2013

Moez Chandani F-180

[FINANCIAL REPORTINGASSIGNMENT 1]

Reserves
Reserves are any part of stockholders' equity, except for basic share capital. Reserves are amounts that are retained in the business and not distributed to the owners. Stockholders' equity, except for basic share capital, is referred to as reserves. Reserves are retained in the business - they are not distributed to company owners.

These can be profits made by the business sometimes referred to as retained earnings and capital reserves which represent a perceived increase the value of some fixed assets such as land or buildings. There are two main types of reserves a) Capital Reserves b) Revenue Reserve

Capital Reserve
The reserve which is created out of the capital profit is known as capital reserve. Capital reserve is created out of the profit of some specific transactions of capital nature. It is not available for the distribution to shareholders as dividend. It is used to meet capital loss. Capital reserve is shown on the liabilities side of the balance sheet. Sometimes, it can be used to issue fully-paid bonus shares. It is a type of account on a municipality's or company's balance sheet that is reserved for long-term capital investment projects or any other large and anticipated expense(s) that will be incurred in the future. This type of reserve fund is set aside to ensure that the company or municipality has adequate funding to at least partially finance the project. A capital reserve may also be established by a company of any size, and be used for ongoing projects or as a means of preparing for some future project.

The main idea behind a capital reserve fund is to set aside assets that are outside the usual operating budget, and can be used to offset expenses with projects that must be funded at least partially outside the operating budget. For example, a municipality may want to build a new city hall. If funds are not set aside in the budget to begin preparation for this activity, then the proceeds from a capital reserve may be withdrawn to manage the costs of preparing a tract of land for the new building, creating blueprints, and in general preparing for the construction of the new facility. Depending on the amount of funds in the capital reserve fund, and the regulations that govern disbursements from that fund, it may be possible to finance the entire construction project using the reserve.

Companies can make use of a capital reserve in much the same manner. The reserve fund can be grown over a number of years, usually by transferring surplus profits generated from time to time into the fund. Should the business wish to expand, possibly by opening a new retail outlet or building a new production facility, the assets contained in the capital reserve can be utilized to launch these projects. Use of the reserves allows the business to manage the process without having to obtain outside financing, and thus eliminates the need to repay interest on loans or lines of credit in order to successfully complete the expansion project.

Any funds that are placed in a capital reserve must be accounted for in the financial records of the municipality or company. For municipalities, this means identifying the origin of any funds deposited into the reserves, including donated funds and funds obtained through government subsidies. Businesses also must accurately account for the origin of any assets assigned to the capital reserve. In many nations, laws govern how a capital reserve must be managed, and provide the basic framework for how a government entity or a business will structure and maintain the reserve, including how the funds are earmarked for specific types of capital expenses.

Items of capital profit out of which capital reserve is created: a) b) c) d) e) f) Profit on revaluation of assets and liabilities. Profit on sale of assets Profit on sale of shares and debentures Profit on forfeiture of shares Profit on redemption of debentures Profit on purchasing running business

Objectives and Advantages of Capital Reserve

The following are the objectives and advantages of capital reserves a) Capital reserve helps in making the organization financially strong. b) Capital reserve helps in writing off the capital losses arising from the sale of fixed assets, shares and debentures. c) Capital reserve helps in the issue of fully paid bonus shares to the existing shareholders.

Disadvantages of Capital Reserve

The following are the disadvantages of capital reserve

a) Capital reserve is not available for the distribution to shareholders. b) Capital reserve does not give any indication of operating efficiency of the business. c) Capital reserve does not help in making the management responsible to sale old assets at satisfactory price.

Revenue Reserve
A reserve which is created out of the revenue profit is called revenue reserve. Revenue profit is earned in the normal course of the business. Revenue reserve refers to the undistributed revenue profit. It is created for strengthening the financial position, replacing deprecialble assets, redeeming liabilities, declaring uniform rate of dividend and conducting research and development functions. If the reserve is not needed in the future, it can be distributed as dividend to the shareholders.

Categories of Revenue Reserve

General reserve
A reserve which is created out of the profit not for a specific purpose is known as general reserve. General reserve is used for general purpose as per the discretion of the management. Usually, general reserve is used for strengthening the financial position and meeting future contingencies and losses. In other words the general reserves are the retained earnings of a company which are kept aside out of companys profits to meet future known or unknown obligations. General reserves are the part of Profit and Loss Appropriation Account. In other words the general reserve is a free reserves which can be utilized for any purpose after fulfilling certain conditions. On the basis of above definitions general reserve may be utilized for following purposes:a) b) c) d) e) f) To settle any unknown future contingencies To increase the working capital To strengthen the financial position of the company To pay dividends to shareholders more than specified limits General reserves kept to offset some specific future losses. General reserves include the money kept aside for litigation or revaluation. General reserves are shown in liabilities side of balance sheet.

Specific Reserves

Dividend equalization fund

A fund maintained by organized, well managed and reputed companies to equalize the dividend in year to year. Well managed companies transfer some part of their profit to this fund to use in upcoming year to retain the reputation of company even in bad patch

Sinking fund A sinking fund is a fund established by a government agency or business for the purpose of reducing debt by repaying or purchasing outstanding loans and securities held against the entity. It helps keep the borrower liquid so it can repay the bondholder.

Dilapidation Reserve The lessee can make lease agreement with the lesser. As per terms of lease he may agree to re-decorate the asset after the lease agreement. The lessee can create reserve to meet the anticipated losses.

Insurance Reserve The large-scale business concern can create insurance reserve to cover the risk of loss. The fire or marine loss may be there so the business can set up an insurance reserve to face the risk of loss.

Difference between General and Specific Reserve

Both general and specific reserves are created out of profit earned in the normal course of business. Yet the following differences are observed between general and specific reserve.

General Reserve: a) General reserve is crated not for a specific purpose. It is created to strengthen the financial position of the business. b) It can be utilized for any purpose. c) Dividend can be paid out of it if needed. Specific Reserve: a) It is created for some specific purpose. For example, debenture sinking fund is created for the purpose of repaying loan on account of debenture.

b) It can be utilized only for the purpose for which it has been created. It cannot be utilized for other purposes. c) Dividend cannot be paid out of it. But on fulfillment of the objective for which a fund has been created the fund will no longer be required, when dividend may be paid out of it. For example, on repayment of loan on account of debenture the debenture sinking fund is not required. Then it is transferred to general reserve fund. In other words the fund money is distributable as dividend.

Government Regulations regarding Reserves and Surplus

According to the Reserve Bank of India, the following categories come under Reserves and Surplus a) Capital reserves: This comprises capital reserves, profit/loss on sale of fixed assets and/or investments, profits realised on purchase of companys own debentures, profits on re-issue of forfeited shares, surplus arising out of acquisition of subsidiary, capital redemption reserves, reserves arising out of revaluation of fixed assets and premium on shares. Premium on shares is shown separately from 1965-66 onwards. b) Investment allowance reserves: This item comprises all reserves set apart in terms of Income Tax Act, 1961 and is available from 1975-76 onwards. For the period prior to 197576, the figures relate to Development Rebate Reserves. c) Sinking funds: Funds created for redemption of debentures or other loans are included in this item. Prior to 1975-76, this item was included in 'Other reserves'. d) Other reserves: All reserves other than Capital Reserves, Investment Allowance Reserves and Sinking Funds are included under this head.