Capital Reserve

A capital reserve is an accounting term that refers to a reserve fund that is set aside for long-term projects or other significant ventures. It is part of a company's equity that is not appropriate for distribution as dividends to shareholders.
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Overview

What is a Capital Reserve?

A capital reserve is an entry on a company’s balance sheet that represents profits earmarked for specific, non-operational purposes. Unlike revenue reserves, which are often distributed as dividends to shareholders, capital reserves are set aside for long-term investments, acquisitions, expansion, or to tackle contingencies. Therefore, these reserves play a crucial role in strengthening a company’s financial stability and facilitating its long-term strategy.

Examples

  1. Asset Revaluation Reserve: The uplift in value from an asset revaluation goes to a capital reserve.
  2. Share Premium Account: Excess money received from shareholders over and above the par value of the shares is recorded in the capital reserve.
  3. Capital Redemption Reserve: Formed when a company buys its own shares out of profits or fresh capital.

Frequently Asked Questions

What is the difference between a Capital Reserve and a Revenue Reserve?

  • Capital Reserve: Set aside for long-term investments, not for dividend distribution.
  • Revenue Reserve: Generated from a company’s operational profits, usually distributed as dividends.

Can Capital Reserves be used for dividend distribution?

No, funds held in capital reserves are generally not distributed as dividends. They are specifically set aside for long-term projects, debt repayment, or other significant investments.

What are some common sources of Capital Reserves?

Sources can include profits from the sale of fixed assets, capital profits, excess money received from issuance of shares, or premiums on debenture redemption.

Why are Capital Reserves important?

Capital reserves provide financial stability, support expansions, and act as a buffer against unforeseen contingencies, thereby safeguarding a company’s future viability.

How is a Capital Reserve reported on the balance sheet?

Capital reserves appear under shareholders’ equity on the liabilities side of the balance sheet. It is distinctly categorized separately from revenue reserves.

Undistributable Reserves

Reserves that cannot be legally distributed as dividends to the shareholders including both capital reserves and some statutory reserves that must be maintained as part of terms and conditions.

Share Premium Account

Funds collected in excess of the nominal value of the shares and used as part of the capital reserve.

Asset Revaluation Reserve

Increase in the carrying amount of an asset due to revaluation, recorded in a separate reserve account under equity in the balance sheet.

References and Online Resources

  1. Investopedia: Capital Reserve
  2. Accounting Coach: Undistributable Reserves
  3. Corporate Finance Institute: Understanding Reserves

Suggested Books for Further Studies

  1. Financial Accounting Theory and Analysis: Text and Cases by Richard G. Schroeder
  2. Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
  3. Accounting Principles by Jerry J. Weygandt, Paul D. Kimmel, Donald E. Kieso
  4. Corporate Finance For Dummies by Michael Taillard

Accounting Basics: “Capital Reserve” Fundamentals Quiz

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Thank you for delving into the intricate world of capital reserves. Armed with this knowledge and the practice quiz, you’re well on your way to mastering essential accounting concepts.

Capital Resource
Capital Requirement