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 4.26 that the definition of liabilities is ‘a present obligation of the entity to transfer an economic resource as a result of past events..’ With a liability there is a present obligation to transfer an economic resource from the firm in the future. With reserves, there is 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 obligations to transfer an economic resource (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.

videoAlso, see Martin’s videos Provisions and Reserves