Difference Between Capital Reserve and Reserve Capital

The main difference between capital reserve and reserve capital is that capital reserve is a portion of a company’s profit that it can use for various purposes, such as starting a new project. On the other hand, reserve capital is an unspecified amount set aside by a company to be used only when the company is on the verge of liquidation.

Distinguishing between Capital Reserve and Reserve Capital is vital in comprehending financial management. These terms, although related, hold distinct implications in safeguarding a company’s fiscal stability. This article will significantly explore the difference between capital reserve and reserve capital.

Table of contents (TOC)

• Difference between the capital reserve and reserve capital
• What is a capital reserve?
• Example of capital reserve
• What is reserve capital?
• Example of reserve capital
• Key differences between the capital reserve and reserve capital

Difference Between Reserve Capital and Capital Reserve

For a better understanding, let’s explore the difference between capital reserve and reserve capital in a tabular format:

What is a Capital Reserve?

Capital reserve definition: Capital reserve is the amount made up of a portion of a company’s profit and can be used for various purposes, such as starting a new project or investment. However, this amount is not accessible for distribution as a dividend.

Example of Capital Reserve

To understand what a capital reserve is, let’s see an example:

Infoedge has made a profit of ₹50,000 on selling an old asset. But, for specific reasons, the company expects to incur a loss of ₹20,000 for the sale of old machinery because it has almost become obsolete. So, the company quickly decides to create a reserve of ₹20,000 out of the profit of ₹50,000 they have made from selling an old asset and can be prepared to write off the loss of ₹20,000.

What is Reserve Capital?

Reserve capital definition: Reserve capital is an unspecified amount set aside by a company to be used only when the company is on the verge of liquidation.

The reserve capital is withheld and not used unless the company is forced to liquidate, and those funds are required as a lifeline. Reserve capital is not required to be disclosed and does not appear on balance sheets.

Example of Reserve Capital

To understand what reserve capital is, let’s see an example:

Suppose a company, Infoedge issued 10,000 Equity shares worth ₹200 each. All shares are subscribed, but the company resolves only to call ₹ 180 per share, and ₹20 will be called when the company is wound up.

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Key Differences Between Reserve Capital and Capital Reserve

Some of the key differences between capital reserve and reserve capital are:

Nature and Purpose

• Reserve Capital: It refers to the portion of authorized share capital not issued to shareholders initially but can be called upon for issuance later if needed. It’s a potential source of additional capital for the company.
• Capital Reserve: Capital reserve is a type of reserve created from profits, usually non-distributable, that is set aside for specific purposes such as funding long-term projects or providing financial stability.

Source of Funds

• Reserve Capital: The funds for reserve capital come from the company’s authorised share capital.
• Capital Reserve: The funds for capital reserve are generated from retained earnings or gains from the revaluation of assets.

Issuance of Shares

• Reserve Capital: Reserve capital is not immediately issued to shareholders; it’s kept in reserve for potential future issuance.
• Capital Reserve: Capital reserve doesn’t involve issuing shares; it’s a financial buffer created from profits.

Distributability

• Reserve Capital: Since reserve capital is not issued, it doesn’t impact dividend distribution or shareholder payouts.
• Capital Reserve: Capital reserve is generally non-distributable to shareholders and is often maintained to strengthen the company’s financial position.

Utilization

• Reserve Capital: It is earmarked to be called upon for the issuance of additional shares if needed, usually in cases of expansion or investment.
• Capital Reserve: It is utilized for specific purposes, such as writing off capital expenses or funding special projects.

Disclosure

• Reserve Capital: Reserve capital is not explicitly shown on the balance sheet until it is called upon for share issuance.
• Capital Reserve: Capital reserve is disclosed separately on the balance sheet, typically under the “Reserves and Surplus” section.

Legal Requirements

Reserve Capital: Legal requirements for reserve capital may vary depending on the jurisdiction and the company’s articles of association.

Capital Reserve: Capital reserves may be subject to legal and regulatory requirements regarding their creation and use.

Impact on Shareholders

• Reserve Capital: Reserve capital does not affect shareholders directly until it is called upon for share issuance, which might dilute existing shareholders’ ownership.
• Capital Reserve: Capital reserve does not directly impact shareholders, but it can indirectly benefit them by strengthening the company’s financial position.

Accounting Treatment

• Reserve Capital: Reserve capital might not be separately disclosed in financial statements until shares are issued against it.
• Capital Reserve: Capital reserve is usually separately disclosed in financial statements, reflecting its purpose and utilization.

Creation Process

• Reserve Capital: Reserve capital is often established during the initial incorporation of the company or through amendments to its articles of association.
• Capital Reserve: Capital reserve is created over time by accumulating profits or revaluation gains.

Conclusion

You can easily identify whether the company is using capital reserve or reserve capital now that you understand what capital reserves and reserve capital are. Regardless of the difference between capital reserve and reserve capital, remember that both are important components of the company’s reserves.