7.1. Types of reserves are determined as per the organizational objectives

Types of Reserves

Reserves are portions of a company’s profits set aside for specific purposes, either as a safety buffer or to fund future activities. The type of reserve a company maintains depends on its organizational objectives, legal requirements, and strategic plans.

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1. Main Types of Reserves

1.1 Revenue Reserves

• Purpose: Fund operational needs, expansion, or contingencies.

• Source: Profits from normal business operations.

• Examples:

  • General reserve

  • Dividend equalization reserve

• Use: Can be distributed as dividends if the company chooses.

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1.2 Capital Reserves

• Purpose: Arises from non-operating activities; usually not available for dividend distribution.

• Source:

  • Sale of fixed assets above book value

  • Revaluation of assets

  • Premium on share issue

• Use: Strengthen financial position or for specific capital projects.

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1.3 Statutory or Legal Reserves

• Purpose: Required by law or regulatory authorities.

• Examples:

  • Banking regulations may require a statutory reserve

  • Insurance companies may have specific reserves

• Use: Protect creditors and ensure financial stability

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1.4 Specific or Special Reserves

• Purpose: Set aside for clearly defined objectives.

• Examples:

  • Research & development reserve

  • Dividend equalization reserve

  • Contingency reserve

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2. Accounting Treatment of Reserves

• Creation of reserve:

  • Dr Profit & Loss Account

  • Cr Reserve Account

• Utilization of reserve:

  • Dr Reserve Account

  • Cr Cash/Bank or Specific Expense Account

Note: Revenue reserves can be distributed as dividends, while capital reserves are usually retained in the business.

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3. Key Points According to Organizational Objectives

1. Operational Efficiency: Revenue reserves support smooth running of business.

2. Expansion & Investment: Capital reserves fund growth projects.

3. Legal Compliance: Statutory reserves ensure the company meets regulatory requirements.

4. Risk Management: Special reserves mitigate unforeseen risks.

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4. Short Exam-Ready Summary