Difference between Provision and Reserves
Provisions
There are certain expenses/losses which are related to the current accounting period but amount of which is not known with certainty because they are not yet incurred. It is necessary to make provision for such items for ascertaining true net profit
| Depreciation | bad and doubtful debts | taxation | discount on debtors | repairs and renewals |
The amount of provision for expense and loss is a charge against the revenue of the current period. Creation of provision ensures proper matching of revenue and expenses and hence the calculation of true profits. Provisions are created by debiting the profit and loss account. In the balance sheet, the amount of provision may be shown either
| By way of deduction from the concerned asset on the assets side | On the liabilities side of the balance sheet along-with current liabilities |
Reserves
A part of the profit may be set aside and retained in the business to provide for certain future needs like growth and expansion or to meet future contingencies such as workmen compensation.
Unlike provisions, reserves are the appropriations of profit to strengthen the financial position of the business. Reserve is not a charge against profit as it is not meant to cover any known liability or expected loss in future. However, retention of profits in the form of reserves reduces the amount of profits available for distribution among the owners of the business. It is shown under the head Reserves and Surpluses on the liabilities side of the balance sheet after capital.
Difference between Provision and Reserves
| Basis | Provision | Reserves |
| Charge | Against profit | Not against profit but apportionment of profit |
| Purpose | Created for a known liability or expense pertaining to current accounting period, the amount of which is not certain. | It is made for strengthening the financial position of the business. Some reserves are also mandatory under law. |
| Effect on tax | Reduces taxable profits | no effect on taxable profit |
| Presentation in Balance Sheet | It is shown either (i) by way of deduction from the item on the asset side for which it is created or (ii) In the liabilities side along with current liabilities. | It is shown on the liabilities. Balance sheet after capital amount. |
| Element of compulsion | Necessary to ascertain true and fair profit or loss in compliance with ‘Prudence’ or ‘Conservatism’ concept. It has to be made even if there are no profits | Creation of a reserve is generally at the discretion of the management. In certain cases law has stipulated for the creation of specific reserves such as Debenture Redemption Reserve. Reserve cannot be created unless there are profits. |
| Use for the payment of dividend | Cannot be used for the purpose | Can be used for the purpose |