Reserves - Meaning, Types and Credit Purchase

Reserves - Meaning, Types and Credit Purchase

Reserves: 

Reserves are accounting terms. In general, it is saving of money, but in accounting terminology , it has different meaning.

According to accounting technician, “ Reserves are that funds which withdraw from general or special profit of business and keep it in safe pocket of company. This sum is used when any loss happens in business."

Accounting Experts always in favor to keep some money or retain some fund for future losses, because future is uncertain and for increasing working capital of business, accountant should retain some money out of total profit before distribution it to shareholders. It is shown in profit and loss appropriation account. Indian company law has fixed it and in other countries , their company laws fix it and from time to time change it due to changing businessenvironment.

Types of Reserves

There are two main types of reserves which I am explaining with following way:

1. Open reserves

Open reserves may be defined all reserves which shows in the balance sheet. Every person or public can know such reserves of company. Those reserves provide full information to shareholders about which amount has gone to reserves or why they are not getting all amount of dividend. This type can also divide in sub parts:

a) Capital reserves

Capital reserves are main type of open reserves. It is not created out of profit of company. This reserve is not used for distributing the dividend to shareholders of company.

The main sources of these reserves are following:

• Profit earned prior to incorporation

• Premium on the issue of shares and debentures.

• Profit on reissue of forfeited shares

• Profit set aside for the purpose of redemption of preference shares.

• Profit on sale of undertaking or part of it.

• Surplus on revaluation of assets and liabilities.

b) Revenue reserves

Revenue reserves are that part of open reserves which are created out of profit of company. It is showed in profit and

loss appropriation account .It can be used for dividend to shareholders.

There are following benefits of revenue reserves:

• Extension of business

• Set off unknown losses of business.

• Used to create strength in the financial position of business.

• To make stability in the dividend rate.

These revenue reserves can also divide into two parts:

i. General reserves

ii. Specific reserves = Specific reserves includes dividend equalization reserve, debenture redemption reserve , staff reserve. Investment fluctuation reserve, taxation reserve and contingency reserves.

 

2. Secret Reserves

Secret reserves may be defined as that type of reserves which is not shown in final account of company. Means it has neither been shown in profit and loss appropriation account nor in balance sheet. These reserves can easy created by showing less value of assets and more value of liabilities in balance sheet. If a company has created such secret reserves for the benefits of company, it will be surely strong his financial position.

These secrete reserves can be created by following ways:

• Showing heavy depreciation value

• Showing the less value of goodwill and closing stock of business.

• Secrete of sale value of business.

• Showing heavy liabilities which is not of company.

• Showing capital expenses as revenue expenses.

• Grouping of free reserves with creditors.

Current asset not shown in balance sheet.

Calculation the Credit Purchase

1. Write creditor account on any excel sheet with making two sides one side is debit and other side is credit.

2. Write your business's creditors opening balance in credit side with giving by balance b/d name.

3. Write the amount that you have given to your creditors in the current year in the debit side of creditor account.

4. Write closing balance of your creditors in the end of this year ( this amount shows unpaid amount which is payable to your creditor at the end of this year ) in the debit side of this account

5. You will see that debit side is more than credit side of this account , the difference will be credit purchase and it should be written in the credit side of this account

6. Now you are seeing your credit purchase.

This credit purchase is very necessary when you will calculate the net consumption of your stock because for calculating net consumption for stock , we always add purchase in the opening stock and deduct closing stock . This net consumption will show in profit and loss account or income and expenditure account .

Difference between Revenue and Capital items

Revenue item

If any item of business which does not create any asset of business that type of items are called revenue items, suppose we pay rent but rent can not create any fixed asset so this is revenue item and it must show in profit and loss account , but if we have a special fund for building , this fund create long term asset up to that period this will show as fixed liabilities . This is not revenue item .

There is also major difference is that revenue items benefit is related to current year but capital items' benefits are related more than one year. If advertisement's expense is 100 Rupees and its benefit can only related to current year then this is revenue item .

But if we expand Rs. 9000000 lakh on advertisement and its estimated benefit is for 10 years then this will be the capital item.

All revenue item will show in profit and loss account

And all capital items will shown in balance sheet or financial statement .

Capital loss

Capital loss may be defined as the loss relating to sale of any fixed asset or any other financial loss like premium given on repayment of debentures or bonds, or discount on issue of shares and debentures. Capital loss may explain with many other examples:

Ist Example

Suppose, if any machine’s book value is $ 50000 and sell it on $ 40000 and $ 10000 is loss on sale of machinery, this is called capital loss.

2nd Example

Suppose, if a company has 100 debentures of other company and each debenture is of $ 100 but these debentures are sold at $ 80 per debenture, so company is getting loss on sale of debenture of $ 2000. This is capital loss in profit and loss account of company, we can not show any capital loss. In other words these losses can not be debited in Profit and loss account of company. These all losses will show in assets side of balance sheet of company. After this, it is written off by dividing number of fixed years and transferring to profit and loss account. If you know what is mean of written off , then , I can also explain it , written off means that part of any expenses or loss which is transferred from balance sheet to profit and loss account for closing the account of loss or expenses , specially capital losses .

Revenue losses

Revenue losses include all losses which happen due to operating any business activity. It includes cash discount on sale, depreciation, loss due to falling of market prices. So, these losses will show in the debit side of profit and loss account of company. It is deemed that when we start the different activities of our business , many losses are happen , so it should be closed by transferring all these losses to profit and loss account .

Feature of revenue expenditures

There are following main features or characteristics of revenue expenditures . These features are very useful for your decision to adding any expenses in profit and loss account:

1. General operating expenses

Any expenses which is related general operation of business that all expenses will be revenue expenditures and will be debited in profit and loss account

2. Expenses related to short period

These type of expenses are related to short period, means benefit of these expenses is less than one year.

3. Expenses for maintaining the stability of fixed assets

These expenses’ main feature is that these expenses is useful for maintaining the stability or efficiency of fixed assets.

4. Recurring Nature

One of most important feature of these expenses that these expenses are recurring nature. In other words these expenses happen Again and again in general business activities. For example , expenses for giving refreshment is revenue expenditure because almost daily, these type of expenses is paid by company.

5. Helpful for maintaining the profit of business

These type of expenditure is useful for maintaining the profit of business , but also above features should include in the expenses which I have mentioned in above points because capital expenditure will also helpful for maintaining the

profit and you will then confused revenue and capital expenditure’s difference .

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