Reserve accounting is the calculation, use, and accounting of reserves, which include capital and income reserves. Reserves are any portion of shareholders’ equity except basic share capital and are used to keep a business going during tough times. Provisions are not included in reserve accounting, and reserves should be saved for a rainy day.
In finance, reserve accounting refers to how reserves are calculated, used, and most importantly, accounted for. There are several types of accounts maintained by a company or business, such as the cash account and the expense account. Similarly, there is also an reserve account with its own ledger and balance. The word “reserve” actually refers to any portion of shareholders’ equity with the exception of their basic share capital. Owner’s equity, also called shareholder funds or owner’s equity, refers to the remaining interest in the company’s assets after all liabilities have been paid. This interest is often properly divided among all shareholders.
Another way to understand the reserve is the profit obtained from interest. A company’s reserve can re-enter the business to keep it going, especially in tough times. In the past, reserve was used interchangeably with another accounting term, “provision.” But this use has now been discontinued. Reserve accounting does not include provisions, which now refer to amounts provided for depreciation losses, known liabilities, and contingencies. Other provisions that are also not within the scope of reserve accounting are provisions for retirement, severance, and reorganization benefits.
Items included in reserve accounting include capital reserves created from company earnings, retained earnings, and shareholder contributions. Shareholder contributions typically come in the form of share bonuses, surplus payments from shareholders that exceed the par values of their shares, and statutory reserve funds that are required in various legislations. Meanwhile, reserves created for profit often come from compensation and translation reserves and also legal reserve funds.
A simple way to distinguish between provisions and reserves is that the company must “provide” the former, as the word suggests, because they are necessary expenses that ensure the survival of the company. Meanwhile, reserves are like extras or surpluses of retained earnings and earnings. However, it does not mean that reserves can be spent freely. In business, it is dictated that reserves be saved for a rainy day.
In reserve accounting, two types of reserves are considered. These are capital reserves and income reserves. Capital reserves are those that arise from earnings but cannot be distributed to shareholders or employees like cash bonuses or dividends. There are many types of capital reserves; Some examples are stock premiums, legal reserves, and foreign exchange reserves.
Meanwhile, examples of income reserves are general reserves and retained earnings. Unlike capital reserves, they can be distributed as cash shares or bonds. Again, prudence dictates that just because they can be distributed, it doesn’t mean that all revenue pools should be given away. Some portion is always reserved for other purposes.
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