Depreciation, Provisions and Reserves

itself from the consequences of unknown expenses and losses, it may be required to bear in future. It may also regard it as more appropriate in certain cases to reduce the amount that can be drawn by the proprietors as profit in order to conserve business resource to meet certain significant demands in future. An example of such a demand is the much needed expansion in the scale of business operations. This is presented as the justification for reserves in business activities and in accounting.

The amount so set aside may be Meeting a future contingency Strengthening the general financial position of the business; Redeeming a long-term liability like debentures, etc. Secret reserve is a reserve which does not appear in the balance sheet. It may also help to reduce the disclosed profits and also the tax liability . The secret reserve can be merged with the profits during the lean periods to show improved profits.

Management may resort to creation of secret reserve by charging higher depreciation than required. It is termed as ‘Secret Reserve’, as it is not known to outside stakeholders. Secret reserve can also be created by way of : Charging capital expenditure to profit and loss account