What are Capital Reserve?
The term capital reserve does not include any amount regarded as free for distribution through the Profit and Loss Account. A capital reserve is generally created out of profits or gains of a capital nature which include the following:
1. Profit on reissue of forfeited shares.
2. Profit on sale of fixed assets.
3. Premium on issue of shares or debentures.
4. Profit prior to incorporation.
5. Profit on revaluation of assets and liabilities.
6. Profit on redemption of debentures. It arises when debentures are redeemed at a discount.
All these profits are not earned in the regular course of the business. Hence, it cannot be distributed by way of dividend amongst the shareholders. The capital profits may, however, be utilized either for the purpose of writing off intangible assets such as goodwill, copyrights, patents, etc., or preliminary expenses or discount on issue of shares or debentures or underwriting commission or to meet capital losses.
Capital reserve vs Reserve Capital
Capital Reserve and Reserve Capital are not the same. They are different from each other. Reserve Capital is that part of the company’s uncalled capital, which has to be called up only in the event of winding up of a company. The company can provide for this by special resolution. Such a conversion of equity capital into reserve capital is useful to third parties, as in the event of winding up of a company they are at least assured of getting this amount.
Auditor’s Duty in auditing of Capital reserve
1. The auditor should see that a capital reserve is created out of capital profit only.
2. He should ensure that capital reserve is utilized for meeting losses of capital nature.
3. In case capital reserve is used for distribution among the shareholders by way of dividend, he should examine the rules given in the Articles of Association and Law.
4. The auditor should see whether it is shown separately in the Balance Sheet and distinguished from the revenue or general reserve.
5. He should verify whether it is invested outside securities or retained in the business.