What is the difference between provision and reserve?

reserve is an appropriation of profit for a specific purpose, while a provision is a charge for an estimated expense.

rovision and reserves both are created for covering future losses. If we do not make, we can face lots of losses and it will be impossible for us to survive by tolerating such losses. So, as a good person, we need to create provisions and reserves. But both are different terms. You can not use one term for other all the times. Know its main differences for proper use of both accounting terms.

 

 

1. Meaning 

 

Provision : Provision is created to show certain liability. For example, from past experience, we have know there will be 10% bad debts out of total debtor asset. So, out of total revenue, we deduct provision for doubtful debt as show it as current liability.

 

Reserve : Reserve is created to show unknown liability. For example, we are doing business in share market. It is risky business. So, we have created Risk for fluctuation in share market as $ 20,000. In past experience, there was no loss but still we are showing it as liability and deducting from our total revenue.

 

 

2. As per Law 

 

 

Provision : As per law, to create provision is necessary. That is reason, we show it as expense side in profit and loss account.

 

Reserve : As per law, to create reserve is not necessary. That is the reason, we deduct it out of net profit by making profit and loss appropriation account.

 

 

3. Aim of Creation

 

 

Provision : Main aim is to create provision to cover loss due depreciation and bad debts. So, we can buy new fixed asset and invest more money in debtors.

 

Reserve : Main aim of reserve is to provide financial strength to the business.

 

 

4. Accounting Treatment

 

 

Provision : We debit the profit and loss account and credit the provision account.

 

Reserve : We debit the profit and loss appropriation account and credit reserve account.

 

 

5. Investment

 

Provision : Fund created with provision can not be invested outside the business

 

Reserve :  Fund created with reserve can be invested outside the business.

 

 

6. Showing in Balance Sheet

 

Provision :  It is shown in balance sheet by deducting specific asset.

 

Reserve :  It is shown in the liability side of balance sheet under reserve and surplus heading.

 

 

 

7. Use of Dividend

 

 

Provision :  It can not be used for giving dividend to shareholder.

 

Reserve :  It can be used for giving dividend to shareholder.

 

 

8. Other Usage

 

 Provision :   It is created for covering specific loss, so use for same purpose. For example, provision for depreciation fund can only be used for buying new fixed asset.

 

Reserve : Reserve can be used by any other purpose.

A reserve is an appropriation of profits for a specific purpose. The most common reserve is a capital reserve, where funds are set aside to purchase fixed assets.  In other word, a reserve is an appropriation of profit for a specific purpose, while a provision is a charge for an estimated expense.

Reserve is credited against the charge of the profit and loss appreciation account, it is a portion of profit earned by business. *A provision is s possible loss,and it created by debiting profit and loss accountAccount, it's a charge against profit, it must be created irrespective of whether there's a profit or loss

Reserves vs Provisions

• While provisions are generally seen to be negative since they reduce income levels, reserves are seen as positive as they add onto the company’s profitability and can be used to provide for unexpected future losses, distribution among shareholders, or reinvestment in the business.

• Provisions provide for any losses, expenses, liabilities, or depletion in assets that have been known and expected.

• The main reason for creating a reserve is to be able to meet any unknown losses that may occur in the future. In contrast, the main reason for creating a provision is to provide for losses that have been known and are expected.

• A reserve can only be created if the company is profitable, but provisions are made regardless of whether the company is making a profit or loss.