Reserve and Provision are two common terms often discussed in business. Both these terms are important for maintaining the integrity of a business.
Difference Between Reserve and Provision
|1. Reserves are made to strengthen the financial position of a business and meet unknown liabilities & losses.||1. Provisions are made to meet specific liability or contingency, e.g. a provision for doubtful debts.|
|2. Reserve is only made when the business is profitable.||2. Provisions are made irrespective of profits earned or losses incurred by a business.|
|3. They can be used to distribute dividends to shareholders.||3. They cannot be used to distribute dividends as they are made for a specific liability.|
|4. They are made by debiting P&L Appropriation Account.||4. They are made by debiting P&L accounts.|
|5. It is not mandatory to create reserves for the business, it is mainly done for prudence.||5. It is mandatory to create provisions as per various laws.|
|6. Reserves are shown on the liability side of a balance sheet.||6. Provisions are either shown on the liability side of a balance sheet or as a deduction from the concerned asset.|
|7. It may be used for investment outside the business.||7. It can not be used for investment purposes.|
Meaning of Reserve
Reserve is the term that refers to a sum or percentage of profit that a company retains or keeps aside at the end of a financial year towards meeting future contingencies that may occur. It helps to strengthen the business. Stabilizes the financial position of a company by being used for expansion of assets, dividend payments, and investments.
There are two types of reserves in an organization
- Capital Reserve
- Revenue Reserve
Meaning of Provision
The provision refers to an amount that is kept aside from a company’s profit to cover probable expenses arising in the future or a possible reduction in the value of an asset. Provisions are important for a business as they address certain expenses in business and payments made for them.