Unit-4 Reserve and Provision Business Accounting | BBA First Year

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Reserve and Provision

• A reserve is an appropriation of profits for a specific purpose. The most common reserve is a capital reserve, where funds are set aside to purchase fixed assets. By setting aside a reserve, the board of directors is segregating funds from the general operating usage of a company.
• There is no actual need for a reserve, since there are rarely any legal restrictions on the use of funds that have been “reserved.” Instead, management simply makes note of its future cash needs, and budgets for them appropriately. Thus, a reserve may be referred to in the financial statements, but not even be recorded within a separate account in the accounting system.
• A provision is the amount of an expense or reduction in the value of an asset that an entity elects to recognize now in its accounting system, before it has precise information about the exact amount of the expense or asset reduction. For example, an entity routinely records provisions for bad debts, sales allowances, and inventory obsolescence. Less common provisions are for severance payments, asset impairments, and reorganization costs.
• In short, reserve is the appropriation of profits for a specific purpose, while provision is a charge for anticipated expenditure.
  

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Provision

• Provision means setting aside a particular amount of money to cover anticipated liabilities arising from past events. It is the recognition of an expected liability that will result in an outflow of cash from the business. To provide this the amount of the liability should be easily estimated by the entity.
• Recognition is to be provided for a known liability or decline in the value of assets over time or for a disputed claim that is more likely than not to occur.
• If provision is made in excess of the required amount, it should be written back to the profit and loss account after the liability has been paid.
  

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Example:

• Provision for bad debts
• provision for depreciation
• Provision for tax

Store

• Reserves are a portion of retained earnings that are set aside for any future use. It is considered a part of the shareholder’s funds. The amount appropriated in the name of the Reserve Fund may be used for any of the following purposes:
• To purchase a property in the future.
• Paying consistent dividends to shareholders year after year.
• To deal with unexpected contingencies.

Reserves are mainly divided into the following categories:

1. Capital reserve
2. Revenue Reserve

• General Reserve
• specific reserve

Preparing Final Accounts With Adjustments

• The reporting information will not be accurate unless we take into account adjusting entries. Treatment of various general adjustments like closing stock, outstanding expenses, earned income, prepaid expenses, income received in advance, bad debts, reserve for bad and doubtful debts, reserve for discount on debtors, reserve for discount on creditors, Interest on capital, interest on withdrawals, depreciation etc. whose knowledge should be used while preparing final accounts.

Special item adjustment:

1. Goods delivered as free samples

• To promote a product, free samples are provided to experts in the field. For example, free samples of books to professors, free samples of medicine to doctors.

Therefore the adjustment entry is as follows:

The net effect will be a reduction in purchases and a charge to the profit and loss account in the form of promotional expenses.

2. Goods sold on the basis of sale or approval

• Goods are sold on the basis of endorsements, sometimes based on quality, to gain customer confidence. If the customer approves it, it becomes a sale. If the customer does not accept it, the sale is not complete and hence cannot be treated as a sale. Suppose at the end of the financial year some goods are sent on approval basis with the customers, then it is required to pass necessary entries for adjustment.

The adjusting entries are as follows:

The treatment is as follows:

• On the credit side of the trading account as a deduction from sales at selling price and as an addition to closing stock at cost price.
• Total stock shown as deduction from sundry debtors on the asset side and at cost value (closing stock at cost + stock with customers on approval) on the asset side of the balance sheet.

3. Goods Sent On Consignment

• Since consignment transaction is not a sales transaction, it does not directly affect the business and profit and loss accounts. A separate consignment account is opened and the goods sent on consignment are debited from the consignment account. When account sale is received, it is treated as consignment sale and is credited to the consignment account and debited to the consignment account.
• Any consignment stock remaining with the consignee will be credited to the consignment account and profit on consignment will be ascertained after charging consignment expenses, consignee’s commission etc. However, closing stock of consignment will be shown on the assets side of the balance sheet and profit will be shown on the balance sheet. The consignment is credited to the Profit and Loss Account (if there is a loss on the consignment the entry will be reversed).

The transfer entry for profit or loss on consignment is as follows:

4. Loss of stock by fire

• If the stock is destroyed by fire, the loss arising under the following three possible situations will be considered separately:
• If the stock is not insured: the full value of the stock destroyed by fire shall be treated as a loss, with an entry made as follows:

• If the stock is fully insured: When the stock What is fully insured is destroyed Enterprise has a claim on insurance To compensate for the loss suffered by the company Due to destruction of goods by fire. Therefore, the claim is given priority

• In fact, the claim on the insurance company is treated as ‘debtor’ and is shown in the balance sheet asset side due to the insurance company.
• If the insurance company settles the dues, the entry will be as follows:

• In fact, the cash/bank balance in the balance sheet will increase to the extent of claims settled and hence, the insurance company’s account will not be reflected in the balance sheet.
• If the stock is partly insured – In this case the total value of the stock destroyed is credited to the trading account, and that part of the claim to be settled by the insurance company is debited from the account of the insurance company and The difference between the stock being destroyed and the insurance claim accepted is debited to the profit and loss account as a loss. The entry is as follows:

5. Deferred Income Expenses

• Heavy expenditure of revenue nature incurred in the initial stages of a business enterprise with the confidence of deriving profits from such expenditure during subsequent years is treated as deferred revenue expenditure, provided that the charge of such expenses is spread over a number of years. During which profit has been received. Hope to receive.
•  Then, each year one-tenth of that expenditure is invested in revenue over a period of ten years. The problem here is that the expenditure which is not included in the revenue is capitalized and shown as a fictitious asset on the balance sheet.
• Suppose, an advertising expenditure of Rs 2,00,000 is capable of giving profit over a period of five years. Then, one-fifth of Rs 2,00,000, i.e. Rs 40,000 is taken to revenue in the first year and the remaining Rs 1,60,000 is shown as notional asset. In the second year, revenue of Rs 40,000 is realized and the remaining Rs 1,20,000 is shown as notional asset. This process continues for five years until the entire expense is waived off. The entries to be passed during the first year are as follows:

6. Creation of reserve fund

• To strengthen the financial position of the enterprise, a part of the net profit may be transferred to the reserve fund account through appropriation. The entry for creating the reserve fund is as follows:

7. Manager’s commission

• Business enterprises sometimes provide profit commissions to managers as an incentive to motivate individuals to increase business profits. Commission is given as a percentage on the price profit. There are two ways of offering this percentage on net profit.
• The percentage of commission on the net profits before charging such commission.
• The percentage of commission on the net profit after charging such commission.