What Are Reserves in Accounting?
Quick Summary
- Reserves = post-tax profit allocations; Provisions = pre-tax charges for known liabilities
- Revenue Reserves (General, Dividend Equalisation) CAN be distributed as dividend
- Capital Reserves, CRR, and Securities Premium CANNOT be distributed as cash dividend
- DRR (Section 71) and CRR (Section 69) are mandatory under the Companies Act, 2013
- Securities Premium use is restricted to 5 purposes only under Section 52
- Revaluation Reserve cannot be distributed — only transferred to retained earnings when asset is used
- All reserves appear under "Reserves and Surplus" in Schedule III of the balance sheet
Reserves are amounts set aside out of profits to strengthen the financial position of the business, meet future needs, or comply with specific legal requirements. They are not created for a definite known liability. Instead, they represent an appropriation of retained profit.
A few basic points define reserves clearly:
- They are usually created out of profits after normal charges have already been considered.
- They appear on the equity side of the balance sheet .
- Some reserves are discretionary.
- Some reserves arise because the law requires them or because a capital event has taken place.
- Some reserves may be used later for bonus shares or other specific purposes.
- Some cannot be distributed as cash dividend.
Book A Demo
Reserve vs Provision: The Most Important Difference
This is one of the most important distinctions in accounting.
| Feature | Reserve | Provision |
|---|---|---|
| Purpose | To strengthen the business or meet future general/specific needs | To meet a known liability or expected loss |
| Created from | Profit after normal charges | Charged to Profit and Loss Account before final profit |
| Certainty of liability | No definite present liability | Liability or expected loss is known, though amount may be uncertain |
| Balance sheet placement | Equity side | Liability side or deduction from asset, depending on nature |
| Effect on profit | Does not reduce operating profit as an expense item | Reduces profit |
| Distributable as dividend | Some revenue reserves may be distributable | No |
| Nature | Appropriation | Charge |
Types of Reserves: Full Classification
A simple classification is as follows:
1. Revenue Reserves
These are created from profits earned in the ordinary course of business.
- General Reserve
- Dividend Equalisation Reserve
- Contingency Reserve
- Other specific revenue reserves
2. Statutory Reserves
These are reserves that arise because law or regulation requires them in specified cases.
- Debenture Redemption Reserve
- Capital Redemption Reserve
- Certain sector-specific statutory reserves
3. Capital Reserves
These arise out of capital profits and not from normal trading operations.
- Capital Reserve
- Securities Premium
- Revaluation Reserve
- In some sectoral contexts, special capital-related reserves
4. Secret Reserves
These are hidden reserves created by understating assets or overstating liabilities. For companies, these are generally inconsistent with the requirement to present a true and fair view.
Revenue Reserves
Revenue reserves are created out of profits earned in the ordinary course of business. They are part of shareholders' funds and, unlike capital reserves, may in some cases be used for dividend, subject to law and financial prudence.
1. General Reserve
A General Reserve is created without tying it to one narrow purpose. It acts as a general financial cushion for the business.
Common reasons for creating a General Reserve include:
- strengthening the balance sheet
- building internal funds for expansion
- improving creditworthiness
- creating a buffer for weaker years
- supporting future bonus issue or internal funding decisions
Example
Rahul Enterprises Ltd. earns net profit of Rs. 8,00,000 for FY 2025-26. The Board resolves to transfer 20% to General Reserve.
20% of 8,00,000 = Rs. 1,60,000
Journal Entry: Transfer to General Reserve
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Profit and Loss Appropriation A/c Dr. | 1,60,000 | - |
| To General Reserve A/c | - | 1,60,000 |
(Being 20% of net profit transferred to General Reserve)
Example of Use
If part of the General Reserve is later used for a bonus issue or internal transfer:
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| General Reserve A/c Dr. | 50,000 | - |
| To Bonus to Shareholders A/c | - | 50,000 |
(Being General Reserve used for bonus issue)
2. Dividend Equalisation Reserve
A Dividend Equalisation Reserve is created so that dividend can be kept relatively stable even if yearly profits fluctuate.
This type of reserve is useful in industries where profits are uneven from year to year. In strong years, part of profit is transferred to this reserve. In weaker years, the reserve can support dividend continuity, subject to law and available distributable resources.
