Account 6 Marks Question

Difference between Reserve and provision:

	Basis	Reserve	Provision
1.	Nature	It is an appropriation of profit.	It is a charge against Profit.
2.	Purpose	It is created to strengthen the financial position and to meet unforeseen liability or losses.	It is made to meet known liability or contingency, when amount is not determind.
3.	Effect on profit	It is debited to the profit and Loss Appropriation Account. Hence, Profit is not affected.	It is debited to the profit and Loss Account. Hence, profit is reduced.
4.	Investment	It may be invested outside the business.	It is not invested.
5.	Distribution	Unutilised part can be distributed as dividend. It reduces divisible profit.	It cannot be used for distribution as profit/ dividend. It reduces net profits.
6.	Compulsion/ Prudence	It is created out of profits as a matter of prudence and due to legal requirements.	It is made because of accounting principles (prudence).
7.	Presentation	A reserve is shown on the liabilities side of Balance Sheet under the head 'Reserves and Surplus'.	It is shown either as a liability under the head 'Current Liabilities' or as deduction from the asset.

“A Provision is the amount written off or retained by way of providing depreciation, renewals or diminution in the value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy."Importance of Provision:

1. Provision is an amount set aside out of current earnings considered necessary to provide for all losses that are expected to arise out of transactions entered into, during the accounting period.
2. Provision is made to retain future operating performance undisturbed by losses arising out of transactions of prior periods.
3. Provision is made following the Prudence Concept of accounting which holds “provide for all anticipated expenses and losses but do not provide for anticipated incomes." By making a provision, a part of the profits and corresponding assets are retained, which otherwise could have been distributed as profits.
4. Any loss or depletion in the value of an asset or any liability as may not have been provided against income or profit would effectively erode the capital of a business. Creation of Provisions is an attempt to maintain the capital of business intact.