Provisions: Provision means any amount written off or retained by way of providing for depreciations, renewals or diminution in value of assets and retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.
Examples of provisions: Provisions for depreciation, provisions for Repairs and renewals, provisions for bad and doubtful debts, provisions for fluctuations in Investments, provisions for Taxation, provisions for contingent liability etc.
Reserves: Reserves refers to the amounts set aside out of profits or surplus of the company, which are neither meant to meet any loss in respect of depreciation, renewals or diminution in value of assets nor mean to meet any known liability.
Example of reserve: sinking fund for the redemption of debenture.
Types of Reserves:
Revenue reserves are profits retained to strengthen the financial position of the company or to retain funds for a specific purpose. These are reserves created out of revenue profits by debiting profit and loss appropriation account.
Reserves created out of capital profits are called Capital Reserves. Example of Reserves created out of capital profits are Profits prior to incorporation, Premium on issue of debentures, profit on forfeiture of shares, profit on sale of fixed assets, profit on revaluation of fixed assets and liabilities.
Difference between provisions and reserves
|It is created for specific purpose.||It is created for future losses.|
|It is charge to profit and loss account.||It is an appropriation of profit.|
|It can not be distributed as profit.||It can be distributed as profit.|
|It can not be invested in securities.||It can be invested in securities.|
|It is created because of legal necessity.||It is a matter of financial prudence.|
|Provisions are shown by the way of deduction from the amount of the items for which it is created.||Reserves are shown separately under reserves and surplus on the liabilities side of the balance sheet.|