Example
Sharma Textiles Ltd. wants to maintain a stable dividend rate. In a strong year, it transfers Rs. 3,00,000 to Dividend Equalisation Reserve. In the next year, when profits fall, it uses Rs. 2,50,000 from the reserve to support dividend policy.
Journal Entry: Creation
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Profit and Loss Appropriation A/c Dr. | 3,00,000 | - |
| To Dividend Equalisation Reserve A/c | - | 3,00,000 |
(Being transfer to Dividend Equalisation Reserve)
Journal Entry: Use
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Dividend Equalisation Reserve A/c Dr. | 2,50,000 | - |
| To Profit and Loss Appropriation A/c | - | 2,50,000 |
(Being reserve utilised to support dividend distribution)
3. Contingency Reserve
A Contingency Reserve is created for uncertain future events that may affect the business, but where no specific present obligation exists.
Examples may include:
- economic downturns
- unusual business risks
- litigation uncertainty at a broad level
- exceptional future losses that cannot be specifically measured now
Journal Entry
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Profit and Loss Appropriation A/c Dr. | 80,000 | - |
| To Contingency Reserve A/c | - | 80,000 |
(Being contingency reserve created)
Statutory Reserves
Statutory reserves are not always optional. In certain cases, the law requires the company to create them.
1. Debenture Redemption Reserve (DRR)
Debenture Redemption Reserve is linked to debenture issues and is governed by Section 71 and the relevant rules. However, the requirement has been relaxed significantly since the 2019 amendment. Listed companies, private companies, NBFCs, and HFCs generally do not have the same DRR obligation that previously existed, while unlisted public companies continue to have a reduced requirement.
Current Position in Broad Terms
| Company Type | Broad DRR Position |
|---|---|
| Listed companies | DRR generally not required |
| Unlisted public companies | DRR required at reduced level |
| Private companies | DRR generally not required |
| NBFCs / HFCs | Separate relaxed treatment |
For unlisted public companies, the adequacy of DRR has generally been reduced to 10% of outstanding debentures. The related investment requirement also applies in specified cases.
Example
An unlisted public company issues debentures of Rs. 50,00,000 redeemable after 5 years. Required DRR is 10%, that is Rs. 5,00,000, which may be built up over the tenure.
Journal Entry: Annual DRR Creation
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Profit and Loss Appropriation A/c Dr. | 1,00,000 | - |
| To Debenture Redemption Reserve A/c | - | 1,00,000 |
(Being DRR created for the year)
Transfer After Redemption
Once debentures are fully redeemed, the reserve may be transferred in accordance with applicable treatment.
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Debenture Redemption Reserve A/c Dr. | 5,00,000 | - |
| To General Reserve A/c | - | 5,00,000 |
(Being DRR transferred after redemption)
2. Capital Redemption Reserve (CRR)
Capital Redemption Reserve is governed by Section 69. When a company buys back its own shares out of free reserves or securities premium, an amount equal to the nominal value of the shares bought back must be transferred to CRR. This helps preserve the capital base from a creditor-protection perspective.
CRR cannot be used for cash dividend. It may be used for issuing fully paid bonus shares.
Example
A company buys back 10,000 equity shares of Rs. 10 each. Nominal value is Rs. 1,00,000. Buyback price is Rs. 150 per share.
Entry: Transfer to CRR
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| General Reserve A/c Dr. | 1,00,000 | - |
| To Capital Redemption Reserve A/c | - | 1,00,000 |
(Being CRR created equal to nominal value of shares bought back)
Entry: Buyback Cancellation
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Equity Share Capital A/c Dr. | 1,00,000 | - |
| Securities Premium / General Reserve A/c Dr. | 14,00,000 | - |
| To Bank A/c | - | 15,00,000 |
(Being buyback and cancellation of shares)
Capital Reserves
Capital reserves arise from capital profits. These are not profits from normal trading operations. Because of their capital nature, they are generally not available for cash dividend.
