Provisions and Reserves in Corporate Finance

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What is the primary difference between provisions and reserves?

Provisions cover known losses and liabilities, while reserves cover future unknown losses.

When are provisions and reserves generally not tax-deductible?

Until the costs are actually incurred.

What type of expenses is incurred when there is a commitment or duty to pay the real expenditure?

An expense

What is the purpose of reserves in corporate financial statements?

To address unforeseen future liabilities that may develop due to various business causes.

What distinguishes certain reserves from provisions?

Certain reserves are created for specific purposes, while provisions are usually specific.

What can reserves be used for?

For specific purposes only

What is the purpose of a provision in accounting?

To record a cost or reduction in the value of an asset before the exact amount is known

What is the purpose of a general reserve according to the text?

Resource conservation and saving for unanticipated losses

What is the purpose of specific reserves as mentioned in the text?

To set aside money for a specific purpose and cannot be utilized for anything else

What is the main purpose of establishing a provision for taxation?

To cover the income tax payable in the current year

Why do most firms establish a provision for debtor discounts?

To accommodate early payers by granting a set amount of discount on their bills

What is the goal of establishing depreciation provisions?

To represent the true worth of an entity’s fixed assets on the balance sheet

What distinguishes reserves from provisions according to the text?

Reserves are deducted from the Profit and Loss account, whereas provisions are not

What do specific reserves enable organizations to do?

Put aside money for a specific purpose and cannot be utilized for anything else

Study Notes

Provisions and Reserves

  • Provisions are liabilities that are uncertain in timing or amount, while reserves are appropriations of profits.
  • Provisions and reserves are generally not tax-deductible, except for specific provisions like bad debts and stock obsolescence.

Purpose of Provisions and Reserves

  • The purpose of provisions is to account for potential future expenses or losses, such as warranties, lawsuits, and potential debts.
  • The purpose of reserves is to set aside a portion of profits for future use, such as expansion, modernization, or distribution to shareholders.

Characteristics of Provisions and Reserves

  • Provisions are typically made when there is a commitment or duty to pay a real expenditure, such as a legal obligation.
  • Specific reserves are used for a specific purpose, such as a dividend equalization reserve, while a general reserve is a nonspecific reserve used for general business purposes.

Accounting for Provisions and Reserves

  • The purpose of a provision in accounting is to match the cost of a potential future expense with the revenue earned in the current period.
  • The main purpose of establishing a provision for taxation is to account for potential taxes owed in the future.

Firm Practices

  • Most firms establish a provision for debtor discounts to account for potential discounts on outstanding debts.
  • The goal of establishing depreciation provisions is to account for the gradual decline in value of assets over time.

Explore the concept of provisions and reserves in corporate financial statements, their purpose, and their impact on a company's net assets and equity. Understand the differences between provisions and reserves and their tax implications.

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