by A capital reserve is an account on the balance sheet to prepare the company for any unforeseen events like inflation, instability, need to expand the business, or to get into a new and urgent project.
A capital reserve is an account in the equity section of the balance sheet that can be used for contingencies or to offset capital losses. It is derived from the accumulated capital surplus of a company, created out of capital profit.
The term capital reserve is sometimes used for the capital buffers that banks have to establish to meet regulatory requirements and can be confused with reserve requirements, which are the cash reserves the Federal Reserve requires banks to maintain.
- Since a company sells many assets and shares and can’t always make profits, it is used to mitigate any capital losses or any other long-term contingencies.
- It works in quite a different way. When a company sells off its assets and makes a profit, a company can transfer the amount to capital reserve.
- Another thing that is important is nature. It is not always received in the monetary value but it is always existent in the book of accounts of the business.
- It has nothing to do with trading or operational activities of the business. It is created out of non-trading activities and thus it can never be an indicator of the operational efficiency of the business.
Objectives of Capital Reserve
- It helps in writing off financial losses.
- Surplus amount in Capital Reserve makes the organization financially strong.
- It is used to finance Long Term Projects of the company.
- It is maintained in order to protect the company during inflation or Economic Crisis.
- It helps in issuing bonus shares to shareholders.
- It is used to increase the working capital of an entity.
- It supports future contingencies of a firm.
Creation of Capital Reserve:
- Profit earned on selling investments.
- Profit earned on the sale of Fixed Assets.
- Profit received on buying an existing business.
- Premium received on issuing shares and debentures.
- Profit generated on the revaluation of assets and liabilities.
