Types of Reserves in Accounting

Capital reserves are those reserves which are not created out of operating profits. Capital reserves refers to the amounts which are not free for distribution by way of dividend.. In case of companies, following are examples of capital reserves :

This statement is false. General Reserves are not kept aside for any particular purpose but for strengthening financial position of the company. Dividend Equalization reserve is a distributable reserve which is specifically set up to  ensure that dividends remain stable for despite being changes in earnings. Dividend equalization reserve is a specific reserve.

This statement is true. Secret reserves refers to a reserve the existence of which is not disclosed in the balance sheet. Secret reserves are also called as hidden reserve or internal reserve. When excess provision is created it reduces the profits of the company and create secret reserve. Such a reserve is not disclosed in the balance sheet. 

General reserve is a part of revenue reserve which is not created for any specific purpose. Example of such reserve include contingency reserve etc.

It is clear that if the preference shares are redeemed out of accumulated profit it will be necessary to transfer an amount equal to the amount repaid on redemption to capital redemption reserve account. if the company issues any fresh shares for redemption purpose the transferred amount will be the difference between nominal value of hare redeemed and the nominal value of share issued.

CRR = Nominal value of share redeemed - Nominal value of share issued

Therefore, in the given question amount should be transferred to capital redemption reserve account is :

Rs. 100000 - Rs. 40000 = Rs. 60000

(Rs. 100000 = Nominal value of share redeemed)

(Rs. 40000 = Nominal value of share issued)

The redempton of preference shares is subject to the following restrictions :

Redeemable Preference Shares: A company may issue this type of shares on the condition that the company will repay the amount of share capital to the holders of this category of shares after the fixed period or even earlier at the discretion of the company. Section 80 of the Companies Act, 1956 deals with the redemption of preference shares.

Before going to redeem the preference shares as per section 80 of the Companies Act, 1956, a company should have to follow the conditions: i) There must be a provision in the Articles of Association regarding the redemption of preference shares.

 ii) The redeemable preference shares must be fully paid up. If there is any partly paid share, it should be converted in to fully paid shares before redemption.

iii) The redeemable preference shareholders should be paid out of undistributed profit/ distributable profit or out of fresh issue of shares for the purpose of redemption.

 iv) If the shares are redeemed at a premium, it should be should be provided out of securities premium or profit and loss account or general reserve account.

 v) The proceeds from fresh issue of debentures cannot be utilized for redemption.

vi) The amount of capital reserve cannot be used for redemption of preference shares.

vii) If the shares are redeemed out of undistributed profit , the nominal value of share capital, so redeemed should be transferred to Capital Redemption Reserve Account. This is also known as capitalization profit.

Secret Reserves are created for contingency's, to avoid competitions, to provide additional working capital and to strengthen the financial position of the business firm.

Secret Reserve is not shown but its effects are seen as follows :
a) undervaluation of closing stock
b) charging Continent liabilities as actual liabilities.

"A reserve which is not visible on the balance sheet is called secret reserves."  It is also known as "Hidden reserve" or "Inner reserve".
It is a surplus concealed. In case of a secret reserve existence the actual financial position of the business is better than shown in the balance sheet. In case of bank, insurance companies and financial institutions secret reserves are justified.

An amount retained from earnings to provide for  distribution of a minimum dividend in subsequent business periods.

Workmen Compensation is a type of insurance policy that safeguards an employee against any injury or death during the job time. The total cost of medical treatment and low wages are covered under Workmen Compensation Insurance Policy, in case the injury is caused during or due to employment. Workmen Compensation Fund is mandatory under the Workmen's Compensation Act, 1923 in India.

According to the amendments in Indian Companies Act, 1956 in 2000, it is stated that Indian corporation who issue debentures must maintain a reserve to protect the investors against possible default  by the company. This reserve is  known as debenture redemption reserve. It states that an adequate amount must be transferred from profits every year to this reserve until issued debentures are redeemed. 

Specific reserve is that reserve which is created for a specific purpose and can be utilized only for that purpose. For example, Dividend Equalization Reserve is a specific reserve, because it is created to maintain a steady rate of dividend flow. Debenture redemption reserve, Capital redemption reserve, Investment fluctuation reserve etc. are the example of specific reserve.

A reserve fund is a saving account or other highly liquid asset set aside by an individual or business to meet any future costs or financial obligations, especially those arising unexpectedly. 

