A part of the profit may be set aside and retained in the business to provide for certain future needs like growth and expansion or to meet future contingency such as workmen compensation. Unlike provisions, reserves are the appropriations of profit to reinforce the financial position of the business. Reserve is not a charge against profit as it is not meant to cover any known liability or expected loss in future.
On the other hand, retention of profits in the form of reserves reduces the amount of profits available for distribution among the owners of the business. It is shown under the head Reserves and Surpluses on the liabilities side of the balance sheet after capital.
Examples of reserves are
- General reserve;
- Workmen compensation fund;
- Investment fluctuation fund;
- Capital reserve;
- Dividend equalisation reserve;
- Reserve for redemption of debenture.