Nature of Reserves and Movement in Reserves Including Dividends

This article explains the nature of reserves and how they are created and used. It also discusses the accounting for movement in reserves, including dividends. The effects of dividends on a company's financial statements are also explained.

Write on nature of reserves and account for movement in reserves including dividends?
Answer
A reserve is nothing but profit which is set aside for a particular reason. It is also set aside in
order to purchase fixed assets in near future, pay any future arisen legal settlement, pay
bonus to employees of firm, pay off debt, Payment to be made for repairs and maintenance.
This is also done in order not to use fund for any other purpose such as payment of dividend
or buy back of shares. The management and board of directors of the company is also
authorized to create such reserves. The fund that have been locked in reserve can be used
for any purpose as there is no restrictions for the purpose of using the same amount.
(AccountingTools.com, 2018)
Accounting of reserve is very much simple, just one need to debit the particular account
with the amount of reserve which is to be set aside and also at the same time credit the
reserve account with that particular amount. When the required activity for which reserve
account has been completed just one need to reverse the particular entry and transfer the
remaining balance to the retained earning account. (AccountingTools.com, 2018)
The above theory can also be explained with the help of one example: a company business
may want to reserve fund for constructing building projects with a total amount of $ 6
million and respectively Building Reserve Fund has to be credited with the respective
amount and debits the retained earning with the same amount. The total cost involved in
the construction of a building is $5.9 million which is shown as a debit figure to the fixed
assets account and the same to be credited in cash. After the building is completed the
original entry which has been created has to be reversed with $6 million debited to Building
Reserve Fund and the same amount credited to retained earnings account. All the reserve
account which is been created by the company for any specific purpose need not to be
present in a separate line in a balance sheet, it may be combined and total together and can
be shown in the retained earning line item.
The movement in the reserve is explained with the help of chart depicted below as it shows
the different types of reserves held by the authority. The one can be classified as ‘usable
reserves’ (the fund which can be applied to meet the expenditure of the company or to
reduce the local taxation of the company) and the other ‘unusable reserves ‘which generally
reflects balances created by the accounting adjustments. The net increase or decrease
before transfer of the same to earmarked reserve shows the statutory General fund balance
and the Housing Revenue Account Balance before any transfer to or from has been done
from the specified reserve. (walthamforest.gov.uk, 2019)
The movement in the amount of reserve during transfer of the reserve amount shows the
General Fund Balance and Housing Revenue Account Balance before any to or for transfer is
made by the council. The below table shows the movement in various types of reserves
during the particular financial year:

(walthamforest.gov.uk, 2019)
Dividend are the payment made by company to the shareholders of the company. They are
many ways in which the company distribute return to its investor, one way is through the
dividend. In many countries there are varied ways of distributing dividend some entity
distribute dividend monthly or some semi-annually. It is a way of rewarding to the
shareholders of the company for their investment made in the company. It is also a way
through which the company depicts their financial stability of the company. The stocks on
which dividend are issues are mostly popular among the investors.
Effects of Dividends
Through the type of dividend issued either in the form of cash or stock the effect of the
same can be seen. Generally, when a company issues a dividend to its shareholders the
amount of dividend distributed to the shareholders of the company is deducted from the
respective retained earning of the company. Even if the dividend is not issued for cash but
issued as a share of a company, the value of the stock is deducted from the retained
earnings of the company. However, if the distribution is in the form of cash dividend to the
shareholders of the company, the same should be deducted straight from the company
retained earnings. If the distribution of dividend is in the form of stock it results in transfer
of fund from the retained earning to the paid-up capital of the company. The distribution of
cash dividend reduces the stockholders’ equity while distribution in the form of stock
dividend rearranges the allocation of equity funds.
Cash dividend affects the company cash and the shareholders equity account. There is no
separate head to be shown in the balance sheet for dividends after the payment is made to
the investors of the company .however before the payment is paid and after the dividend is
declared the management of the company records the same as a liability with the heading
name dividend payable account. (Accounting Coach LLC, 2019)
After same when the dividend is paid to the shareholders of the company the account of
dividend payable is reversed and is no longer to be shown in the balance sheet item.
Dividends are paid lead to decrease in the retained earning and the cash balance of the
company.

