Provision and reserves both are created for covering future losses. If we do not make, we can face lots of losses and it will be impossible for us to survive by tolerating such losses. So, as a good person, we need to create provisions and reserves. But both are different terms. You cannot use one term for other all the times. Know its main differences for proper use of both accounting terms.
Provision : Provision is created to show certain liability. For example, from past experience, we have know there will be 10% bad debts out of total debtor asset. So, out of total revenue, we deduct provision for doubtful debt as show it as current liability.
Reserve : Reserve is created to show unknown liability. For example, we are doing business in share market. It is risky business. So, we have created Risk for fluctuation in share market as $ 20,000. In past experience, there was no loss but still we are showing it as liability and deducting from our total revenue.
2. As per Law
Provision : As per law, to create provision is necessary. That is reason, we show it as expense side in profit and loss account.
Reserve : As per law, to create reserve is not necessary. That is the reason, we deduct it out of net profit by making profit and loss appropriation account.
3. Aim of Creation
Provision : Main aim is to create provision to cover loss due depreciation and bad debts. So, we can buy new fixed asset and invest more money in debtors.
Reserve : Main aim of reserve is to provide financial strength to the business.
4. Accounting Treatment
Provision : We debit the profit and loss account and credit the provision account.
Reserve : We debit the profit and loss appropriation account and credit reserve account.
Provision : Fund created with provision can not be invested outside the business
Reserve : Fund created with reserve can be invested outside the business.
6. Showing in Balance Sheet
Provision : It is shown in balance sheet by deducting specific asset.
Reserve : It is shown in the liability side of balance sheet under reserve and surplus heading.
7. Use of Dividend
Provision : It can not be used for giving dividend to shareholder.
Reserve : It can be used for giving dividend to shareholder.
8. Other Usage
Provision : It is created for covering specific loss, so use for same purpose. For example, provision for depreciation fund can only be used for buying new fixed asset.
Reserve : Reserve can be used by any other purpose.