Difference Between Reserves and Provisions
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.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.