Investors of the company can also see the total amount of dividend paid to the shareholders
in the statement of cash flow of the company. (Bank, 2019)
Accounting standard AASB 136 – Impairment of Assets.
This Accounting standard AASB 136 applies on impairment of Assets. Assets includes
Property plant and Equipment, Capital Work in Progress, Intangible Assets including
Goodwill, Investment in subsidiary, Associates and Joint Ventures (if such investments are
recorded at cost in the books) and any other assets on which impairment is not dealt by
their respective standards.
Impairment means reduction in Carrying Amount (CA) of Assets up to its Recoverable
Amount (RA)
Impairment loss = CA-RA.
This Impairment loss represents the excess value of future economic value expected from
the said assets. Here RA is the higher of the following:
(a) Value in use (entity Specific value) or
(b) Fair Value less cost to disposal (Market Specific Value).
Value in use means value that will be derived from continuous use of asset till its ultimate
disposal. This value is based on cash flows, discounted using appropriate asset specific
Capital Asset Pricing Model discount rate. Risk factor should either affect cash flows or
Discount Rate. Calculation of value of use can be based on the Traditional Method or
Expected Cash Flow Method.
Fair value less costs to sell is the value which is obtained after selling of an assets or cash-
generating unit in an arm’s length transaction between interested parties less the costs of
disposal.
CA is the carrying Amount of asset as on the date of calculation of impairment loss. This CA
should be after any revaluation and depreciation and earlier impairment losses.
For the purpose of calculation of value in use, Cash flows needs to be calculated using the
most recent financial budget relevant for asset. Such cash flows should be after considering
any operating cost or overheads on use of such assets.
Indicators of Impairment Loss
Entity should test for the existence of any indicators of Impairment loss at the end of the
Reporting Period. But in the following cases, it is compulsory check the test of Impairment
loss:
 Goodwill in Business Combination;
 Intangible Asset under Development;
 Intangible Asset having indefinite life;

 Intangible Asset not being used.
Hence in the above four cases, entity can impair at any time during the Reporting Period.
Present Case
In the present case, the value in use of the asset is $ 1,097,700. Since, the data regarding the
fair value less cost to sell is not provided, recoverable amount has been considered cost as
value in use. Post above, the carrying value of the asset has been computed to $ 1,223,700.
Accordingly, the value of impairment loss comes to $ 126000.
Also, the loss on impairment has been allocated in the following hierarchy:
(a) Goodwill;
(b) Plant;
(c) Copyright and Inventory
No impairment loss has been written off against the inventory as the same is not guided by
AASB 136.
Based on the above, the impairment has been adjusted against goodwill to the tune of Rs.
42,000, plant to the tune of Rs. 30559, Copyright and machinery of Rs. 32793.3 and Rs.
20647.7 respectively.
Computation of Impairment Amount
Sl No Particulars Carrying Amount Fair Value Impairment
1 Plant 822700 792141 30559
2 Copyright 189000 32793.3
3 Machinery 119000 20647.7
4 Inventory 51000
5 Goodwill 42000 42000
6 Total Carrying Amount 1223700
7 Value in Use 1097700
8 Impairment (6-7) 126000
Sl No Particulars Impairment Amount
1 Goodwill 42000
2 Plant 30559
3 Total 72559
4 Total impairment 126000
5 Balance Impairment (4-3) 53441
6 Allocation
7 Copyright 32793.3
8 Machinery 20647.7

In the books of Gali Limited
Journal Entries
Date Particulars Dr Cr
30-Jun Loss on Impairment A/c..Dr
12600
0
To Goodwill A/c 42000
To Plant A/c 30559
To Copyright A/c
32793.
3
To Machinery A/c
20647.
7
(Being Asset Impaired)
30-Jun Profit and Loss A/c..Dr
12600
0
To Impairment Loss A/c 126000
(Being Final entry passed)
References
Accounting Coach LLC, 2019. How do cash dividends affect the financial statements?.
[Online]
Available at: https://www.accountingcoach.com/blog/dividends-financial-statements
[Accessed 27 May 2019].
AccountingTools.com, 2018. Reserve Accounting. [Online]
Available at: https://www.accountingtools.com/articles/what-is-reserve-accounting.html
[Accessed 27 MAy 2019].
Bank, E., 2019. Do Dividends Decrease a Stockholder's Equity?. [Online]
Available at: https://smallbusiness.chron.com/dividends-decrease-stockholders-equity-
58810.html
[Accessed 27 May 2019].
walthamforest.gov.uk, 2019. Movement in Reserves Statement. [Online]
Available at: https://democracy.walthamforest.gov.uk/documents/s9802/5.%20Appendix
%205%20Example%20SMR.pdf
[Accessed 27 May 2019].