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Learning Objective:
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What is the difference between
reserve and reserve fund?
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What are the advantages of
reserve fund?
Contents:
There are various types of
reserves. To read a detailed article about
reserves please visit our
reserves article. On this page we are
going to explain the difference between
reserve and reserve fund. The portion of profit that
is kept in the business to increase working capital and to strengthen
the
financial position of the business is
known as reserve. In many
cases the amount of reserve is invested out side the
business in government papers or in gilt-edged
securities, then it is known as reserve fund. Thus
the amount of reserve which is not invested outside
the business is only reserve, while reserve invested
outside the business in some quickly saleable assets
is called reserve fund. However, in actual practice
no distinction is usually draw between the two,
i.e., reserve and reserve fund are used in the same
sense.
A business has earned a profit of
$8,000 for the year ended 31.12.2005 and 10% of the
profit is to be transferred to reserve. The entry
will be:
| Profit and loss
appropriation a/c |
Dr. |
800 |
|
|
Reserve a/c |
|
|
800 |
| (Being the amount of profit
appropriated to reserve) |
|
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Balance Sheet (extracts)
As at 31.12.2005
|
Assets |
$ |
Liabilities |
$ |
|
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Reserve |
800 |
|
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Profit and loss appropriation a/c |
7,200 |
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If the amount of reserve is invested
outside the business, there will be an additional
entry:
| Reserve fund investment a/c |
Dr. |
800 |
|
|
Bank a/c |
|
|
800 |
| (Being the amount of reserve
invested) |
|
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This effect will be shown in the
balance sheet as follows:
Balance Sheet (extracts)
As at 31.12.2005
|
Assets |
$ |
Liabilities |
$ |
|
Reserve fund investment |
800 |
Reserve |
800 |
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Profit and loss appropriation a/c |
7,200 |
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The following advantages are
obtained from reserve fund:
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Regular income is earned from
investment
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The investment having been made
in Government Papers of gilt-edged securities
the amount of reserve is safe.
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Money can be obtained by selling
investments, whenever necessary.
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There may be a profit on sale of
investments, if market price rises. There will,
however, be loss if market price falls.
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