A companies share capital will remain fixed from year to year, unless new shares are issued. Reserves are difficult to define neatly since different reserves arise for different reasons, but it follows from the above that:
Reserves = net assets – share capital
So the total amount of reserves in a company varies, according to changes in the net assets of the business.
A distinction should be made between:
• Statutory reserves, which are reserves which a company is required to set up by law, e.g., the revaluation reserve, and which are not available for the distribution of dividends.
• Not statutory reserves, which are reserves consisting of profits which are distributable dividends, if the company so wish.
Profit and Loss Reserves
The most significant not-statutory reserve is variously described as:
• Revenue reserve
• Retained profits
• Retained earnings
• Undistributed profits
• Profit and loss account
• Un-appropriated profits
These are profits earned by the company and not appropriated by how to start a Limited company dividends, taxation or other transfer to another reserves account.
Provided that a company is earning profits, this reserve generally increases from year to year, as most companies do not distribute all their profits as dividends. Dividends can be paid from it: even if a loss is made in one particular year, a dividend can be paid from previous years’ retained profits.
Very occasionally, you might come across a debt balance on the profit and loss account. This would indicate that the company has accumulated losses.
Not Statutory Reserves
The company directors may choose to set up other reserves. These may have a specific purpose (e.g. plant and machinery replacement reserve) or not (e.g. general reserve). The creation of these reserves usually indicates a general intention not to distribute the profits involved at any future date, although legally any such reserves, being not-statutory, remain available for the payment of dividends.
Distinction between reserves and provisions
A reserve is an appropriation of distributable profits for a specific purpose while a provision is an amount charged against revenue as an expense. A provision relates either to a diminution in the value of an asset or a known liability, the amount of which cannot be established with any accuracy.