Accountancy · Ch 2 — Depreciation
Provisions and Reserves
Provisions and Reserves
A Provision is an amount set aside, as a CHARGE against profit (that is, debited to the Profit and Loss Account before profit is even arrived at), to meet a known liability or an anticipated diminution in the value of an asset whose exact amount cannot be measured with certainty. Provision for Depreciation, Provision for Doubtful Debts, and a Provision for Taxation are all everyday examples — in each case, the business KNOWS it must set something aside, even though the precise final figure involves an estimate.
A Reserve, in contrast, is an amount set aside as an APPROPRIATION of profit (that is, it is created only AFTER profit has already been arrived at, out of the profit that remains) to strengthen the business's financial position, meet a future contingency, or fund a specific future purpose — a General Reserve, a Dividend Equalisation Reserve, or a Reserve for Expansion are typical examples.
| Basis of distinction | Provision | Reserve |
|---|---|---|
| Nature | A charge against profit | An appropriation of profit |
| When created | Whether the business earns a profit or not — it is a necessary expense either way | Only when the business has earned sufficient profit |
| Purpose | To meet a known liability or an anticipated fall in asset value | To strengthen the business generally, or fund a specific future need |
| Effect on distributable profit | Reduces the profit available for distribution, since it is deducted BEFORE profit is computed | Reduces the profit AVAILABLE FOR DISTRIBUTION only after it has already been calculated and set aside from it |
| Can it be used to pay a dividend? | No — a provision is not a distributable surplus | A general reserve can be used to pay a dividend, or for any other general business purpose the business decides |
| Where it appears | Deducted from the concerned asset on the assets side (e.g., Provision for Depreciation), or shown as a current liability (e.g., Provision for Taxation) | Shown under Reserves and Surplus, on the liabilities side, as part of the owners' funds |
An amount charged against profit (debited before profit is arrived at) to meet a known liability or an anticipated fall in the value of an asset, where the exact amount involves an estimate — Provision for Depreciation and Provisio …
An amount appropriated out of an already-earned profit to strengthen the business's financial position or fund a specific future purpose — created only when sufficient profit exists, and available, unlike a provis …