Answer Posted / prasanna11149@yahoo.co.in
Provision:
Is an amount written off to provide for depreciation, or
diminution in value of assets or retained to provide for a
known liability.
Provisions made for expected losses and contingencies are
charges against profits
The liability should be a present obligation whether legal
or constructive which has arisen as a result of a past
event and where payment is probable ( more likely than not)
and the amount can be estimated reliably.
Arises from the accrual and prudence principles
Examples of these liabilities appearing in the liabilities
side of the balance sheet are:
Provision for retirement benefits
Provisions for reorganization or severance : this provision
is recorded when a company announces a plan to change its
organization structure, which will incur significant costs,
including termination of personnel
However, take note that the provisions can also be
classified on the asset side of the balance sheet which are
then known as negative assets with the objective to
decrease the value of other assets of the company.
Examples of provision as negative assets:
Bad debt provision - provision decreasing the value of
receivables, because their recoverability is doubtful.
Mostly recorded based on aging of the receivables, older
receivables are more doubtful that new ones.
Provision for product returns / credit note provision -
provision decreasing the value of receivables due to
expected sales returns. Normally recorded based on
historical experience as a percentage of recent sales.
Provision for excessive, obsolete or damaged inventory -
decreasing the value of inventory with uncertain
marketability (due to its obsoletness, damages or excessive
volume on stock)
Impairment provisions - generally any provisions recorded
when a book value of an asset is significantly higher than
its fair value
RESERVES:
Reserves are appropriations of profit namely when profits
have been ascertained after deducting all expenses which
includes provision and others. Reserves are residual
earnings after all expenses and taxation which belongs to
the owners namely the shareholders.
There are essentially two(2) types of Reserves:
Capital Reserves
Revenue Reserves
Capital Reserves:
Are appropriation from profits which cannot be distributed
by way of cash dividends.
These capital reserves arises mainly from (i) equity
transactions between the enterprise and its shareholders;
(ii) from adjustments arising in accounting for business
combinations; (iii) from differences arising on translation
of foreign currency operations; (iv) from surpluses arising
from asset revaluation; (iv) any unrealized gain which has
not been included in income.
Examples of capital reserves includes: share premium,
capital redemption reserves, capital reserves arising on
merger and acquisition, statutory reserves, asset
revaluation reserve and exchange fluctuation reserves.
Revenue Reserves are:
Are appropriation from profit which can be distributed by
way of cash dividends although some may be set aside for
other purposes.
Examples like retained profits and general reserves.
MAIN DIFFERENCE BETWEEN PROVISION AND RESERVE:
Remember that provision is a charge to the profit whilst a
reserve is an appropriation to the profit. Reserves belongs
to the owners equity side while provision can be on a
liability side or on the assets side but as a negative asset
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