Provision vs Reserve: Difference with Examples
Definition
A provision is a charge against profit for a known liability or loss whose amount is uncertain, such as doubtful debts or warranty claims. A reserve is a part of profit set aside after it is earned, to strengthen the business — it is an appropriation, not an expense.
| Term | Provision vs reserve |
|---|---|
| In Hindi | प्रावधान और संचय (रिज़र्व) |
| Area | Accounting |
| Search phrase | difference between provision and reserve |
| Try it | Balance sheet format |
प्रावधान और संचय (रिज़र्व) — हिंदी में अर्थ
प्रावधान ज्ञात देनदारी या हानि के लिए लाभ पर डाला गया खर्च है जिसकी राशि अनिश्चित है, जैसे संदिग्ध ऋण। संचय (रिज़र्व) कमाए गए लाभ का वह हिस्सा है जो व्यवसाय को मज़बूत करने के लिए अलग रखा जाता है — यह खर्च नहीं, लाभ का विनियोजन है।
Key differences
Nature: a provision is a charge against profit; a reserve is an appropriation of profit. Timing: a provision must be made whether or not there is a profit; a reserve can only be created out of profit. Purpose: a provision meets a specific known liability or loss; a reserve is for general strength or a stated future purpose. Balance sheet: provisions sit under liabilities (or are deducted from the asset, as with doubtful debts); reserves sit under shareholders' funds as 'reserves and surplus'.
Common examples
Provisions: provision for doubtful debts, provision for warranty, provision for tax, provision for gratuity and leave encashment. Reserves: general reserve, capital reserve, securities premium, capital redemption reserve, and the balance in the P&L (surplus).
Example
Debtors are ₹10,00,000 and 5% are expected to be doubtful: Profit and Loss A/c Dr ₹50,000; To Provision for Doubtful Debts ₹50,000 — debtors shown at ₹9,50,000. After a net profit of ₹20,00,000, the owners transfer ₹2,00,000 to General Reserve: Profit and Loss Appropriation A/c Dr; To General Reserve A/c.
Related tools and guides
Frequently asked questions
What is the main difference between provision and reserve?
A provision is a charge against profit for a known liability; a reserve is profit set aside after it is earned.
Can a reserve be created in a loss year?
No. Reserves come out of profit. Provisions must be made even in a loss year.
Is provision for tax a provision or a reserve?
A provision — it meets a known liability whose exact amount is fixed later.
Where is a reserve shown in the balance sheet?
Under shareholders' funds as reserves and surplus (for companies), or added to capital for proprietors and firms.
Related terms
- Accounts receivableAccounts receivable is the money customers owe a business for goods or services already supplied on credit. It is shown as trade receivables (debtors) under current assets.
- Accrual vs cash basis of accountingUnder the accrual (mercantile) basis, income and expenses are recorded when they are earned or incurred, whatever the payment date. Under the cash basis, they are recorded only when cash is actually received or paid.
- Balance sheetA balance sheet is a statement of what a business owns (assets) and what it owes (liabilities and owners' equity) on a particular date. Total assets always equal total equity plus liabilities.
- Cash conversion cycleThe cash conversion cycle (CCC) is the number of days between paying for raw material and collecting cash from the customer for the finished goods: days inventory outstanding plus days sales outstanding minus days payables outstanding.
- Contra entryA contra entry is a transaction between cash and bank accounts of the same business — such as cash deposited into the bank or cash withdrawn for office use — where both the debit and the credit side are cash or bank.
- Contribution marginContribution margin is selling price minus variable cost. It is the amount each sale contributes first towards fixed costs and then to profit; as a percentage of sales it is called the contribution margin ratio or P/V ratio.