Provision Vs Reserve

Provision Vs Reserve

Provision?

Provision refers to the amount that is put aside from the business profits, to provide for any known liability, the amount of which cannot be determined with accuracy.
or

Provision refers to the amount set aside, by charging to the Profit and Loss Account, to provide for any known liability, the amount of which cannot be determined with accuracy.

  • Provision is charged in the Profit and Loss Account or statement of Profit and Loss (in case of companies) on an estimated basis.
  • Provision differs from liability to the extent that provision is an estimated amount, while liability is a certain amount.
  • A provision stands for liability of uncertain time and amount.

Examples of Provision

1. Provision for depreciation,
2. provision for doubtful debts,
3. provision for discount on Debtors,
4. provision for tax,
5. Provision for Repairs and Renewal.

Features of Provision

  • Created out of Profit: Provisions are created out of the profit of the current year.
  • Created to meet known Liability: The provision is created to meet a known liability.
  • Estimated Amount: The exact amount of anticipated loss or expenses or depletion in the value of the assets cannot be determined with reasonable accuracy.
  • Charge against profit: All provisions are charged to Profit and Loss Account or Statement of Profit and Loss. So they reduce the profit of the year in which they are created.

Provision Vs Reserve

Reserve?

Reserve refers to the amount aside out of profits of the business to strengthen its financial position.
It is an appropriation of profits and not a charge against profit, so the creation of reserve does not reduce the net profit, but only reduces the divisible profits.

Examples of Reserve

1. General Reserve,
2. Investment Fluctuation Reserve,
3. Dividend Equalisation Reserve,
4. Capital Reserve,
5. Debenture Redemption Reserve,
6. Workmen’s Compensation Reserve
7. Revenue Reserve.

Reserve Fund?
An amount equal to reserve is invested in outside securities, then such reserve is termed as ‘Reserve Fund’.

Provision Vs Reserve

Features of Reserve

  • Reserve is an appropriation of profits as it is credited out of divisible profits.
  • Reserve cannot be created in case of loss.
  • Reserves are created voluntarily to strengthen the financial position of the business.
  • Reserves are shown on the liability side of the Balance Sheet as the reserve is a part of the profit, which would have been distributed otherwise.
  • When the amount of reserve is invested in outside securities, it is known as ‘Reserve Fund’.
  • Reserve is not created to meet any known liability or depreciation in the value of assets but for meeting an unknown liability or loss in the future.

Provision Vs Reserve
Or

Difference Between Provision and Reserve

Basis Provision Reserve
Nature It is charged against Profit. It is an appropriation of profit.
Purpose It is created to meet the known liability. It is created to strengthen the financial position and to meet the unknown liability.
Utilisation for Dividend It cannot be used for distribution by way of dividend It can be used for distribution by the way of Dividend
Effect on Profit Provision reduced net Profit. Reserve is an appropriation of profit. So, it reduces the divisible Profit.
Investment Provisions are never invested outside the business. Reserve may be invested outside the business.
Legal Necessity It is made out of legal necessity. It is created as a matter of Prudence.
Presentation in Balance Sheet It is shown either as a liability under the head ‘Current Liability’ or as a deduction from Assets. It is shown on the Liability side of the Balance Sheet under the head ‘Reserve and Surplus’.
Accounting Treatment Provisions are recorded on the debit side of profit and loss Account Reserves are recorded on the debit side of profit and loss Appropriation Account
Availability of profit The creation of provision does not depend on profit. The creation of reserve depends upon profit.

Provision Vs Reserve

 

 

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