Why reserves and surplus are liabilities

The following briefly describes a few examples of the reserves you might come across. This will give you a sense of their purpose on the balance sheet. Reserves on the balance sheet can include these items:. When you hear investors, accountants, or analysts talk about reserves, they may not be talking about the reserves shown in the shareholders' equity section of the balance sheet.

Rather, certain types of accounting transactions require reserves to keep the income statement as close to reality as possible. For example, reserves might come into play in this situation: A company has a large amount of its current assets in accounts receivable.

The company charges off some of the total amount it believes won't be paid. Perhaps past experience has led them to decide this.

Or, perhaps they're basing their choice on an examination of the current balances. This accounting transaction lowers current assets. It is known as an allowance or reserve for bad accounts.

It is a contra asset account, and offsets accounts receivable. If management turns out to be too pessimistic, the reserves can be reversed in the future. In this case, profitability will appear to increase. Capital reserves are capital profits that are set aside for anticipated expenses or long-term projects. These are funds that have a purpose when they are taken from the capital profits. Reserve capital is the business's emergency fund and is not required to be on the balance sheet.

This money is set aside without a direct purpose apart from additional funds if the company needs it. With the help of reserves, the company can maintain its working capital requirements as the reserves can be used to contribute towards working capital at the time of the insufficiency of funds in the working capital of the company. One of the main advantages of having reserves and surplus is to overcome the future losses of the companies as the time of losses reserves can be used to pay off the existing liabilities.

Reserves are the main source of the amount required for dividend distribution available. It helps in maintaining the uniformity in the dividend distribution rate by providing the amount required for maintaining the uniform rate of the dividend when there is a shortage of amount available for distribution.

The general reserves that constitute the major part of reserves and surplus are not created for any specific purpose but the general use so there are chances that there can be a misappropriation of funds accumulated in general reserves by the management of the company and there is a possibility that the funds will not be used properly for business expansion. The Creation of more reserves by the company may lead to a reduction in the distribution of dividend to the shareholders of the company.

The utilization of the reserves and surplus includes purposes such as dividend distribution, meeting future obligations, overcoming losses, managing working capital requirements, fulfilling funds requirement for expansion of business, etc. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Your Money. Personal Finance. Your Practice. Popular Courses. What Are Balance Sheet Reserves?

Key Takeaways: Balance sheet reserves are liabilities that appear on the balance sheet. The reserves are funds set aside to pay future obligations. The balance sheet reserves of insurance companies are regulated so that these companies have sufficient reserves to pay client claims.

Insurance companies will often set up balance sheet reserves that equal the value of claims filed but not yet paid. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. To answer this question lets know about the principle of accounting "Convention of conservatism" states that "anticipate no profits but for provide all possible losses.

Therefore reserves and surplus are so created to meet the contingencies of the business. Here contingencies are those obligations which may or may not to be paid.

However, in order to pose any future liability reserves are created so that a business may not hamper on such events and hence it the liability for the business. Post New Answer.