Nature of Reserves and Accounting for Movements in Reserves including Dividends

This article explains the nature of reserves and accounting for movements in reserves, including dividends. It covers the types of reserves, accounting of reserves in the books of the company, and how dividends affect reserves. It also includes impairment journal entries.

Accounts
Explain the nature of reserves and account for movements in reserves, including
dividends?
Answer
The term Reserves shall be defined as to set aside money for a particular purpose or time. In
other words, when something is retained for future it is termed as reserves. These reserves are
generally set aside by the company for the purpose of meeting out any future exigencies or
for the purpose of future investment. The examples of types of reserves have been detailed
here-in-below:
(a) General Reserve/ Revenue Reserve: These reserve is created from the normal profits
earned by the company in the course of business and is accumulated over the years of
operations of the company. (accountslearner.com, 2019) These are generally divided into
two classes which has been detailed here-in-below:
(i) General Reserves: These reserve as the name implies is not set aside by the company
for any specific purpose and can be used for any future activity. These reserves are
generally set aside for the purpose of strengthening of financial statement of the
company; (accountslearner.com, 2019)
(ii) Specific Reserves: these are special reserves, are created for specific purpose, and
cannot be used for any other purpose other than for which it is created like
investment fluctuation reserve or debenture redemption reserve. These reserves are
at times known as special reserves. (lawinsider.com, 2019) The common examples
of specific reserves have been detailed here-in-below:
 Bade debt Reserve;
 Investment Fluctuation Reserve;
 Debt Redemption Reserve;
 Asset Purchase Reserve;
 Asset Fluctuation Reserve etc.
(b) Capital Reserve: These reserves are created by the company out of the capital profits
and these profits generally accrue to the company on account of activities other than
trading. These reserves are generally set aside for meeting out any capital losses in
future. (Debittor, 2019)
Accounting of Reserves in the books of company
Reserves are generally created in the books of company by passing a journal entry by
debiting the retained earning account and crediting the reserve account which needs to be
created. Further, once the activity for which reserve has been created is satisfied than reversal
entry is passed and the balance is shifted to retained earning account or the same is utilised.
Further, the above detail has been explained via an example. Suppose a company wants to
purchase a new machinery and the expenditure involved in purchasing the said machinery is

lump sum. Thus, company shall create a reserve for same by passing the following journal
entry
Retained Earnings Account …Dr Euro 1 Mio
To Office Reserve Fund A/c Euro 1 Mio
Further, once the sale is finalised, the original entry shall be reserved and the following
journal entry shall be passed:
To Retained Earnings Account …Cr Euro 1 Mio
Office Reserve Fund A/c Euro 1 Mio
In addition, Reserve Account are shown as liabilities on the balance sheet under the head
Reserve and Surplus. Further, if a company incurs losses, no reserves are created in the books
of company.
Account for Movement in Reserves including Dividend
Dividend can be distributed to the shareholders of the cash or stock. Whatever the form of
distribution is it reduces the reserves, if the dividend is paid in form of cash it leads to cash
outflow as is shown in the books of accounts as reduction. As the payment of cash dividend
reduces the liquid assets of the company, it also affects the RE of the company’s balance
sheet. However, dividend distribution in the form of stock does not lead to any outflow of
cash but it usually transfers a part of surplus to stock of the company. For instance if an entity
pays one share to every share held by the shareholder, the price of per share will be half as
the number of shares is doubled. As by distribution of dividend to the shareholder, the
company has not created any value the pre market price of the share will automatically adjust
itself according to the dividend of the stock .But the increment in the share number will not
have any affect on the balance sheet as the market price of the company share will adjust
automatically but the market price valuation of per company share will be shown in capital
accounts.
Company which is highly growth oriented may not pay dividend to its shareholder at all or if
pay also very small amount. As the highly growth oriented company may wants to use the
same for research and development activities, marketing activities, to meet the working
capital requirement, to meet the expenditure on capital, company acquisition in order to make
additional growth for the company. Such type of companies always have a high RE over the
period of years .A company which is in maturing stage may not have many alternatives
available to park their surplus cash ,and it may prefer using the surplus cash to pay the
dividend to the shareholders of the company. Such company always have a very low PE ratio.
Impairment Journal Entries
Date Particulars Amount Amount
Impairment A/c.. Dr 69000

To Goodwill A/c 23000
To Plant A/c 33469.0
To Vehicle A/c 4860.5
To Trademark A/c 7670.5
( being Cash generating Unit Impaired)
Profit and Loss A/c….Dr 69000
To Impairment A/c 69000
(Being Transferred to Profit and loss A/c)
(Smirnov, 2018)
References:
accountslearner.com, 2019. What is a General Reserve?. [Online]
Available at: https://accountlearning.com/general-reserves-objectives-of-creation-duties-of-auditor/
[Accessed 26 JAnuary 2019].
Debittor, 2019. Reserves – What are reserves?. [Online]
Available at: https://debitoor.com/dictionary/reserves
[Accessed 26 January 2019].
lawinsider.com, 2019. Definition of Specific Reserve. [Online]
Available at: https://www.lawinsider.com/dictionary/specific-reserve
[Accessed 26 January 2019].
Smirnov, Y., 2018. Asset Impairment Accounting. [Online]
Available at: http://financialaccountingpro.com/asset-impairment-accounting/
[Accessed 26 January 2019].