What are Provisions?

What are Provisions?

Provisions are the present obligation (probability of occurrence is more than 51%) arising out of past events. Provision can be made by retaining the amount by way of providing for any known liability, the amount of which can not be determined accurately. It is a liability that can be measured only by using a substantial degree of estimation. It is an amount kept aside to cover the expenses that may occur in the future....

What are Reserves?

Reserves are the amount kept aside from a company’s profits for specific purposes or unknown liability in the future, like buying a fixed asset, repayment of debentures, payment of dividends, etc., and also for general purposes as General Reserve. It is an appropriation of profit, and not a charge against profit. Reserves are a part of the owner’s capital/shareholder’s fund, and hence profit is not reduced by making any reserve....

Difference between Provisions and Reserves

Basis Provisions Reserves Meaning The portion set aside for meeting known liabilities or expenses whose probability is certain. The portion set aside from the company’s profits to meet an unforeseen business event. Nature It is a charge against profits, which means that they are created even if there is no profit. It is an appropriation of profits, which means that they are only created when the company is profitable. Objective Provisions are always made for a defined liability or expense. Reserves may or may not be made for a defined purpose. Example- Debenture Redemption reserve/General reserve. Purpose Provisions are created to meet a specific liability and fulfill the requirement of the law. Reserves are made to give strength to the financial position of the company.  Mode of Creation It is created by debiting Profit and Loss Account. It is created by debiting Profit and Loss Appropriation Account. Necessity It is mandatory to create provisions as per various laws. It is not mandatory to create reserves. They are only created when the company has surplus profits. Payment of Dividend Dividends cannot be paid from provisions.  Dividends can be declared and paid from reserves to the shareholders. Presentation in Balance Sheet They are always shown on the liabilities side as a current liability or reduced from the concerned asset for which it is made. Reserves are shown under the head of ‘Reserve and Surplus’ as the Owner’s Capital/Shareholders’ Fund on the liability side of the balance sheet. Investment The amount of provision can never be invested outside the business. The amount of reserve can be invested outside the business, as in case of Debenture Redemption Reserve Investment Utilisation Provisions can only be used for the specific purpose for which they are created. Reserves can be used to meet any unknown loss or liability....