The central purpose of most businesses is to earn a profit for services rendered. Profit is calculated by subtracting incurred expenses from accounting revenue. By definition, accounting revenue is the gross income that businesses receive from providing services or goods to the public. Although accounting revenue encompasses provision revenue, it does not include reserve money in financial accounts.
"Provision" in accounting refers to money written off to cover possible depreciation of assets and other liabilities. Such write-offs also cover the expected losses and contingencies of a company. Financial institutions utilize provisions when providing loans to consumers and companies. The provision allows the institution to operate within the budget should a consumer or company fail to repay a loan in full. In contrast to provisions, "reserve" means the amount of money that remains after provisions and other fees have been deducted from the budget. Such money typically belongs to the business owner or company shareholders.
Examples and Types
Provision can be recorded in practically any budget. Retirement plans, for instance, might have a provision established in case a person chooses to cash in the plan before it matures. Provisions are also given during company restructuring that causes significant costs and personnel termination. There are two types of reserves: capital and revenue. Although capital reserves cannot be distributed in cash, revenue reserves may be given to shareholders and owners in the form of cash. Examples of capital and revenue reserves include share premiums and retained profits.
Reserve: Positive Asset
Reserve is additional money included as profit. The extra income can come from an increase in funding from shareholders or successful business mergers. Reserves are often discovered after careful budget analysis and re-evaluation. During this process, analysts discover unrealized gains that had not been added to accounting revenue. Regardless of the discovery method, reserve in accounting is a positive addition to any budget.
Provision: Negative Asset
Although provisions have the potential to be positive additions to the budget, they are typically negative attributes in accounting. Bad-debt provisions decrease income, because debts might not be paid in full. In addition, excessive or damaged inventory decreases the value of assets and hence means less accounting revenue. Because they are viewed more as insurance and less as profit, provisions should be viewed as negative attributes to a budget.