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Difference Between Reserve and Provision

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

Reserves Provisions
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

  1. Capital Reserve
  2. 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.

Reserve and Provision