Reserve
Also written Reserves
Part of a company's equity set aside from profit for a general or specific future use, such as a general reserve or a capital reserve — distinct from a provision, which is a liability.
In plain language
When a company retains profit rather than paying it all out as dividend, some of that retained amount can be earmarked for a purpose the board chooses. That earmarked portion is a reserve.
A reserve sits in equity, not in liabilities — it belongs to the shareholders, even though it is not sitting in cash waiting to be distributed.
How it works
The workbook names three kinds. General reserve: "the part of retained earnings which a company has set aside for utilising in future for any specific purpose." Capital reserve and revaluation reserve: "the surplus arising out of recognizing asset at values above its acquisition price" — critically, "these reserves are typically not available for distribution as dividend," unlike general reserve or retained earnings.
The word "reserve" carries other meanings elsewhere in this same workbook — a bank's cash reserve ratio, a country's reserve currency, and a central bank's gold reserves are all different concepts that happen to share the word. This equity-side meaning, from Chapter 8, is the one meant here.
A worked example
Illustrative. A company retains Rs 40 crore of annual profit. Its board earmarks Rs 15 crore of it as a general reserve for future expansion, leaving Rs 25 crore in ordinary retained earnings.
Separately, when the company revalues a factory building upward by Rs 10 crore, that entire amount is booked to a revaluation reserve — money that adds to reported equity but, unlike the general reserve or retained earnings, cannot be paid out to shareholders as a dividend.
Why NISM asks about it
Chapter 8.3.1 (Balance Sheet, the Equity section) sets out general reserve, capital reserve and revaluation reserve together. Expect a question testing which reserves are distributable as dividend and which are not, or one distinguishing a reserve from a provision.
Common exam traps
- Capital and revaluation reserves are not distributable as dividend, unlike general reserve or retained earnings — a common trap in a question about what a company can legally pay out.
- "Reserve" means several different things across this workbook — this equity item, a bank's cash reserve ratio, and a country's reserve currency are unrelated concepts that only share a name. Read the chapter, not just the word.
Check yourself
1.Statutory Liquidity Ratio (SLR) refers to the minimum percentage of total deposits which commercial banks have to hold in:
- a)Cash reserves with the central bank
- b)Cash equivalents such as gold and Government of India securities
- c)Current accounts with other commercial banks
- d)Foreign currency assets
Show the answer
Answer: (b) Cash equivalents such as gold and Government of India securities
SLR is the minimum percentage of total deposits banks must hold in cash equivalents such as gold and Government of India securities — held by the bank itself.
Option A is the definition of CRR — the Cash Reserve Ratio is the minimum percentage of total deposits held as cash reserves with the central bank. Both definitions begin with the identical phrase "minimum percentage of the total deposits", so the phrase cannot separate them. What separates them is the form of the asset (cash versus gold and G-secs) and where it is held (with the central bank versus with the bank itself).
Options C and D are not part of either definition.
2.Which of the following would be classified as an economic factor in a PESTLE analysis?
- a)Freedom of the press and ease of doing business
- b)Forex reserves and the monetary policy of the central bank
- c)Consistency of the legal system and enforcement of contracts
- d)Policies on waste disposal and protection of natural flora and fauna
Show the answer
Answer: (b) Forex reserves and the monetary policy of the central bank
Forex reserves and the monetary policy of the central banker are both listed by the workbook under Economic factors, along with GDP growth, inflation and interest rates, imports and exports, balance of payments, exchange-rate stability, taxation and a country's dependence on other countries for natural resources such as oil.
Option A is Political — stability in legislation and policy, minimal corruption and bureaucracy, freedom of press, ease of doing business. Option C is Legal, where the workbook cites the Vodafone retrospective tax case and the cancellation of telecom and mining licences. Option D is Environmental.
This maps directly onto a workbook sample question, which offers forex reserves, RBI monetary policy and resource dependence and asks which is economic — the answer there is "all of the given options".
3.When a company issues new shares to its existing shareholders without any consideration, it is known as a:
- a)Rights issue
- b)Bonus issue
- c)Preferential issue
- d)Buyback
Show the answer
Answer: (b) Bonus issue
A bonus issue, also known as equity dividend, is an alternative to cash dividend. Bonus shares are issued to the existing shareholders by the company without any consideration from them.
What actually happens in the books: the reserves lying in the books of the company (shareholders' money) gets transferred to another head i.e., paid-up/subscribed capital. Issuance of bonus shares is termed as capitalization of reserves.
Option A is the other route to existing shareholders, but at a price: in a rights issue, shareholders buy shares offered to them — generally offered at a discount to the prevailing market prices, but not free.
And the workbook's assessment of what a bonus achieves: the shareholders do not pay anything for these shares and there is no change in the value of their holdings in the pre and post-bonus stages. The issuance of bonus shares is more to influence the psychology of investors without any economic impact.
The ratio convention: a bonus issue in the ratio of 1:3 entitles a shareholder for 1 bonus share for every 3 shares held by them.
Where this is taught
Free preparation for NISM Series XVRelated terms
- Book valueA company's net worth — equity capital plus reserves — divided by its outstanding shares, the accounting value each share would theoretically get if the company wound up today.
- Off-balance sheet itemAn asset, liability or exposure that does not appear on a company's balance sheet, such as certain leases, contingent liabilities or derivative contracts disclosed only in the notes.
- ProvisionAn amount a company sets aside on its balance sheet for a liability that is probable but whose exact amount is not yet known, such as a warranty or a pending legal claim.
- Qualified audit reportAn auditor's opinion that part or all of a company's financial statements do not give a true and fair view — issued when the auditor disagrees with an accounting policy or finds a serious discrepancy.
- GoodwillThe amount an acquirer pays over and above the fair value of the net assets it takes over, shown as an intangible asset and tested periodically for impairment.