance sheet.
2. What are the different types of reserves in accounting?
Several types of reserves exist, categorized by their purpose and source. Key types include:
- Capital reserves: Arising from capital transactions, like share premiums.
- Revenue reserves: Generated from business operations and retained profits.
- General reserves: Accumulated profits with no specific allocation.
- Specific reserves: Set aside for a defined purpose (e.g., expansion, debt repayment).
- Secret reserves: Hidden reserves created by undervaluing assets or overvaluing liabilities (not usually disclosed).
- Legal reserves: Required by law (e.g., statutory requirements).
3. Why are reserves shown on the liabilities side of the balance sheet?
Reserves represent the company's retained earnings and are therefore a liability to the owners of the company. They are not assets that can be readily used but funds set aside for future needs, representing an obligation to shareholders. Therefore, they're shown on the liabilities side of the balance sheet, under the equity/reserves section.
4. What is the difference between capital reserves and revenue reserves?
Capital reserves arise from transactions affecting the company's capital structure (e.g., share premium, revaluation of assets), while revenue reserves come from the company's operating activities (e.g., retained earnings, accumulated profits). Capital reserves are typically not available for dividend distribution, while revenue reserves often are.
5. Are reserves assets or liabilities in accounting?
Reserves are considered liabilities in accounting. They represent the company's retained earnings, which are essentially funds owed to the owners (shareholders). They are not available for immediate use like assets.
6. How are reserves created and used by companies?
Reserves are created by setting aside a portion of the company's profits, typically through the profit appropriation account. They are used to fund future investments, cover potential losses, pay dividends (in the case of revenue reserves), meet legal requirements, or handle emergencies. The specific usage depends on the type of reserve.
7. What are reserves with example?
Reserves are accumulated profits retained by a company for future needs. For example, a company might create a general reserve to strengthen its financial position or a specific reserve for a planned factory expansion. Capital reserves could arise from issuing shares at a premium.
8. What are the reserves in a balance sheet?
Reserves appear in the equity/reserves section of the balance sheet. They include various types of reserves (e.g., capital reserves, revenue reserves, general reserves), reflecting the accumulated profits retained by the company.
9. What does reserve mean in accounting class 11?
In Class 11 accounting, a reserve refers to accumulated profits retained within the business, not distributed as dividends. These funds are set aside for specific purposes or to strengthen the company's financial position. Understanding different types of reserves (capital reserves, revenue reserves) is crucial.
10. How to calculate reserves in balance sheet?
The calculation of reserves depends on the specific type. For revenue reserves, it's often a cumulative figure of retained earnings less any withdrawals or appropriations. For capital reserves, calculations involve specific capital transactions. The balance sheet presents the net amount of all reserves.
11. What are free reserves in accounting?
Free reserves are the portion of retained earnings available for distribution as dividends or for other corporate purposes after setting aside funds for legal requirements and other commitments. They are part of the revenue reserves and represent a company's readily available funds.
