Reserve is created to meet an unknown liability. It is an appropriation of profit. It may be invested outside the business. Reserve is divided into Revenue Reserve & Capital Reserve. Further Revenue Reserve is divided into General & Specific Reserve.
How are Revenue & Capital reserve different?
REVENUE RESERVE- It is created out of business profit which have been earned during the day-to day business operations. It represents undistributed profits and it can be used for distribution of dividends without any precondition.
GENERAL RESERVE– A businessmen do not withdraw the entire profits from the business but retain a part of it in the business to meet unforeseen future uncertainties. Profits so retained in the business for the future are known as General Reserve. Similarly, companies also do not distribute the entire profit as dividend but keep aside a part of it in the form of general reserve. Such reserves are termed as Contingency Reserves or Free Reserves because these are not created for any specific purpose and can be freely used for any purpose.
SPECIFIC RESERVE– It is created for a specific purpose and can be utilized only for that specific purpose. Dividend equalization reserve, Workmen compensation fund, Investment Fluctuation fund, Reserve for replacement of asset, Debenture redemption reserve & Capital Redemption Reserve are the example of specific reserve.
CAPITAL RESERVE– Capital profits are also earned along with the normal business profits from many other sources of the business. The reserve created out of such capital profit are known as capital reserve. Generally, Such reserves are not available for distribution as dividend among the shareholders of a company. Profit on sale of fixed assets, profit on revaluation of fixed assets and liabilities, Securities Premium received on issue of share or debentures, Profit on acquisition of business, Profit prior to incorporation of a company, Profit from the reissue of forfeited shares, Profit on redemption of debentures are the example of capital reserve.