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Difference between the income reserve and the capital reserve

febrero 9, 2020

In business, all the profit earned during a financial year is not used for the payment of the dividend to the shareholder, rather a certain amount is allocated and retained in the business, in order to meet future needs or cope with emergency situations. as reserves. Based on the nature of the profit from which the reserves are created, they are grouped as income and capital reserves. The Revenue Reserve created with profit deriving from daily commercial operations, while the Capital reserve created with capital gains

Reserves are nothing more than an appropriation of profit and therefore decrease the amount of profit available with the company for distribution to shareholders. It appears on the passive side of the position statement (Balance sheet) under the item Reserves and Surplus. In this article, you can find substantial differences between the income reserve and the capital reserve.

Comparative chart

Basis for comparison Reserve Reserve Capital reserve
SenseRevenue Reserve refers to the amount of money retained in the business, in order to meet future contingencies.Capital Reserve alludes to a fund, created to finance long-term projects or to amortize capital expenditure.
sourceThe profit of the company's revenue is the source of the revenue reserves.The company's capital gain is the source of the capital reserve.
PurposeTo cope with contingencies and improve the entity's financial position.To comply with legal requirements or accounting principles.
utilizationDepending on the type of reserve, it can only be used for specific purposes.The capital reserve can be used for the purpose for which it was created.
Dividend freely available for distribution as a dividend.Not available for distribution as a dividend.

Definition of Revenue Reserve

The Revenue Reserve refers to the part of profit set aside and not distributed to shareholders as a dividend but maintained in the business to meet unexpected future expenses or losses or to invest in expanding the business. generated by the profit of the income, which the result of operating activities carried out by the corporate entity, during the financial year. used to improvise the entity's financial position. There are two types of revenue reserves:

Types of revenue reserve

  • General Reserve : The reserve whose purpose for the creation not mentioned called general reserve. Since management can use the reserve for any purpose, a general reserve also known as a free reserve.
  • Specific reserve : the reserve fund, which can only be used for the defined purpose, known as the specific reserve. Some examples of this reserve are:
    • Bond repayment reserve
    • Compensation fund for workers
    • Investment fluctuation fund
    • Dividend Equalization Reserve.

Definition of capital reserve

The capital reserve can be understood as the sum allocated for specific purposes or long-term projects. the result of the capital gain that the company earns from capital transactions, such as:

Example of capital profit

  • Profit on the sale of fixed capital or investment.
  • Pre-incorporation profit
  • Award for the issue of securities
  • Profit on bond redemption.
  • Profit on the reissue of lost shares
  • Profit on the revaluation of assets and liabilities.

The capital reserve aimed at canceling capital losses, which occur due to the sale of fixed assets, investments, etc. The amount of the capital reserve can be used by the company for the issue of bonus shares fully paid to shareholders.

Key differences between the income reserve and the capital reserve

The following points explain the difference between the income reserve and the capital reserve:

  1. Income reserve means a part of the profit retained in business, in order to cover future expenses or losses. On the contrary, the capital reserve can be defined as a reserve fund, created for a specific purpose, i.e. to finance large-scale projects or to amortize capital expenditure.
  2. The profit from daily business activities can be used for the creation of income reserves. Conversely, the profit from non-operating commercial activities is the source of the capital reserve.
  3. The main objective of creating an income reserve to deal with contingencies and improve the entity's financial position. Otherwise, the capital reserve created to meet legal requirements or accounting standards.
  4. The reserve of revenue of two types, namely a general reserve which can be used for any purpose and a specific reserve which can only be used for a specific purpose.
  5. The dividend can be declared outside the income reserve, but it cannot be declared outside the capital reserve.

Conclusion

The creation of vital reserves for the company, to protect itself from any unexpected losses or contingencies, which could arise in the future. It can also be used to strengthen the firm's overall financial position and to repay long-term debt such as bonds. While an income reserve represents the operational efficiency of the concern, than in the case of the capital reserve.

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