Difference Between Provision And Reserve Quite a number of us use the word provision and reserves interchangeably as if they

are the same but actually there is a very great difference between them. SO LETS LOOK AT WHAT IS CALLED A PROVISION: A 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 SO WHAT IS 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. RECAP: 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 Reserves 1. It is created by debiting the profit and loss appropriation account.

2. It is created to meet an unknown liability, or to strengthen the financial position of the company or for equalization of dividends etc. 3. A reserve is created only when there is profit in the business. 4. It can be distributed among shareholders as dividend. 5. The reserve is created without taking into consideration the actual amount required except in the case of redemption of debentures when a definite sum is set aside. 6. Creation of reserve depends upon the financial policy of the business and discretion of its management. 7. It is usually shown on the liability side of the balance sheet as it is not a specific reserve. Provisions 1. It is created by debiting the profit and loss account. 2. It is created to meet a known liability or a specific contingency, e.g.. provision for bad and doubtful debts, or provision for depreciation etc. 3. A provision is created irrespective of whether there is profit or loss in the business. 4. It is not available for distribution as dividend among shareholders. 5. A provision is made for a definite amount and, therefore, a definite sum is set aside every year to meet the known contingency. 6. Making of a provision is a must to meet known liability or contingency. 7. The provision is generally shown on the assets side of the balance sheet. Distinction between general reserve and specific reserve General reserve 1. It is created for a specific purpose. 2. It is utilized for that specific purpose, for which it was created. 3. Whether profit or no profits, it must be created. 4. It is necessary to create in order to ascertain profit. 5. It is shown on the debit side of profit and loss account. 6. Net profits are reduced because of it. Specific Reserve 1. It is created not for any specific purpose but for meeting future contingencies. 2. It can be utilized for meeting any future loss. 3. It is created only when there are sufficient profit. 4. They are created only when there are profits i.e. they depend upon profits. 5. It is shown on the debit side of profit and loss appropriation account. 6. Only distributable profits are reduced because of it.

Difference Between Provision and Reserve:

The points of difference between provision and reserve are stated in the tabular form: 1. It is a possible loss so it is created by debiting profit and loss account. It is a charge against profit 1. It is a portion of profit earned by business. It is created by debiting profit and loss appropriation account. It is an appropriation of profit. 2. Profit and loss account discloses true profit/loss, even if no reserve is created. 3. It is meant for meeting any unknown loss or liability. It is generally created with a portion of profit earned by business.

Profit and loss account will not disclose true profit/loss, unless provision is created. 3. It is created to meet specific loss or liability. But the amount of loss or liability cannot be determined exactly. So the amount of provision is an estimated amount. 4. It must be created irrespective of whether 4. It cannot be created unless there is there is a profit or loss. In other words its a sufficient profit. Its creation is the creation is obligatory. discretion of management. In other words, it is not obligatory. 5. Profit or loss is effected by its creation 5. It does not effect profit or loss, profit decreases or loss increases. since it is created after ascertaining profit. 6. Dividend cannot be paid out of it. 6. Dividend can be paid out of it. 7. Its amount must be sufficient to meet the 7. Its amount is generally determined loss or liability. by management on the basis of the amount of profit earned. 8. It cannot increase working capital - it is 8. It increases working capital and utilized for meeting the specific loss or thereby strengthen the financial liability. position of the business concern. 9. The owner of the business cannot have 9. The owner can claim it, since it is any claim over it, since it is created for created out of profit. meeting a specific loss or liability. 10. It is shown on asset side of the balance 10. It is shown on liability side of the sheet as deduction from the concerned balance sheet as a separate item. asset, e.g., provision for doubtful debts is shown as deduction from sundry debtors. 11. It is used for the specific purpose for 11. It can be used for the purpose which is has been created. whatsoever. 12. Auditors must check its adequacy. 12. Auditors are not required to check adequacy. In spite of the above distinction between provision and reserve it may be noted that both of them are created out of the same source, i.e. revenue of the business. Again, if there be any surplus provision after meeting the liability or loss for which it was created, such surplus provision is as good as reserve. For example, a provision of $500 is created in this year for doubtful debts. But actual bad debts in the next year comes to $400 only leaving a surplus provision of $100 (500 - 400). This surplus will be credited to profit and loss account. In other words, it becomes payable to the owner of business like reserves.

2.

Definition of Provision in Accounting

In general words provision means system to complete any work . But accounting provides very technical definition of provision . In small business like shop , general store , there is no need to make any provision , so you will find minimum reference in

basic accounting books but from time to time business expands and reaches at corporate level . It needs to understand the real meaning of provision and what is its importance and how can it implement in business accounting . In very simple accounting term , " Provision is that action of business in which business organisation reserves his money for future losses for safeguarding business ." Now from this definition we get idea that it is the part of profit or money which we receive from sale or from debtors because money of sale , money of debtor and even money of other fixed asset which is saved and reserve for fulfilling losses due to bad debts , depreciation , income tax and other losses which we can not forecast . But for any loss we make different provision accounts like provision for doubtful debts , provision for depreciation , provision for income tax . Because in real sense this is the part of profit of shareholder which should be give to shareholders in the form of dividend but we did not give them due to security of business , so it must be shown in the liability side of business with that given % and should also provide footnote that this is provision and taken for "________" purposes .

Definition of Reserves
Reserves are accounting terms. In general, it is saving of money, but in accounting terminology , it has different meaning. According to accounting technician, Reserves are that funds which withdraw from general or special profit of business and keep it in safe pocket of company. This sum is used when any loss happens in business. " Accounting Experts always in favor to keep some money or retain some fund for future losses, because future is uncertain and for increasing working capital of business, accountant should retain some money out of total profit before distribution it to shareholders. It is shown in profit and loss appropriation account. Indian company lawhas fixed it and in other countries , their company laws fix it and from time to time change it due to changing business environment.