How Revenue Reserves Are Derived

How Revenue Reserves Are Derived

How revenue reserves are derived

Revenue reserves are any reserves other than capital reserves, and are free for distribution both by way of dividend and scrip issues. The sources are trading profits retained and not distributed to shareholders.

As already stated there are two types of reserves general reserves and specific reserve finds. Whether reserves are capital or revenue, they will be one or other of these two types, general or specific.

In our constructed balance sheet and to be seen in other balance sheets also, you will observe a list of revenue reserves such as:

General reserve.

Working capital reserve.

Contingencies reserve.

Dividend equalisation reserve. Profit and loss account balance.

These reserves are all general, i.e., they have been retained to create expansion in the business. One might ask why they have been given labels such as 'Contingencies reserves' if they are all basically the same. The answer is that at one time it was considered more informative if some idea was given of the purpose of ploughing back profits, but this system of classification has been losing popularity fist and you will now quite often see only one revenue reserve in a balance sheet called 'General revenue reserve'.

The essential point of distinction about revenue reserves (of whatever label) is that they can be transferred back to profit and loss account to bolster up the results of a poor year and enable a dividend to be paid if such is considered desirable. Hence the wording of the Companies Act regarding capital reserves as stated above: 'shall not include any amount regarded as free for distribution through the profit and loss account.' The original purpose behind the classification of revenue reserves is illustrated by the following examples:

Working capital reserve: A lack of cash can hamper a company's business and a working capital reserve would have been created with the intention of enhancing the liquid position of the company.


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