What are General Reserves?
Retention of profit with no specific purpose may be utilized by the company for many purposes. The Board of Directors decides upon the percentage of profit to be appropriated to general reserve. The company law also requires a company to transfer a specific percentage of profit to be transferred to general reserve before declaring dividend. Articles of Association of a company may direct the company in this regard.
Purpose of General Reserves
The general reserve may act as a cushion (buffer) at the time of financial crisis, by providing funds for
- working capital.
- meeting long term liability
- expansion of business.
- acquiring capital assets.
- meeting unexpected liability.
General reserve can also be utilized for distribution as dividend, whenever the current profits are inadequate.
What are Special Reserves?
When the profit is appropriated and transferred to a reserve created for special purpose, it is called special reserve. Special reserve may be created in the following situations –
- As per the decisions made by the board of directors.
- As per the requirement of Articles of Association
- To comply with the requirements of Companies Act. (Example — Capital redemption reserve)
Some of the example of special reserves are:
- Dividend Equalization reserve
- Staff welfare reserve.
- Debenture redemption reserve, etc.
Of the various special reserves, only dividend equalization reserve can be utilized for payment of dividend. All the other reserves can be utilized only for the purpose for which they are created. If there is any surplus in such reserves, such excess amount can be utilized for payment of dividend.
Duties of an Auditor in verification of General and Special Reserves
1. The auditor has to verify the minutes of the board of directors and ensure that the profits are appropriated as per the decision taken by the directors.
2. The auditor should ensure that the requirements of Articles of Association regarding the appropriation of profit to general or special reserves are duly followed by the company.
3. The auditor should verify the accounts and ensure that the company has transferred the required amount to the general reserves and special reserves before declaring the dividend, as required by the company law.
4. If any part of the general reserve is utilized for payment of dividend, the auditor should ensure that the provisions of Companies Act are duly complied with.
5. The auditor should also ensure that the reserves are utilized only for the purpose for which they are created.
6. He should also ensure that the general reserves and special reserves are disclosed in the liabilities side of the balance sheet under appropriate heads.