What is reserve accounting?

A reserve is profits that have been appropriated for a particular purpose. Reserves are sometimes set up to purchase fixed assets, pay an expected legal settlement, pay bonuses, pay off debt, pay for repairs and maintenance, and so forth. This is done to keep funds from being used for other purposes, such as paying dividends. The board of directors is authorized to create a reserve.

A reserve is something of an anachronism, because there are no legal restrictions on the use of funds that have been designated as being reserved.

Reserve accounting is quite simple - just debit the retained earnings account for the amount to be segregated in a reserve account, and credit the reserve account for the same amount. When the activity has been completed that caused the reserve to be created, just reverse the entry to shift the balance back to the retained earnings account.

The term reserve is not defined under Generally Accepted Accounting Principles, except for its application to oil and gas reserves.

Related Topics

Allowance for doubtful accounts 
Warranty accounting 
What is a bad debt provision? 
What is an inventory reserve? 
What is the distinction between a reserve and a provision?