Tag: kinds of reserves

Capital reserves are those reserves which are not created out of operating profits. Capital reserves refers to the amounts which are not free for distribution by way of dividend.. In case of companies, following are examples of capital reserves :

This statement is false. General Reserves are not kept aside for any particular purpose but for strengthening financial position of the company. Dividend Equalization reserve is a distributable reserve which is specifically set up to  ensure that dividends remain stable for despite being changes in earnings. Dividend equalization reserve is a specific reserve.

This statement is true. Secret reserves refers to a reserve the existence of which is not disclosed in the balance sheet. Secret reserves are also called as hidden reserve or internal reserve. When excess provision is created it reduces the profits of the company and create secret reserve. Such a reserve is not disclosed in the balance sheet. 

General reserve is a part of revenue reserve which is not created for any specific purpose. Example of such reserve include contingency reserve etc.

It is clear that if the preference shares are redeemed out of accumulated profit it will be necessary to transfer an amount equal to the amount repaid on redemption to capital redemption reserve account. if the company issues any fresh shares for redemption purpose the transferred amount will be the difference between nominal value of hare redeemed and the nominal value of share issued.

CRR = Nominal value of share redeemed - Nominal value of share issued

Therefore, in the given question amount should be transferred to capital redemption reserve account is :

Rs. 100000 - Rs. 40000 = Rs. 60000

(Rs. 100000 = Nominal value of share redeemed)

(Rs. 40000 = Nominal value of share issued)

The redempton of preference shares is subject to the following restrictions :

Redeemable Preference Shares: A company may issue this type of shares on the condition that the company will repay the amount of share capital to the holders of this category of shares after the fixed period or even earlier at the discretion of the company. Section 80 of the Companies Act, 1956 deals with the redemption of preference shares.

Before going to redeem the preference shares as per section 80 of the Companies Act, 1956, a company should have to follow the conditions: i) There must be a provision in the Articles of Association regarding the redemption of preference shares.

 ii) The redeemable preference shares must be fully paid up. If there is any partly paid share, it should be converted in to fully paid shares before redemption.

iii) The redeemable preference shareholders should be paid out of undistributed profit/ distributable profit or out of fresh issue of shares for the purpose of redemption.

 iv) If the shares are redeemed at a premium, it should be should be provided out of securities premium or profit and loss account or general reserve account.

 v) The proceeds from fresh issue of debentures cannot be utilized for redemption.

vi) The amount of capital reserve cannot be used for redemption of preference shares.

vii) If the shares are redeemed out of undistributed profit , the nominal value of share capital, so redeemed should be transferred to Capital Redemption Reserve Account. This is also known as capitalization profit.

Secret Reserves are created for contingency's, to avoid competitions, to provide additional working capital and to strengthen the financial position of the business firm.

Secret Reserve is not shown but its effects are seen as follows :
a) undervaluation of closing stock
b) charging Continent liabilities as actual liabilities.