Reserves are the surplus created out of profits earned. Reserves cannot be created when the business unit suffers losses during a defined period.

Explanation: Reserves are created out of profits for various purposes right for the contingency needs to a specified purpose of development or investment. When then there are losses, there is no meaning in creating reserves because the word “reserves” means “retained earnings”. However, accumulated reserves could be used for equalizing the dividends, or for wiping the losses etc