Capital Reserve V/S Revenue Reserve: What Is The Difference?
Reserves are nothing but an allocation of profit. Any company must have financial reserves to meet its immediate financial requirements for its growth and development, to expand the business in other different areas, etc. Reserves are broadly classified into two different categories namely revenue reserve, and capital reserve. In this article, we will discuss the difference between capital and revenue reserves in tabular form for better understanding.
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What Is a Capital Reserve?
A reserve that is created out of the capital profits of a business is termed a capital reserve. According to Part III of Schedule VI of the Companies Act, “a capital reserve is the type of reserve which cannot be legally distributed to shareholders.
The capital reserve is an account that is shown on the balance sheet made by the company and is reserved for long-term capital investment projects or reserved to pay off any anticipated expenses. In simple terms, capital reserves are created by the companies, to face emergencies like inflation, instability, and some other special purposes discussed above. Normally, capital reserves are created by the non-trading activities of the company. The two most famous examples for capital reserve are revaluation reserve and share premium (increase in value of non-current assets over the book value).
Following are the capital profits of the company:
Profits on revaluation of fixed assets and liabilities.
Profit on sale of fixed assets.
Profit earned in purchasing a business.
Profit of redemption of debentures at discount.
Profit received on issue of shares and debentures.
Profit earned from forfeited shares and reissue of forfeited shares
Exceptional profit that is not earned during the regular business activities.
Capital profits discussed above should not be used while distributing dividends to the shareholders but should be kept aside to build up the financial position of the business and to meet capital or abnormal revenue losses.
What Are Revenue Reserves?
Revenue reserves are the reserves that are created from the revenue profits and are earned during the normal course of business activities. Revenue reserves refer to the undistributed revenue profit. It is created for reinforcing the financial position, replacing depreciable assets, redeeming liabilities, declaring constant rate of dividend, and conducting research and development activities. If the reserve are not required in the future, it can be distributed as a dividend to the shareholders.
Revenue Reserves Are Divided Into Two Types:
General Reserves: As the name suggests, the general reserves are not set aside by the company for specific purposes, but are kept aside to strengthen the financial position of the business.
Specific Purpose: As the name suggests, the special reserves are set aside by the company for specific purposes, and cannot be used for any other purpose. Special reserves are also often known as specific purposes. For example, a bad debts reserve is a debt that is set aside by the company if the customer fails to pay.
Distinguish Between Revenue Reserve And Capital Reserve
The distinguish between revenue reserve and capital reserve are discussed below:
Revenue Reserves
It is created out of revenue profits.
It is available for dividends.
It is used to meet unexpected losses or expenses.
It provides additional working capital to the business.
It is not mandatory
It is not mandatory to create such reserves.
Capital Reserve
It is created out of capital profits
It is not available for dividends.
It is used for writing-off various intangible and fictitious assets.
It does not provide any additional working capital to the business.
It is mandatory to create such reserves.
Differentiate Between Revenue Reserve And Capital Reserves: Tabular Form
Following table shows 10 significant points that differentiate between revenue reserve and capital reserve:
FAQs on Difference Between Capital Reserve and Revenue Reserve
Question 1: What are the different examples of revenue reserves and capital reserves?
Ans: The popular examples of revenue reserves are retained earning, general reserve, dividend equalization reserve, and dividend redemption reserve.
The popular examples of capital reserves are profits or issue of shares, issue of shares at a premium, sale of fixed assets, and profit on redemption of shares.
Question2: How revenue reserves are used by the company?
It is used as a great source of internal finance to meet the short-term requirement of the business.
It can be used to distribute among shareholders.
It can be received in monetary terms and also exists in the books of accounts.
It is used to replace old assets ( which are the immediate requirement of the business) or to pay off an urgent liability. It cannot be retained for the long term, but always plays a crucial role to meet the short or mid-term contingencies.
Question 3: What is the purpose of creating capital reserves?
Ans: The purpose of creating capital reserves is to prepare the company for sudden events like business expansion, inflation, and funds for a new project. A capital reserve is created from capital profit earned either through sales of capital assets such as the sale of fixed assets, or profit on the sale of shares.
Question 4: What are the three types of reserves in accounting?
Ans: The three types of reserves in accounting are revenue reserves, capital reserves, and specific reserves.
Question 5: What is the main purpose for creating capital reserves?
Ans: The main purpose for creating capital reserves are:
To issue bonus shares to the shareholders.
To write off intangible assets of the company such as goodwill, preliminary expenses, etc.
These reserves are provided for the premium payable on the redemption of debentures or redeemable preference shares.
To write off discounts that are allowed, commission paid or expenses incurred on the issue of shares or debentures of a company.
