1) GENERAL RESERVE / CONTINGENCY RESERVE
-
Part of the profits which is set aside to meet
any future unknown contingency or emergency
May be credited:
o
To meet the increasing demands of the business;
o
To stabilize the economic conditions of the
firm;
o
To meet unforeseen losses; and
o To control the profits of the company.
2) SPECIFIC
RESERVE
-
Created of some definite or specific purpose
i.e.
o
Dividend “Equalization Reserve,
o
Reserve for Repair,
o
Reserve for Outstanding Expanses, and
o Reserve for Building etc.
3) REVENUE
RESERVE
-
Consist of un-contributed revenue gains
consisting of profits made in the ordinary course of business.
-
The funds of these reserves may be used:
o
To maintain a business or
o
Pay dividends.
- Revenue reserves are ‘Free Reserves’ that are available for distribution as profits.
4) CAPITAL
RESERVES
-
Not available for distribution among
shareholders as dividends. They are created to strengthen the financial
position of the company.
-
Capital reserves are built out of capital
profits and not out of business profits, such as:
o
Profit prior to incorporation;
o
Premium on issue of shares or debentures;
o
Profit on redemption of debentures;
o
Profit on forfeited shares;
o
Profit on sale of fixed assets; and
o Profit on revaluation of fixed assets.
5) VALUATION
OR ASSETS RESERVES
-
Set up to offset the loss of value of some
assets such as
o
Plant and machinery,
o
Accounts receivables,
o
Investments,
o
Marketable securities and
o
Patents and intangibles
-
Which have a limited life
Objectives:
o
To restore the integrity of investments which they
have suffered or loss in value;
o
To recognize expenses this cannot be determined
accurately;
o
To reduce assets to their estimated realizable values;
o
To provide for losses arising out of bad debts;
o To provide for losses arising out of obsolescence.
6) PROPRIETARY
RESERVES
-
Elements of ‘padded surplus’ and are also
referred to as surplus or ‘net worth reserves’.
-
A part of shareholders equity which may be
set up for the following purposes:
o
To provide cushion against future risks;
o
To offset subjectivity in determination of profits;
o
To reduce free surplus available for
distribution to shareholders as dividends;
o
To provide for future expansion and growth;
o
To provide for repayment of debt; and
o
To increase the real value of the firm
-
There are many kinds of proprietary reserves,
which include:
o
Reserve for dividend i.e. Dividend Equalization Fund;
o
Reserve for contingencies;
o
Reserve for working capital;
o
Reserve for improvement; and
o
Reserve for insurance, etc.
7) LIABILITY
RESERVES
-
For current as well as emergency liabilities.
Current Liabilities are known and are sure to materialize but the extent of the liability or the amount due is not certain. Reserve for taxation is an
important example of such reserves. Emergency liabilities, on the other hand,
may be non-recurring which may be established through transfer from contingency
reserves
8) FUNDED
RESERVES
-
A reserve does not mean cash or fund. It is
merely a surplus appropriation that is included in shareholders’ equity. A fund
is an actual asset in the form of cash or other investments. When the amount of
reserve is invested in securities, etc., it is called funded reserve or
‘reserve fund’. A funded reserve protects the working capital position of the
company and ensures the availability of funds as and when needed.
9) SINKING
FUND RESERVES
- A sinking fund is a fund built up by regular contribution/appropriation out of profits and the amount of interest on such contributions and the interest itself. The purpose of sinking fund may be either payment of a liability on a certain day in future or accumulation of funds to replace wasting assets.
10) SECRET
RESERVES
-
A secret reserve is a surplus which although
exists in a business but is not disclosed in the balance sheet. The management,
to be conservative, may write down the value of the assets below their fair value
for the purpose of creating a secret or ‘hidden reserve’.
-
Secret reserves may be created by the simple method
of showing profits at a figure much lower than the actual. When secret reserves
exist, the financial position of the business is much better than what appears
from the balance sheet.
Methods of
Creating Secret Reserves:
Secret
reserves may be created by any of the following methods:
o
Writing off excessive depreciation;
o
Charging capital expenditure as revenue expenditure;
o
An understatement of income;
o
An undervaluation of closing stock;
o
An undervaluation of assets;
o
An overstatement of liabilities;
o
Capitalizing revenue receipts; and
o
Showing contingent liabilities as actual liabilities.
o
Sometimes secret reserves may arise themselves,
e.g., increase in the value of assets.
Advantages of
Secret Reserves:
o
It is a means for stabilizing dividends;
o
It ensures better financial position;
o
It helps to hide out profits from the existing and
potential competitors;
o
It acts as a cushion during the rainy days, and save
business from collapse; and
o
It increases the actual capital employed in the business
and improves the profitability.
Disadvantages
of Secret Reserves:
o
Balance sheet does not reveal the true and fair position
of the business;
o
Investors cannot make their buying and selling decisions
correctly;
o
Management can conceal its inefficiency;
o
It provides an opportunity to the management for
manipulation and misuse of the company’s funds.