Any surplus in Sinking fund account may be transferred to general reserve account. If any deficit, that may be transferred to profit and loss account. The journal entry for this transaction is:

Any surplus in Sinking fund account may be transferred to general reserve account. If any deficit, that may be transferred to profit and loss account. The journal entry for this transaction is:

The Capital Redemption Reserve (CRR) is a restricted reserve created under the Companies Act and can only be used for specific purposes, such as issuing fully paid-up bonus shares.

As per the Companies Act 2013, CRR is created
from the Profits of the company which only includes the Free Reserves.

Hence, Free Reserve includes following items:

1. Profit and loss accounts

2. General Reserve funds

3. Contingency reserve

4. Dividend equalisation reserve

5. Workmen compensation fund

6.  Workmen accident fund

Therefore, CRR can be created from the above mentioned accounts in the same order of preference.

Initial debtors = 50,000. Bad debts = 1,000. New debtors = 49,000. Required reserve at 5% = 2,450. Existing reserve = 2,000. Amount to be charged to P&L = 2,450 - 2,000 = 450.

An Investment Fluctuation Reserve is specifically created to absorb potential losses arising from the volatility in the market value of investments.

Investment Fluctuation Reserve: To bear any loss in case of decrease in value of such investments, business enterprises sets aside a part of profit in Investment Fluctuation Reserve, so that any loss arising on account of decrease in value of such investment can be met from this reserve.

A specific reserve is one, which is created for some specific purpose by debiting Profit and Loss Appropriation Account. Normally, it is available for the purpose for which it has been created.

The
issue of shares at par implies that the shares have been issued for an amount
exactly equal to their face or nominal value. 

The issue of shares at par implies that the shares have been issued for an amount exactly equal to their face or nominal value. In case shares are issued at a premium, i.e. at an amount more than the nominal or par value of shares, the amount of premium is credited to a separate account called ‘Securities Premium Reserve Account’ under the head Reserves and surplus in the balance sheet.

It can be used only for the following five purposes:-

(a) To issue fully paid bonus shares to the extent not exceeding un-issued share capital of the company;

(b) To write-off preliminary expenses of the company;

(c) To write-off the expenses of, or commission paid, or discount allowed on any securities of the company; and

(d) To pay premium on the redemption of preference shares or debentures of the company.

(e) Purchase of its own shares (i.e., buy back of shares).

The issue of shares at par implies that the shares have been issued for an amount exactly equal to their face or nominal value. In case shares are issued at a premium, i.e. at an amount more than the nominal or par value of shares, the amount of premium is credited to a separate account called ‘Securities Premium Reserve Account’ under the head Reserves and surplus in the balance sheet.

It can be used only for the following five purposes:

(a) To issue fully paid bonus shares to the extent not exceeding unissued share capital of the company;

(b) To write-off preliminary expenses of the company;

(c) To write-off the expenses of, or commission paid, or discount allowed on any securities of the company; and

(d) To pay premium on the redemption of preference shares or debentures of the company.

(e) Purchase of its own shares (i.e., buy back of shares).

When the purchase consideration (1,00,000) is less than the value of net assets acquired (1,20,000), the difference represents a capital gain, which is credited to the Capital Reserve account.

When two or more partnership firms are amalgamated, the books of old firm are closed and books of new firm are opened.

From the above conditions it is clear that if the preference shares are redeemed out of accumulated profit it will be necessary to transfer an amount equal to the amount repaid on redemption to capital redemption reserve account. if the company issues any fresh shares for redemption purpose the transferred amouunt will be the difference between nominal value of hare redeemed and the nominal value of share issued.

CRR = Nominal value of share redeemed - Nominal value of share issued

Therefore, in the given question amount should be transferred to capital redemption reserve account is :

Rs. 100000 - Rs. 50000 = Rs. 50000

(Rs. 100000 = Nominal value of share redeemed)

(Rs. 50000 = Nominal value of share issued)

Redeemable preference shares :                                             $Rs.200000$

Redeemable preference shares :                                             $Rs.200000$

Reserves which are created out of capital profit are known as capital reserve. Generally these reserves are not available for distribution as dividend among shareholders. Example of such reserves are - Profit prior to incorporation, Profit on forfeiture of shares, etc. In short, all capital profits are regarded as capital reserves.

Secret reserve is a reserve, the existence and/ or the amount of which is not disclosed in the balance sheet. It is also called as "Hidden Reserves or Internal Reserves."

Secret reserve is a reserve, the existence and/ or the amount of which is not disclosed in the balance sheet. It is also called as "Hidden Reserves or Internal Reserves."

Option C is the correct One.