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Types of Reserves

A reserve created by retention of profit of the business can be for either a general or a specific purpose.
  1. General reserve: When the purpose for which reserve is created is not specified, it is called General Reserve. It is also termed as free reserve because the management can freely utilise it for any purpose. General reserve strengthens the financial position of the business.
  2. Specific reserve: Specific reserve is the reserve created for some specific purpose and can be utilised only for that purpose.
Examples of specific reserves are given below:
  1. Dividend equalisation reserve: This reserve is created to stabilise or maintain dividend rate. In the year of high profit, amount is transferred to Dividend Equalisation reserve. In the year of low profit, this reserve amount is used to maintain the rate of dividend.
  2. Workmen compensation fund: It is created to provide for the claims of the workers due to accident, etc.
  3. Investment fluctuation fund: It is created to build up the decline in the value of investment due to market fluctuations.
  4. Debenture redemption reserve: It is created to provide funds for redemption of debentures.
Reserves are also classified as revenue and capital reserves according to the nature of the profit out of which they are created.
  1. Revenue reserves: Revenue reserves are created from revenue profits which arise out of the general business activities and are otherwise freely available for distribution as dividend.
Examples of revenue reserves are:
  • General reserve;
  • Workmen compensation fund;
  • Investment fluctuation fund;
  • Dividend equalisation reserve;
  • Debenture redemption reserve;
  1. Capital reserves: Capital reserves are created out of capital profits which do not arise from the normal business activities. Such reserves are not available for distribution as dividend.
These reserves can be used for writing off capital losses or issue of bonus shares in case of a company.

Examples of capital profits, which are treated as capital reserves,whether transferred as such or not, are:
  • Premium on issue of shares or debenture.
  • Profit on sale of fixed assets.
  • Profit on redemption of debentures.
  • Profit on revaluation of fixed asset & liabilities.
  • Profits prior to incorporation.
  • Profit on reissue of forfeited shares

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