January 26, 2022

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Meaning of Revenue Reserves in Accounting and key Explanations

Meaning of Revenue Reserves in Accounting and key Explanations
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For a business, keeping certain funds as reserve is like saving for the rainy days. Businesses are stronger when they maintain a culture of setting aside funds to meet planned and unexpected events. This article discusses revenue reserves to some extent.

Definition of Revenue Reserve

It can be defined as a fund established by the board of directors or the owner(s) of a business from the profit earned in a particular accounting year.

Key Explanations

The fund is established by the board of directors. The Board of directors may decide to set aside the fund. This is decided after recognising that the firm has earned profit for the year. Normally, the amount to set aside is stated as a percentage of retained earning. For example, the Board may agree that 20 percent of profit should be set aside as the reserve.

Read: Meaning of Statutory Reserves and key Explanations

The board of directors may set aside this money voluntarily or by a legal right. For voluntary revenue reserve, it is the entity’s top management that has decided to keep the fund for the business. Legal or statutory reserves are compulsory.

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The government or one of its agencies has bluntly told companies in a particular sector of the economy to keep the fund. Liquidity reserves is a good example of this. The Central Bank of Nigeria huge all commercial banks to have these funds in their books of accounts.

A Board may decide not to set aside money but keep the profit. The truth is the retained earnings or net profit in the books of account of a business is a revenue reserve. Insofar, the entity does not use its remaining profit for any planned business activity.

Note that small business owners may decide to set aside money from profit. When this is a case, the business must establish the account under discussion. This is a good thing as it helps the owner(s) not to withdraw all the profits for their personal use.

Types of Revenue Reserve

Two types of this fund exist. General and specific.

General Reserves: This amount is set out of profit for general use. The board does not have any specific reason for this fund. The fund is for events the entity does not plan will occur. The reserve may be plough back into the business the following year. It might be used to pay dividends during the next year. Or meet other unexpected contingencies.

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Specific Reserve: This is arranged by the Board members or owner(s) of the business for a particular reason. A statutory reserve is a specific fund. There is a reason the government or its agencies want the entity to keep such funds. A company’s board may decide to keep money to repay debt, pay dividend or bonus shares. Meet a known contingency and so on.

Advantages of Revenue Reserve

It helps investors boost confidence in the business. Since the money will be used for planned and unplanned events, the investors know that their money is in good hands.

It can be used to pay debt. If the entity has a huge debt in the previous years. It may decide to use the reserve fund to pay up the obligations.

Read: Meaning of Reserves (accounting) and key Explanations

It can be used for the rainy days. Since businesses operate under a world of uncertainty, the fund kept can be used if unseen events occurred.

It can be created to melt inflation and volatility of foreign exchange. Prices of goods may rise the following year, setting a fund aside can help melt the effect of rise in price and keep the business going despite the odds. Also, volatility occurs with exchanges of currency. If the business buys its goods outside the country, it definitely will be affected by changes in exchange rate from time to time. To beat the effect of the exchange rate, money can be set aside for it.

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Conclusion

To conclude, revenue reserve is decided by the entity’s board of directors from profit. Normally, the aim is to provide funds within one year. And money may be a voluntary one or mandatory by a legal law. In any case, the reserve helps keep the business strong and healthy.

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