Reserves are created by retention of profit in the business for either a general or a specific purpose. They are appropriations of profit meant to strengthen the financial position of the business. Unlike provisions, reserves are not a charge against profit as they are not meant to cover any known liability or expected loss. Reserves are shown under the head Reserves and Surpluses on the liabilities side of the balance sheet after capital.

1. General Reserve: When the purpose for which a reserve is created is not specified, it is called General Reserve. It is also termed as free reserve because the management can freely utilise it for any purpose. The main objective of creating a general reserve is to strengthen the financial position of the business.

2. Specific Reserve: Specific reserve is created for some specific purpose and can be utilised only for that purpose. Some important examples of specific reserves are:

• Dividend Equalisation Reserve: This reserve is created to stabilise or maintain dividend rate. In the year of high profit, amount is transferred to Dividend Equalisation Reserve. In the year of low profit, this reserve amount is used to maintain the rate of dividend.

• Workmen Compensation Fund: Created to meet future compensation claims of workers.

• Investment Fluctuation Fund: Created to adjust for fluctuations in the value of investments.

• Reserve for Redemption of Debenture: Created for the specific purpose of redeeming debentures.

Importance of Reserves: Reserves help in meeting future contingencies, strengthening the general financial position of the business, and redeeming long-term liabilities like debentures. They also help in conserving business resources for future expansion and growth.