Difference between Reserve and Provision
The following are the differences between reserves and provisions:
- Basic nature: A provision is a charge against profit while reserve is an appropriation of profit. Therefore, net profit cannot be calculated unless all provisions have been debited to profit and loss account, while a reserve is created after the calculation of net profit.
- Purpose: Provision is made for a known liability or expense pertaining to current accounting period, the amount of which is not certain. But the reserve is created for strengthening the financial position of the business. Some reserves are also mandatory under the law.
- Presentation in balance sheet: Provision is shown either:
- By way of deduction from the item on the asset side for which it is created, or
- On the liabilities side along with current liabilities.
On the other hand, reserve is shown on the liabilities side after capital.
- Effect on taxable profits: Provision is deducted before calculating taxable profits. Hence, it reduces taxable profits. A reserve is created from profit after tax and therefore it has no effect on taxable profit.
- Element of compulsion: Creation of provision is necessary to find out the true and fair profit or loss in compliance with 'Prudence' or 'Conservatism' concept. It has to be made even if there are no profits. But, creation of a reserve is generally at the discretion of the management. Though, in certain cases law has stipulated for the creation of specific reserves such as Debenture Redemption Reserve. Reserve cannot be created unless there are profits.
- Use for the payment of dividend: Provision cannot be used for distribution as dividends while general reserve can be used for dividend distribution.
Basis of Difference
1. Basic nature
4.Presentations in Balance sheet
Charge against profit.
It is created for a known liability or expense pertaining to current accounting period, the amount of which is not certain.
It reduces taxable profits.
Appropriation of profit.
It is made for strengthening the financial position of the business. Some reserves are also mandatory under law.
It has no effect on taxable profit.
'Debenture' 'Redemption' reserves.
It can be used for divided distribution.
Fig. 7.4: Showing comparison between provisions and reserves