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Concept
Reserve (accounting)
Summary
In financial accounting, reserve always has a credit balance and can refer to a part of shareholders' equity, a liability for estimated claims, or contra-asset for uncollectible accounts.
A reserve can appear in any part of shareholders' equity except for contributed or basic share capital. In nonprofit accounting, an "operating reserve" is the unrestricted cash on hand available to sustain an organization, and nonprofit boards usually specify a target of maintaining several months of operating cash or a percentage of their annual income, called an Operating Reserve Ratio.
There are different types of reserves used in financial accounting like capital reserves, revenue reserves, statutory reserves, realized reserves, unrealized reserves.
Equity reserves are created from several possible sources:
Reserves created from shareholders' contributions, the most common examples of which are:
legal reserve fund - it is required in many legislations and it must be paid as a percentage of share capital
share premium - amount paid by shareholders for shares in excess of their nominal value.Within the framework of capital increase by share premium a larger proportion of capital increase is placed into a capital reserve while the subscribed capital is increased by a minimum amount. This is because the initial losses are covered by the capital reserve. If capital increase was carried out fully or to a significant degree through the increase of subscribed capital, equity could easily fall to below the subscribed capital due to the losses.
Reserves created from profit, especially retained earnings, i.e. accumulated accounting profits, or in the case of nonprofits, operating surpluses. However, profits may be distributed also to other types of reserves, for example:
legal reserve fund from profit - many legislations require creation of the fund as a percentage of profits
remuneration reserve - will be used later to pay bonuses to employees or management.
Official source
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