Difference between reserves and provisions

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 22, 2021

The important difference between reserves and provisions is their nature. A Provision is created in respect of a loss or expense that is most likely to happen in the near future. For example, provisions for bad debts are created because a business knows out of experience that some of its debtors will fail to fully settle their dues. A provision is created by making a debit to Profit and Loss Account. i.e. it represents an expense.
A Reserve, on the other hand, is an appropriation of profit, i.e. it is created out of profits. Instead of crediting the entire profit to current accounts of partners, a part is transferred to Reserve Account. Its objective is not to cover a potential loss but to allow growth or expansion of the business.
The balance on a Provisions Account is shown In the Balance Sheet as a deduction from some asset’s value (e.g. provisions for bad debts are deducted from Debtors and net amount of Debtors is shown in the Balance Sheet.
A Reserve on the other-hand is a part of the firm’s equity. It is shown in the Balance Sheet, on the liabilities side, alongside the Capital Accounts of the partners.

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