Meaning of Equity Reserves
Reserves refer to a component of shareholders’ equity, the amount kept apart for estimated claims or creation of contra asset accounts for bad debts.
Reserves always have a credit balance. The reserve which belongs to equity shareholders or where it is marked for any purpose is equity reserves.
The reserves appear in shareholders’ equity except in the computation of contributed share capital. Inequity section of the balance sheet, stocks are issued at a discount, par, or premium. The latter options are widely used.
When shares are issued at a premium, the par value goes towards the basic share capital. Any amount above par will be considered as share premium and will be added to Paid-up capital-share premium account. This is just one such example of equity reserves to give nuance to the concept.
The company operates in a business environment and strives to obtain higher and higher profits each year. The net profit is obtained by deducting the expenses from the revenues. The net profits are appropriated to reserves and surplus.
The profits are transferred to reserves and surplus after paying off the dividend to equity and preference shareholders which forms part of equity reserves. Many more such equity reserves form the balance sheet.
Types of Equity Reserves and Their Accounting Treatment
Equity reserves form part of the Equity Section of the Balance sheet. It is a part of stockholders’ equity that is unmarked for any purpose and is residual in nature. The general presentation of equity reserves in the balance sheet is given below:
|Liabilities and Capital Section
|Equity share capital, at par
|Preference Share capital, at par
|Reserves and surplus
|Securities Premium – Equity
|Securities Premium – Preference
|Total Liabilities and Capital
The Bolded portion is all part of Equity reserves. By equity, we mean the common shareholders. The equity reserves are distributable to equity shareholders.
Now, we move ahead to discuss varieties of equity reserves and their accounting treatment:
a. Foreign Currency Translation Reserve
We are almost living in a borderless society in terms of business transactions being done. Hence, the company is likely to get exposure to foreign currency as a result of business transactions or as a result of a corporation set up with associates or subsidiaries.
These transactions have to be converted into home currency in order to prepare financial statements.
Any losses or gains would depend on the exchange rates and would directly come out of equity pocket and benefits to be only given to them.
Various methods of translation such as the current rate method, temporal rate method, and monetary-nonmonetary translation method shall be used.
The GAAP provisions state that items in the balance sheet should be converted in accordance with the rate of exchange on the date of the balance sheet while the income statement items shall be converted according to the weighted average rate of exchange.
Any gains or losses arising from foreign currency transactions are recorded in the equity section of the balance sheet.
b. Revaluation Reserve
When the fixed assets are purchased, they are recorded using the cost method or revaluation model. In the case of the revaluation model, all fixed assets would be evaluated on the reporting date.
There would be a difference in the balances of these fixed assets on each such date. These revaluations would be recorded as revaluation reserves, part of equity reserves.
The changes due to revaluation would not be reflected in the income statement until the fixed assets are disposed of. These will only be shown in the equity section of the balance sheet.
c. General reserved/ Retained Earnings
The businesses earn revenues throughout the year. With successful planning, they are able to churn out the net profit for the company.
After payment of dividends, the net profit is transferred to general reserves or retained earnings which is shown in the reserves and surplus side of the balance sheet.
d. Fair value through other comprehensive income.
The fair value approach lays down various criteria. The financial assets and liabilities which meet such criteria impact the equity reserve.
The value of financial instruments value is dynamic in nature. Before the disposal of such financial instruments, they should be reported on the balance sheet.
Any gain or loss realized from the sale will be recognized only after they are settled. Such gain would impact the Other comprehensive income i.e. through FV-OCI as per GAAP provisions.