Page 245 - DMGT104_FINANCIAL_ACCOUNTING

Unit 10: Accounting and Depreciation for Fixed Assets

10.4.4 Distinction Notes

The identification and understanding of the precise scope of ‘provisions’ and ‘reserves ’ require
explanation of differences between them for clarification of their respective roles in business
and in accounting.
 Purpose: A provision is created for some specific liability in view but reserve is meant to
meet the future legal obligations or investment requirements of business for development.
 Mode of Creation: A provision is a charge against profit and loss account of the year and
has to be created even when profits are not expected. A reserve is an appropriation of
profits and can be made out of either profit earned during a year or from already existing
surplus, e.g. contingency reserve.

 Presentation in Balance Sheet: A provision is generally presented as a deduction from the
item for which it has been created on the asset side of the balance sheet or as a liability
after current liabilities as part of external equities. Reserve is listed as distinct item on the
liabilities side of them balance sheet.

 Utilization: Very rigid restrictions are enforced in practice on the use of provisions in
business operations to make them adhere to the purpose for which they have been meant.
Contrary to this, the balance of general reserve, or any account of such a nature, is always
available for any bonafide requirements of business. However, reserves created under
specific legal obligations such as “Capital Redemption Reserve or Debenture Redemption
Reserve” is to be used within the framework of the law only.
 Identification with Operations: A provision is made for meeting a particular liability or
likely loss on a specific item. Therefore, they cannot be distanced from business operations
and their investment outside the business is just not possible. Reserves, being of a general
nature, can be invested outside the business to avoid the possibility of their non-availability
in the event of need as well as to earn some additional income with their help. However,
outside investment of reserves by business is not mandatory in all situations.

10.4.5 Types of Provisions

The number of provisions maintained by a business undertaking depends upon its requirements,
which are governed by the volume, range and nature of its operations. Generally, a business
firm creates and maintains provisions for taxations, repairs and renewals, depreciation, discount
on debtors, bad and doubtful debts. But provision for doubtful debts and provision for discount
on debtors has been discussed at appropriate stages.

Notes Provision for Doubtful Debts
When business transaction takes place on credit basis, debtors may be of three types:

 Good Debtors are those from where collection of debt is certain.
 Bad Debts are those debtors from where collection of money is not possible and the
amount of credit is a loss.

 Doubtful Debts are those who may pay but firm is not sure about cent per cent
collection from them. In fact, as a matter of business experience, some percentage of
such debtors is not likely to pay, hence treated as doubtful debts.

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