What is the difference between a provision and a reserve?

What the interviewer wants to hear

• Provision is for a known liability or loss with uncertain amount or timing
• Provision is a charge against profit
• Reserve is an appropriation of profit and part of equity
• Examples of each

Model answer

A provision is an amount set aside for a present obligation or expected loss where the amount or timing is uncertain, for example a warranty provision, a provision for a lawsuit we will probably lose, or an allowance for doubtful debts against receivables. It is a charge against profit, so it is booked as an expense whether the company makes a profit or a loss. A reserve is different: it is an appropriation of profit kept in the business, shown under equity. Examples are retained earnings, general reserve, securities premium or a capital reserve. Creating a reserve does not reduce profit for the year; it only shows how profit after tax is kept or used. So provisions reduce profit and sit in liabilities or against assets, while reserves come out of profit and belong to the shareholders.

More easy Accountant questions

• Explain double-entry bookkeeping to someone new, using a simple example.
• What is the difference between cash basis and accrual basis accounting, and why do companies use accrual?
• Walk me through how you prepare a bank reconciliation statement.
• Explain CGST, SGST and IGST. When does each apply?
• How does a transaction travel from a source document all the way to the financial statements?
• What is depreciation and why do businesses charge it?
• Explain input tax credit under GST with a simple example.
• How would you handle a weekly vendor payment run?
• Name the main financial statements and explain how they are linked.