Common Sources of Capital Reserve
| Source | How It Arises |
|---|---|
| Profit on sale of fixed assets | Sale value exceeds carrying value |
| Share forfeiture-related surplus | Balance retained after reissue adjustments |
| Capital profit on amalgamation | Specific business combination situations |
| Profit prior to incorporation | In company accounting context |
| Capital reduction surplus | Where law permits and surplus results |
(Being buyback and cancellation of shares)
Example: Profit on Sale of Fixed Asset
Land was purchased for Rs. 20,00,000 and later sold for Rs. 32,00,000.
Profit = Rs. 12,00,000
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Bank A/c Dr. | 32,00,000 | - |
| To Land A/c | - | 20,00,000 |
| To Capital Reserve A/c | - | 12,00,000 |
(Being land sold and profit transferred to Capital Reserve)
Can Capital Reserve Be Used for Dividends?
As a general rule, capital reserve is not treated as a freely distributable cash dividend reserve. It is capital in nature and should be handled carefully in light of the law, articles, and accounting treatment.
Securities Premium Reserve
A Securities Premium arises when shares are issued above their face value. Section 52 requires that the premium be credited to a separate securities premium account and restricts its use to specific permitted purposes.
Example
A company issues 1,00,000 equity shares of face value Rs. 10 at Rs. 50 each.
- Face value portion = Rs. 10,00,000
- Premium portion = Rs. 40,00,000
Journal Entry
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Bank A/c Dr. | 50,00,000 | - |
| To Equity Share Capital A/c | - | 10,00,000 |
| To Securities Premium Reserve A/c | - | 40,00,000 |
(Being shares issued at a premium)
Permitted Uses Under Section 52
Section 52 restricts the use of Securities Premium to specific purposes. Broadly, these include:
- issue of fully paid bonus shares
- writing off preliminary expenses
- writing off expenses, commission, or discount on issue of shares or debentures
- buyback of own shares or securities under Section 68
- other uses specifically allowed by Section 52 and related law
It Cannot Be Used For
- cash dividend
- routine operating losses
- general management expenses
- any use not permitted under Section 52
Example: Use for Bonus Issue
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Securities Premium Reserve A/c Dr. | 20,00,000 | - |
| To Bonus to Shareholders A/c | - | 20,00,000 |
(Being securities premium used for bonus issue)
Revaluation Reserve
Revaluation Reserve arises when a fixed asset is revalued upward. Under Ind AS 16, the upward revaluation surplus is recognised in other comprehensive income and accumulated in equity under revaluation surplus, unless it reverses a prior decrease recognised in profit or loss. That surplus may be transferred directly to retained earnings as the asset is used, or when it is derecognised, but not through profit or loss.
Upward Revaluation Example
Land with carrying amount of Rs. 15,00,000 is revalued to Rs. 22,00,000.
Increase = Rs. 7,00,000
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Land A/c Dr. | 7,00,000 | - |
| To Revaluation Reserve A/c | - | 7,00,000 |
(Being land revalued upward)
Downward Revaluation
If the value falls, the reduction is first adjusted against existing revaluation reserve for that asset, and any excess goes to profit and loss, depending on the applicable framework.
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Revaluation Reserve A/c Dr. | 3,00,000 | - |
| Impairment / P&L A/c Dr. | 1,00,000 | - |
| To Machinery A/c | - | 4,00,000 |
(Being downward revaluation/impairment adjusted)
Investment Fluctuation Reserve
The Investment Fluctuation Reserve is particularly relevant in banking and certain regulated sectors. It is built to absorb possible valuation losses in investment portfolios, especially where prudential norms require such cushioning.
This reserve is more sector-specific and should be applied in line with the relevant RBI or sectoral regulatory framework.
Example Entry
| Account | Dr. (Rs.) | Cr. (Rs.) |
|---|---|---|
| Profit and Loss Appropriation A/c Dr. | 4,50,00,000 | - |
| To Investment Fluctuation Reserve A/c | - | 4,50,00,000 |
(Being reserved created as per regulatory requirement)
Secret Reserves
A secret reserve is a hidden reserve created by:
- undervaluing assets
- overstating liabilities
- charging excessive depreciation
- otherwise suppressing visible profits
For companies, this is generally inconsistent with the requirement of a true and fair view under Section 129 of the Companies Act, 2013.
