Reserve vs Provision
Provisions and reserves are important components in accounting. Reserves are seen as positive as they add onto the company’s profitability and can be used to provide for unexpected future losses, distribution among shareholders, or reinvestment in the business. Provisions, on the other hand, provide for any losses, expenses, liabilities, or depletion in assets that have been known and expected. The article offers clear explanations and examples for provisions and reserves and highlights how they are quite different to one another.
Reserves
A reserve is the amount of money that’s left after provisions and other costs have been reduced. Reserves are additional funds that have been discovered through budget analysis, and added onto a company’s profit numbers. The two types of reserves are capital reserves and revenue reserves. While capital reserves such as share premium, capital redemption reserves, and asset revaluation reserves cannot be distributed, revenue reserves such as retained earnings and general reserves can be distributed among the company’s owners and shareholders. Alternatively, the retained earnings can also be reinvested in the business for development purposes. Capital reserves can arise from asset revaluation surpluses, equity transactions, foreign currency translation exposure, accounting adjustments, etc.
Provisions
Provisions are funds that are kept aside to cover possible depreciation of assets, to provide for liabilities, expenses, and losses such as provision for bad debts. Provisions are usually kept for losses that have been anticipated. Provisions act as an insurance policy in case a loss that has been foreseen materializes. For example, provisions for bad debts are kept in case the debtors are unable to repay the funds that they borrowed.
Provisions are seen to be negative as they reduce income by assigning a portion of that income as a provision for a probable loss. Examples of other types of provisions include provision for retirement benefits, provisions for losses that may arise through company reorganization, product return provision, provision for damaged goods or inventory, etc.
What is the difference between Reserves and Provisions?
Provisions and reserves are both important components in accounting. While provisions are generally seen to be negative since they reduce income levels, reserves are seen to be positive and result in higher profits. The main reason for creating a reserve is to be able to meet any unknown losses that may occur in the future. In contrast, the main reason for creating a provision is to provide for losses that have been known and are expected. Another difference between the two is that a reserve can only be created if the company is profitable. However, provisions are made regardless of whether the company is making a profit or loss.
Summary:
Reserves vs Provisions
• While provisions are generally seen to be negative since they reduce income levels, reserves are seen as positive as they add onto the company’s profitability and can be used to provide for unexpected future losses, distribution among shareholders, or reinvestment in the business.
• Provisions provide for any losses, expenses, liabilities, or depletion in assets that have been known and expected.
• The main reason for creating a reserve is to be able to meet any unknown losses that may occur in the future. In contrast, the main reason for creating a provision is to provide for losses that have been known and are expected.
• A reserve can only be created if the company is profitable, but provisions are made regardless of whether the company is making a profit or loss.
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