These represent the amounts set aside by management out of accumulated profits for various purposes. Reserves are commonly classified into two categories:
Types of Reserves
- Revenue reserves
These are the reserves that are set aside from the profit of the company for various purposes. For example, a company may transfer the amount to a revenue reserve instead of paying a dividend in order to raise funds for future business expansion.
- Capital reserve
These are the reserves created from the capital gains rather operational income of the company. For example, an increase in the value of assets or investments, gain on sale of fixed assets, or premium charged on the issuance of shares. The main purpose of setting aside capital reserves is to not let these amounts be distributed as dividends. Moreover, capital reserves can be used to set off future capital losses. Further, in various regions utilization of capital reserves may be subject to limitation imposed by the local laws.