Secret reserve is a reserve which does not appear in the balance sheet. It may also help to reduce the disclosed profits and also the tax liability. The secret reserve can be merged with the profits during the lean periods to show improved profits. Management may resort to creation of secret reserve by charging higher depreciation than required. It is termed as ‘Secret Reserve’, as it is not known to outside stakeholders.
Creation of secret reserves
| Undervaluation of inventories/stock | Charging capital expenditure to P&L account | Making excessive provision for doubtful debts | Showing contingent liabilities as actual liabilities |