Reserves and Surplus, It is the money saved from profit and held back to pay on a future date incase of any uncertainties. They only appear when the entity makes profit. Without asking for extra capital from shareholders, This amount helps us to meet the expenditure. The undistributed profits are in the form of reserves and surplus.
It’s the company’s duty to decide on what percentage it wants to maintain the reserves according to its obligations. They are a part of equity shareholders and are a part of owners equity.
Reserves and surplus comprises of :
Reserves and Surplus = General reserve + capital reserves+ securities premium reserve + surplus for the year
The Surplus is extra which is left with the company itself. It might be profits from the core business, asset sale, returns from investment etc. It is found on the credit balance of the Profit&Loss account which is retained with the entity.
Securities premium reserves are the amount set aside from the profit earned by pricing the face value of the forfeited shares issued shares and redeemed shares.
There are 2 types of reserves, namely Revenue reserves and capital reserves.
Revenue reserves are a part of profit.They are saved out of the profit earned in the normal course of the business from sales and trade. They are divided into 2types :
General reserves are not put aside for any specific purpose. They are simply maintained to strengthen and meet the contingencies.
Specific reserves have a specific reason to maintain. For example, Plant and Machine replacement reserve under sinking fund method, Dividend equalization reserve, Investment fluctuation reserve etc.
Capital reserves are saved when they earn a capital profit to meet with capital loss.That is when an asset is sold for a price more than actual price . They earn a profit which is kept aside to meet an expenditure when an asset is sold at a less price than they expected. For example, Forfeited share, Sale of assets yields Capital reserve.
Disclosure of Reserves & Surplus in a company’s balance sheet
In the Balance Sheet Of ABC & CO.
|EQUITIES & LIABILITIES|
|I. SHAREHOLDER FUNDS|
|1. SHARE CAPITAL||X|
|2. RESERVES & SURPLUS|
|Securities premium account||X|
|As per last Balance Sheet||X|
|ADD: Transfer from surplus in the Statement of Profit & Loss||X|
|AMOUNT TO BE SHOWN IN THE BALANCE SHEET||X|
Retained earning and Reserves sounds similar but they are not.
Retained earnings are not a part of the reserves. Reserves are transferred after the lofty tax but before the dividend, retained earnings are the post process of transferring i.e., the amount after dividends. Explicitly, before dividends is reserved, after dividends is retained profits.
Why it matters?
Reserves and surpluses is also a criteria that you can acutely concentrate about because one disadvantage that’s been in notice is that if you do not concentrate about the entity’s profit and hurray-in only for receiving dividends, then it’s only for a year or a short period, as the sum reaches reserves after the dividends are paid, It does not depict the exact picture for us.