How Secret Reserves May Arise
| Method | How It Works |
|---|---|
| Asset undervaluation | Asset shown below its fair or realistic carrying amount |
| Excess depreciation | More depreciation is charged than justified |
| Liability overstatement | Excessive provision or liability recorded |
| Immediate write-off of value | Writing off amounts that still have continuing value |
Journal Entries for Reserve Types: Quick Reference
| Reserve Type | Debit | Credit | Narration |
|---|---|---|---|
| General Reserve creation | Profit and Loss Appropriation A/c | General Reserve A/c | Transfer of profit to reserve |
| General Reserve use | General Reserve A/c | Bonus to Shareholders A/c | Bonus issue or approved use |
| Dividend Equalisation Reserve creation | Profit and Loss Appropriation A/c | Dividend Equalisation Reserve A/c | Reserve created for stable dividend |
| Dividend Equalisation Reserve use | Dividend Equalisation Reserve A/c | Profit and Loss Appropriation A/c | Reserve utilised |
| Contingency Reserve | Profit and Loss Appropriation A/c | Contingency Reserve A/c | Reserve created |
| DRR creation | Profit and Loss Appropriation A/c | Debenture Redemption Reserve A/c | DRR created |
| DRR transfer after redemption | Debenture Redemption Reserve A/c | General Reserve A/c | DRR transferred |
| CRR creation | General Reserve / Securities Premium A/c | Capital Redemption Reserve A/c | CRR created on buyback |
| Capital Reserve on asset sale | Bank A/c | Asset A/c + Capital Reserve A/c | Profit on sale transferred |
| Securities Premium on issue | Bank A/c | Share Capital A/c + Securities Premium A/c | Shares issued at premium |
| Securities Premium for bonus | Securities Premium A/c | Bonus to Shareholders A/c | Premium used for bonus issue |
| Revaluation upward | Asset A/c | Revaluation Reserve A/c | Asset revalued upward |
| Revaluation downward | Revaluation Reserve / P&L A/c | Asset A/c | Downward revaluation |
| IFR creation | Profit and Loss Appropriation A/c | Investment Fluctuation Reserve A/c | IFR created |
Schedule III Balance Sheet Placement
Under Division I of Schedule III, reserves are shown under Shareholders' Funds -> Reserves and Surplus. Under Ind AS presentation, similar balances are shown within Other Equity.
Notes: Break these into separate reserve categories.
Illustrative Note Structure
| Reserve Type | Amount (Rs.) |
|---|---|
| Capital Reserve | 12,00,000 |
| Securities Premium Reserve | 40,00,000 |
| Capital Redemption Reserve | 2,00,000 |
| General Reserve | 85,00,000 |
| Dividend Equalisation Reserve | 8,00,000 |
| Debenture Redemption Reserve | 5,00,000 |
| Revaluation Reserve | 8,00,000 |
| Surplus / Retained Earnings | 15,50,000 |
Tax Implications of Reserves
General Rule
Reserves are appropriations of profit. So transferring an amount to the General Reserve does not usually reduce taxable income in the normal way. It is not a charge like depreciation or a tax provision.
Special Reserve Under Section 36(1)(viii)
Certain eligible financial institutions can claim a deduction when transferring profits to a specified special reserve under the Income-tax Act. This is a special case and not the general rule for ordinary corporate reserves.
MAT Angle
Under MAT, book profit computation can be affected by provisions, reversals, and certain accounting treatments. Hidden or secret reserve-type adjustments can also affect book profits when reversed later.
DRR and Tax
Creating DRR itself is not a normal tax deduction. But the underlying debenture interest expense, where otherwise allowable, is a separate matter.
Explore All BUSY Calculators for Easy GST Compliance
Conclusion
Reserves are not just a balance sheet label. They show how a company retains and classifies profit for stability, legal compliance, capital protection, and future use. The most important distinctions to get right are:
- reserve vs provision
- revenue reserve vs capital reserve
- what is freely distributable and what is not
- what the law specifically allows under Sections 52, 69, and 71
- how the balances are presented under Schedule III or Ind AS formats
BUSY can help organise reserve ledgers, journal entries , and reporting, but the accounting treatment still depends on the nature of the reserve, the applicable law, and the reporting framework the business follows.
