Provision vs Reserve
A provision is a charge against profit made for a known liability whose amount is uncertain. A reserve is an appropriation of profit set aside to strengthen the business. One reduces profit; the other distributes it.
The quick answer
A provision must be created whether or not there are profits, because it recognises an expense already incurred. A reserve is created only out of profits, at management's discretion, and represents retained earnings rather than a cost.
Side-by-side comparison
| Basis | Provision | Reserve |
|---|---|---|
| Nature | Charge against profit — an expense | Appropriation of profit — retained earnings |
| Purpose | To meet a known liability of uncertain amount | To strengthen financial position or meet future needs |
| Created when there is a loss? | Yes — mandatory regardless of profits | No — can only be created out of profits |
| Effect on profit | Reduces net profit for the period | Does not reduce profit; allocates it |
| Shown in balance sheet | Deducted from the related asset or shown as a liability | Shown under Reserves and Surplus in equity |
| Distributable as dividend | No | Yes, in the case of free reserves |
| Examples | Provision for doubtful debts, provision for tax, depreciation | General reserve, capital redemption reserve, retained earnings |
The exam angle
Examiners frequently test this through a scenario where the entity has incurred a loss. If the item must still be recognised, it is a provision. Provision for doubtful debts is the classic trap — students often call it a reserve because of the word 'reserve for bad debts' in older texts.
Related comparisons
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Talk to usIs depreciation a provision or a reserve?
Depreciation is a provision. It is a charge against profit that recognises the consumption of an asset's economic benefit, and it must be recorded whether or not the business is profitable.
Can a provision be created when the business makes a loss?
Yes, and it must be. A provision recognises a liability or an expense that has already arisen, so profitability is irrelevant to whether it is created.
Is a provision for doubtful debts really a provision?
Yes. Despite older terminology sometimes calling it a reserve, it is a charge against profit made against a known category of loss whose exact amount is uncertain.
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