Equity: Q2

Q2: How are reserves different to provisions?

A:

The key difference between provisions and reserves is that provisions are liabilities and reserves are equity. We have seen in AASB CF Framework para 49 (b) that the definition of liabilities is ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.’ With a liability there is an expectation of the outflow from the firm in the future of economic benefits arising from a present obligation. So with provisions, we expect a future outflow of economic benefits; with reserves there is no such expectation and no such present obligation. Rather, reserves represent the results of past value creation activities of a firm that are now used to support future value generating activities of our firm.

Another key difference is that provisions arise from entries where judgements and estimates are made about future loss of economic benefits (for example, Provision for warranties). Also, unlike reserves, provisions are defined in the accounting standards, in AASB 137 Provisions, Contingent Liabilities and Contingent Assets para 10: “A provision is a liability of uncertain timing or amount.” For reserves, we will have to make do with Martin Turner’s definition of reserves in Section 8.1 above.

videoAlso, see Martin’s videos Provisions and Reserves

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