Reserve is an appropriation of profit. Any company must have financial reserves to meet its sudden financial requirements, for growth and development, to expand the business in other areas, etc. Reserves in any company can be broadly categorized into two based on the kind of profit it appropriates. One category is capital reserve, and the other is revenue reserve. Reserves must be kept aside to meet requirements.
Capital Reserves
A reserve made out of capital profit is simply called capital reserve. Capital reserve is an account on companies’ statement of financial position or balance sheet, which is reserved for long term capital investment project or reserved to pay off any anticipated expenses. Simply, the capital reserves are made by companies, to face contingencies like inflation, instability, and some other purposes discussed above. Normally, capital reserves are raised by non trading activities of the company. Revaluation reserve and share premium (increase in value of non-current assets in excess to the book value) are the two most famous examples for capital reserve. Profit on sale of asset, profit on sale of shares and debentures, profit on redemption of debentures, profit on purchases of a running business are some other elements which can contribute to capital reserve. Capital reserve can be used to repurchase company shares, as well.
Revenue Reserves
Revenue reserves are reserves created out of profit from trading activities. Retained earnings are one of the widely known revenue reserves. When a company earns more profit in one year, based on the retention ratio it may reserve some part of the profit as retained earnings, which is a revenue reserve. Generally, revenue reserves are not kept for long term. Revenue reserves can be distributed among share holders in the form of bonus issue or dividend. The amount that is set aside in the name of revenue reserves is used to strengthen company resources to declare uniform rate of dividend in the future and protect the business from sudden, unexpected loss. This is also known as undistributed revenue profit.
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What is the difference between Capital Reserves and Revenue Reserves? As the names indicate, both capital reserves and revenue reserves have some differences. • Revenue reserves are arisen from trading activities like retained earnings, while capital reserve are arisen due to non trading activities like revaluation reserve. • Generally, revenue reserves can be distributed as dividend among shareholders, but capital reserves can never be distributed as a dividend. • Capital reserves are usually kept for long-term purposes, but revenue reserves are not kept for long-term purposes. • Some capital reserves like revaluation of assets cannot be realized in monetary terms, even though book shows the value; however, revenue reserves can be realized in monetary terms.
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