Retained Earnings implies a portion of companies net earnings that is set aside and not paid as a dividend, for the purpose of investing the amount in primary activities of the business or pay the debt. On the other hand, reserves can be understood as the part of profit earmarked to provide for business needs in future or to fulfill future contingencies and unexpected liability.
Risk and uncertainties are inherent in business and so they set up a mechanism to protect the business, on the event of contingencies or losses. Retained earnings and reserves are two such mechanisms.
Keeping aside profit, in the form of retained earnings or reserves, ultimately reduces the amount of profit available for distribution among the shareholders of the business. The fundamental differences between retained earnings and reserves are explained in the article provided to you.
Content: Retained Earnings Vs Reserves
|Basis for Comparison||Retained Earnings||Reserves|
|Meaning||Retained Earnings are a part of company's net income which is left after paying out dividends to shareholders.||Reserves are a part of retained earnings that is appropriated for a specific purpose.|
|Purpose||It is kept by the entity for reinvesting it in the main business.||It is maintained by the company for meeting future losses.|
|Current Year Profit||Added to retained earnings after paying dividends.||Certain percentage transfers to reserves every year out of current year profit before giving dividend.|
Definition of Retained Earnings
Retained earnings are the cumulative earnings of the company since its establishment. It is that portion of a company’s net profit, which is left out after paying dividends. The company reinvests the amount to its core business for getting lucrative returns which help in the development of the company. It is also termed as accumulated profits, surplus, etc.
In the Revised Schedule VI Balance Sheet, it comes under the head Reserves and Surplus. The primary objective of keeping retained earning is to ensure the solvency of the company and for meeting out any future contingency.
Definition of Reserves
Reserves are a part of the profit which is kept aside by the company for specific purposes like meeting out unexpected contingencies, etc. It is the portion of the company’s profit which is transferred after paying taxes but before paying the dividend.
There are various uses of reserves, which are – writing off fictitious assets, distribution of dividend in case of profit is not earned in a particular year, procurement and replacement of assets, redemption of debentures or preference shares, bonus issue, etc. the major objective of creating reserve is to strengthen the financial status of the company for its perpetual succession in future years.
Key Differences Between Retained Earnings and Reserves
- Retained Earnings are left after paying dividends while Reserves are transferred before declaring the dividend.
- Reserves are a part of Retained Earnings, but Retained Earning is not a part of the Reserves.
- Retained Earning has no further classification, whereas Reserves are classified into Revenue and Capital Reserves.
- Retained Earnings ensures the solvency of the company. On the other hand, Reserves helps in fulfilling losses if any.
There are very few differences between the two entities which are discussed here. However, there are many similarities in them. Retained Earnings and Reserves both are a part of Shareholder’s Equity and are represented under the head Reserve and Surplus. Every entity wants to make its future. The two entities help in increasing the financial stability of the company and helpful in covering future uncertainties and losses.