Reserves And Surplus Meaning Example Top 4 Types

Reserves and Surplus Meaning

Types of Reserves and Surplus on Balance Sheet

#1 – General Reserve

A general reserveGeneral ReserveGeneral reserve is the amount kept aside from the profit earned by the company during its normal course of the operation to meet future needs like contingencies, strengthening the company’s financial position, increasing working capital, paying dividends, offsetting specific future losses.read more is also known as a revenue reserveRevenue ReserveRevenue Reserve, also known as Retained Earnings, is a reserve type created out of profits that a business generates from its operating activities over a given period. It is used to expand the business operations or to handle contingencies in the long run. read more. The amount kept separately by an entity from its profits for future purposes is known as revenue reserves. It is simply the retained earnings of an entity kept aside from its profits for meeting certain or uncertain obligations.

#2 – Capital Reserve

Capital ReserveCapital ReserveCapital reserve is a reserve that is formed from the company’s profits earned from its non-operating activities during a period of time and is retained for the purpose of financing the company’s long-term projects or writing off its capital expenses in the future.read more refers to a part of the profit kept by an entity for a specific purpose, like financing long-term projects or writing off any capital expenses. This reserve is created from any capital profit of an entity that is earned from profit other than the company’s core operations.

#3 – Capital Redemption Reserve

Capital Redemption Reserve is created out of the undistributed profits that are general reserve or the Profit and loss accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization’s revenue and costs incurred during the financial period and is indicative of the company’s financial performance by showing whether the company made a profit or incurred losses during that period.read more on the redemption of preference shares or during buyback of own sharesBuyback Of Own SharesShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.read more to reduce the share capital.

#4 – Dividend Reserve

Dividend reserve is the amount kept in a separate account to ensure that a similar amount of the dividend is declared every year.

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Example of Reserves and Surplus

Let’s take the example of a Corporation named Computer Web Inc., which is doing the business of computers and laptops. The corporation’s earnings from its normal course of operation during the financial year 2017–18 were $ 500,000. It is decided by the management of the company to keep aside 8 % of the profits earned during the financial year for meeting future liabilities, i.e., General Reserve and the corporation has issued sharesIssued SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner’s equity on the Company’s balance sheet.read more for which they have received a premium amounting to $ 25,000.

Also, the amount in capital redemption reserve and dividend reserve amounted to $ 14,000 and $ 19,000, respectively, during the same period. So now we need to calculate the total amount of reserves and surplus, which is the sum of the general reserve, share premium accountShare Premium AccountShare premium is the difference between the issue price and the par value of the stock and is also known as securities premium. The shares are said to be issued at a premium when the issue price of the share is greater than its face value or par value. This premium is then credited to the share premium account of the company.read more, capital redemption reserve, and dividend reserve.

Solution:

Total Amount of Reserves and Surplus = $40,000 ($500,000 * 8%) +$25,000 +$14000 + $19,000 = $98,000

Advantages

Disadvantages

Suppose the company incurs the losses, which are adjusted/set off with the company’s reserves. In that case, this will somehow lead to the manipulation of accounts as the correct picture of the company’s profitability will not be shown to the users of the financial statementsUsers Of The Financial StatementsFinancial statements prepared by the Companies are used by different categories of individuals and corporates on the basis of their relevancy to the respective parties. The most common users to the financial statements are Management of the Company, Investors, Customers, Competitors, Government and Government Agencies, Employees, Investment Analysts, Lenders, Rating Agency and Suppliers.read more.The general reserves that constitute the major part of reserves and surplus are not created for any specific purpose. Still, the general use, so there are chances that there can be a misappropriation of funds accumulated in general reserves by the management of the company, and there is a possibility that the funds will not be used properly for business expansion.The Creation of more reserves may lead to a reduction in the distribution of dividends to the shareholders.

Important Points about Reserves and Surplus

The utilization of the reserves and surplus includes purposes such as dividend distribution, meeting future obligations, overcoming losses, managing working capital requirements, fulfilling funds requirements for business expansion, etc.It is required for the company to maintain reserves, sometimes in cash, to manage the reduction in revenues and slow-paying customers. Generally, the maintenance of cash reserves depends upon the company’s business type.

Conclusion

Reserve and surplus created by the company are the reserves that the company can utilize for the purpose according to nature or the type of such reserve and surplus. Generally, the company creates these reserves to settle any future contingencies. E.g., for strengthening and increasing the company’s financial position in the market, paying off the dividends to all the shareholders of the company, increasing working capital in the company, etc., after fulfilling all the conditions required for that reserve. Sometimes reserves and surplus are maintained in cash to manage the reduction in revenues and slow-paying customers.