Balance Sheet Reserves

Balance Sheet Reserves

RESERVES

Reserves (apart from the share premium account, explained below) are profits retained, 'ploughed back', and accumulated over the years. As they are thus retained in the business they are classified with the share capital, under permanent liabilities. Most reserves are retained for general purposes, i.e., to assist the expansion of the business in the best way possible, and are called general reserves. Some reserves, forming only a small part, may be set aside for specific purposes, and appear in the balance sheet as 'reserve funds'. When a 'reserve fund' so appears, this means that it is for a specific purpose, such as the redemption of redeemable preference shares, and normally an equal amount of liquid assets (cash and/or short-term investments) is earmarked to represent it.

Quite independently of whether reserves are general or specific, they fall into two classes: CAPITAL RESERVES and REVENUE RESERVES, and it is these headings which are required by law to be shown in published accounts.

CAPITAL RESERVES are reserves not regarded as free for distribution by way of dividend (the Companies Act describes this as follows: 'the expression "capital reserve" s/toil not include any amount regarded as free for distribution through the profit and loss account'). There is, however, an occasion when a dividend may be paid to shareholders out of capital reserve and this is where a capital profit (i.e., excess of proceeds of sale of a fixed asset over its original cost) has been received in cash and is credited to capital reserve, provided that there are sufficient tangible assets to meet deferred and current liabilities. E.g., selling a subsidiary for cash at a profit. This type of distribution has not been derived from revenue profits and in the past has not been subject to tax in the hands of the shareholders. But under the provisions of the 2009 Finance Act, all such distributions will be taxable in the same way as dividends.

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