Provisions and Reserves PDF

PROVISIONS AND RESERVES · Meaning of Provision Provision are fund set aside to cover a probable future expenses or reduction in the value of an asset. Examples; Accurals, Assets impairment, Bad debt, Depriciation, Doubtful debts, Guarantees ( Product warranties ), Income taxes, Inventory obsolesc...

PROVISIONS AND RESERVES · Meaning of Provision Provision are fund set aside to cover a probable future expenses or reduction in the value of an asset. Examples; Accurals, Assets impairment, Bad debt, Depriciation, Doubtful debts, Guarantees ( Product warranties ), Income taxes, Inventory obsolescence, Pension, Restructing liabilities and Sales allowances. · Features of Reserves 1. Provisions are made for future events or situations. 2. Provisions are made for uncertain events or outcomes. 3. Provision often represent a liability or potential liability. 4. Provision can result in an expense or reduction in assets.  5. Provision are recognized in financial statement in accordance with acconting standards. 6. Provisions often involve estimation and judgment. 7. Provisins are reviewed and updated reguralarly to reflect changing circumstances. 8. Provisions are made for specific events or situations. 9. Provisions are material in amount and impact on financial statements. 10. Provisions are disclose in financial statements and notes. · Provisions can be classified into various types, including: 11. Provisions for bad debts 12. Provisions for warranties 13. Provisions for legal claims 14. Provisions for restructuring 15. Provisions for environmental liabilities 16. Provisions for taxation These features and types of provisions help ensure that companies account for potential future liabilities and expenses in a transparent and consistent maner. · Objectives of Provisions. 17. Provisions help match costs with revenues in the same accounting period. 18. Provisions recognize potential liabilities that may arise in the future. 19. Provision provide for uncertain events or outcomes that may impact the business. 20. Provisions ensure transparency in financial reporting by disclosing potential liabilities. 21. Provisions facilitate better decision-making by providing a more accurate picture of a company's financial position. · Importance of Provisions 22. Provisions ensure accurate financial reporting by recognizing potential liabilities. 23. Provisions help manage risks by providing for potential losses or liabilities.  24. Provisions ensure compliance with accounting standards and regulatory requirenments. 25. Provisions promote stakeholder confidence by demonstrating a company's commitment to transparency and accountability. 26. Provisions facilitate business planning by providing a more accurate picture of a company's financial position and potential liabilities. 27. Provisions help manage cash flows by providing for potential expenses or liabilities. 28. Provisions reduce surprises by providing for potential liabilities or losses. By recognizing provisions, business can ensure accurate financial reporting, manage risks, and promote stakeholder confidence. · Meaning of Reserves Reserves are created by allocating a portion of a company's net income to a reserve account, rather than paying it out as dividends. This means that the funds are retained within the business and can be used for various purposes, such as: 29. Future investment 30. Expansion or growth 31. Paying off debts 32. Meeting unexpected expenses or losses 33. Smothing out dividend payments · Reserves can be classified into different types, including: 34. Revenue resrves: Created from revenue profits. 35. Capital reserves: Created from capital profits, such as the sales of assets. 36. General reserve: A broad reserve for unspecified purpose. 37. Specific reserve: A reserve for a specific purpose, such as reserve for a specific purpose, such as a reserve for tax liabilities. · Reserves are important because they: 38. Providing a cushion against unexpected losses or expenses. 39. Allow companies to invest in growth  apportunities. 40. Enable companies to maintain a stable dividend policy. 41. Demonstrate a company's financial strenght and stability. · Note that reserve are different from provisions, which are set aside for specific liabilities or expenses. · Capital Reserve: A capital reserve is a type of reserve that represents accumulated profits or gains made by a company from non-operating activities, such as: 42. Sale of fixed assets 43. Investments 44. Foreign exchange gains 45. Revalution of assets 46. Capital contribution Capital reserves are created when a company retains these gains and does not distribute them as dividends to shareholders. Instead, they are transferred to a reserve account and can be used for various purposes, such as: 47. Financial new projects or investments 48. Paying off long-term debts 49. Enhancing the company's capital base 50. Meeting future capital requirements · Characteristics of capital reserves: 51. Created from non-operating activities 52. Represent accumulated profits or gains 53. Not available for dividend distribution 54. Can be used for long-term financial needs 55. Typically reported in the equity section of the balance sheet · Examples of capital reserves include: 56. Share premium reserve (created when shares are issued at a premium) 57. Capital redemption reserve (created when a company redeems its own shares) 58. Revalution reserve (created when assets  are revalued upwards) 59. Foreign currency translation reserve (created from freign exchange gains or losses) Capital reserves are important because they provide a source of long-term financing for companies and can help to strengthen their financial position. · Revenue Rserves: Revenue reserves are created when a company retains a portion of its net income or profit, rather than paying it out as dividends. This means that the funds are retained within the business and can be used for various purposes, such as: 60. Financing working capital requirements 61. Investing in new projects or expansion 62. Paying off short-term debts 63. Enhancing the company's liquidity position 64. Meeting unexpected expenses or losses · Characteristics of revenue reserves: 65. Created from operating activities 66. Represent accumulated profits or earnings 67. Available for dividend distribution 68. Can be used for short-term financing needs 69. Typically reported in the equity section of the balance sheet · Examples of revenue reserves include: 70. Retained earnings (accumulated profits reinvested in the business) 71. General reserve (a broad reserve for unspecified purpose) 72. Dividend equalization reserve (created to smooth out dividend payments) 73. Contingency reserve (created for unexpected expenses or losses) · Revenue reserves are important because they: 74. Provide a source of internal financing for companies  75. Allow companies to invest in growth opportunities 76. Enhance a company's liquidity position 77. Demonstrate a company's financial strenght and stability · Note that revenue reserves are different from capital reserves, which are created from non- operating activities, such as the sale of fixed assets or investments. · Secret Reserves: Secret reserves refer to hidden or undisclosed reserves that are not reported in a company's financial statements. These reserves are not publicaly disclosed and are kept confidential within the organization. · Secret reserves can take many forms, including: 78. Undisclosed profits: Profits that are not reported in the financial statements. 79. Hidden assets: Assets that are not disclosed in the balance sheet. 80. Unrecorded liabilities: Liabilities that are not recorded in the financial statements. 81. Off-balance-sheet financing: Financing arrangements that are not disclosed in the financial statements. · Secret reserves can be created for various reason, such as: 82. Tax avoidence: To reduce tax liabilities. 83. Earnings management: To manipulate earnings and present a more favorable financial picture. 84. Financial flexibility: To maintain financial flexibility and avoid disclosing sensitive information. · However, secret reserves can also pose risks, such as: 85. Lack of transparency: Secret reserves can reduce transparency and accountability. 86. Regulatory issues: Secret reserves can lead to regulatory issues and penalties. 87. Invester mistrust: Secret reserves can errode investor trust and confidence. · It's important to note that secret reserves are not always illegal or unethical, but they can be controversial and may violate accounting standards or regulatory requirenments.