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Difference Between Provision and Reserve:

The points of difference between provision and reserve are stated in the tabular form:

1. It is a possible loss so it is created by debiting profit and loss account. It is a charge against profit 1. It is a portion of profit earned by business. It is created by debiting profit and loss appropriation account. It is an appropriation of profit.
2. Profit and loss account will not disclose true profit/loss, unless provision is created. 2. Profit and loss account discloses true profit/loss, even if no reserve is created.
3. It is created to meet specific loss or liability. But the amount of loss or liability cannot be determined exactly. So the amount of provision is an estimated amount. 3. It is meant for meeting any unknown loss or liability. It is generally created with a portion of profit earned by business.
4. It must be created irrespective of whether there is a profit or loss. In other words its creation is obligatory. 4. It cannot be created unless there is a sufficient profit. Its creation is the discretion of management. In other words, it is not obligatory.
5. Profit or loss is effected by its creation - profit decreases or loss increases. 5. It does not effect profit or loss, since it is created after ascertaining profit.
6. Dividend cannot be paid out of it. 6. Dividend can be paid out of it.
7. Its amount must be sufficient to meet the loss or liability. 7. Its amount is generally determined by management on the basis of the amount of profit earned.
8. It cannot increase working capital - it is utilized for meeting the specific loss or liability. 8. It increases working capital and thereby strengthen the financial position of the business concern.
9. The owner of the business cannot have any claim over it, since it is created for meeting a specific loss or liability. 9. The owner can claim it, since it is created out of profit.
10. It is shown on asset side of the balance sheet as deduction from the concerned asset, e.g., provision for doubtful debts is shown as deduction from sundry debtors. 10. It is shown on liability side of the balance sheet as a separate item.
11. It is used for the specific purpose for which is has been created. 11. It can be used for the purpose whatsoever.
12. Auditors must check its adequacy. 12. Auditors are not required to check adequacy.

In spite of the above distinction between provision and reserve it may be noted that both of them are created out of the same source, i.e. revenue of the business. Again, if there be any surplus provision after meeting the liability or loss for which it was created, such surplus provision is as good as reserve. For example, a provision of $500 is created in this year for doubtful debts. But actual bad debts in the next year comes to $400 only leaving a surplus provision of $100 (500 - 400). This surplus will be credited to profit and loss account. In other words, it becomes payable to the owner of business like reserves.


More study material from this topic:

Definition, explanation and causes of depreciation
Depreciation is not a matter of valuation but a means of cost allocation
Activity method of depreciation
Straight line method of depreciation
Sum of the years' digits method of depreciation
Reducing balance method
Annuity method
Depreciation fund method or sinking fund method
Insurance policy method
Revaluation method
Depletion method
Machine hour rate, mileage, and global method
Methods of recording depreciation
Difference between general reserve and specific reserve
Difference between capital reserve and general reserve
Difference between reserve and reserve fund
Difference between provision and reserve



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