What is the distinction between a reserve and a provision?

A reserve is an appropriation of profits for a specific purpose. The most common reserve is a capital reserve, where funds are set aside to purchase fixed assets. By setting aside a reserve, the Board of Directors is segregating funds from the general operating usage of a company.

There is no actual need for a reserve, since there are rarely any legal restrictions on the use of funds that have been "reserved." Instead, management simply makes note of its future cash needs, and budgets for them appropriately. Thus, a reserve may be referred to in the financial statements, but not even be recorded within a separate account in the accounting system.

A provision is the amount of an expense or reduction in the value of an asset that an entity elects to recognize now in its accounting system, before it has precise information about the exact amount of the expense or asset reduction. For example, an entity routinely records provisions for bad debts, sales allowances, and inventory obsolescence. Less common provisions are for severance payments, asset impairments, and reorganization costs.

In short, a reserve is an appropriation of profit for a specific purpose, while a provision is a charge for an estimated expense.

Related Topics

The accruals concept
Allowance for doubtful accounts
Obsolete inventory accounting
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