Classwork Series and Exercises {Financial Accounting – SS2}: Reserves and Provisions

Financial Accounting, SS 2, Week 5

Topic: Reserves and Provisions

Contents:

• Meaning of Reserves
• Types of Reserves
• Division of reserves

Meaning of Reserves

Reserves are the amount set aside out of the profit of the business in order to improve the standard of business.they are not designed to meet with any liabilities or losses but they are retained in the business.

Types of Reserves

1. Share premium
2. Capital redemption
3. Revaluation surplus

 Division of Reserves

1. Capital reserves: These are the reserves which are not available for distribution as dividend.such as
   1. Share premium
   2. Pre-incorporation profit
   3. Profit on forfeiture shares
   4. Capital redemption of asset
2. Revenue reserve: These are part of the profit that are available for distribution through profit and loss account.it can be divided into general reserves and specific reserves.

Provisions : These are money set aside out of profit to provide for depreciation ,renewals,diminishing in the value of asset of which the amount cannot be determined with substantial accuracy. examples of provisions are

• Provisions for depreciation
• Provisions for doubtful debt
• Provisions for discount allowance.

Differences between provisions and reserves

• Reserves are set aside to strengthen the financial position of the organization while provisions are set aside for a specific purpose.
• Reserves are not used to meet any liabilities while provisions are met for liabilities
• Reserves ate treated in the appropriation account while provisions are treated in profit and loss account.
• It forms part of the companies proprietorship while provision is a diminish to proprietorship

Provisions for bad debt

Bad debt is the term used to describe a fund due to the organization but cannot be recovered due to certain factors, it is also known as irrecoverable debt.

Bad debt it Is an estimated expenses for bad debt it cannot be calculated with substance accuracy it is a charge against the profit.

It should be noted that where you have bad debt and provision for bad debt,the two will be deducted from the profit in the profit and loss account while only the provision for bad debt will in the balance sheet

Reasons for bad debt

1. Death of the debtor
2. Bankruptcy of the debtor
3. Liquidation of the debtor company
4. Relocation or absconding of the debtor.

Accounting entries in treating provisions for bad debt

1. Bad debt account
2. Profit and loss account
3. Balance sheet

Differences between provisions for bad debt and bad debt

Bad debt are the debt which cannot be recovered from the debtors which may come as a result of inability of the customer to pay his debt ,while provision for bad debt or doubtful debt is an estimated expenses for bad debt it cannot be calculated with substantial accuracy.

Account entries involved are:

1. Journal
2. Ledger account
3. Profit and loss account
4. Balance sheet

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