If the amount of Reserve is invested in the business itself, it will be simply called "Reserve", but if invested in outside securities and such securities are appropriated (devoted to a specified purpose) for the reserve, it is called "Reserve Fund".
Reserves may be "general" or "specific". General reserve is meant for the purpose of strengthening the financial position of the company so as to enable it to meet any contingency that may arise. Specific reserves (note the word used in plural) are meant for specific purposes. One important purpose is Dividend Equalization. Dividend Equalization Reserve helps to so manage that the dividends that the company may pay in future are as far as possible uniform. In years of low profits, this Reserve can allow maintaining the dividend at the desired level.
Reserve may be Revenue Reserve or Capital Reserve. Capital Reserves shall not include any amount regarded as freely utilisable for distribution through the P & L A/c; any other reserve amount is Revenue Reserve. However, mutual reallocation is possible. On the occurrence of certain events, profits which were previously treated as Capital Reserve may become available for dividend payments; they will thereafter be Revenue Reserve. Following three such eventualities are prominently recognised :
- Debenture Redemption Reserve is built up of Revenue profits for the purpose of collecting funds for the redemption of debentures or repayment of any other fixed liability. On completing the redemption, the balance can be used for dividend payments. Any further balance will be converted to Capital Reserve or General Reserve.
- Plant Replacement Reserve is meant to come in handy for the indicated purpose. Amount of depreciation based on cost for the current asset may not meet the price to be paid to replace the asset on the expiry of its life. This Reserve, together with the amounts under depreciation pooling, is intended to effect the replacement at the proper time. Once the replacement is effected, any balance will be converted to Capital Reserve or General Reserve.
- Development Rebate Reserve is governed by elaborate set of legal conditions and is, as permitted under such conditions, available for new acquisition of productive assets, setting up plants and industries in designated areas (for the industrial growth of such areas), and so on. (Investment Allowance is another legally governed opportunity for the same purposes. This is managed by debiting the P & L A/c and crediting an "Investment Allowance Reserve Account".)
The Reserves discussed under generalhpecific classification and RevenueICapital classification above do not affect the Share Capital (discussed further on). In a different category of Reserve, the amount transferred from profits into it are never (to be) available for dividends. Companies issue what are called Redeemable Preference Shares. When the company eventually carries out the Redemption of these shares out of profits, they have to do so by transfer of an amount equal to the face value of the shares (to be) so redeemed from out of their P & L A/c or general reserve into an account designated as "Capital Redemption Reserve Account". This can be utilised only for the issue of fully-paid bonus shares. For any other use, Court sanctions have to be obtained; such reductions in this Account will be treated as reduction in Share Capital.
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