Provisions

Provision refers to the setting aside of certain amount  to meet some contingencies which may be expected but not yet incurred. In other words, provision usually means any amount written of or retained by way of providing depreciation, renewal or diminution in the value of assets. It is a charge to the profit and loss account. Some examples of provision are as:

1. Provision for bad and doubtful debt.
2. Provision for discount on debtors.
3. Provision for taxation.
4. Provision for depreciation.
5. Provision for repairs and renewals etc.

Provisions are either shown as deductions from assets in the balance sheet or on the liability side of balance sheet. When provision is no longer required, it is treated as a profit.

Features:

1. Provisions are made for expected contingencies.
2. It is a charge to the profit and loss account.
3. They are always made for a specific purpose.

Importance:

1. To ascertain the true net profit or loss.
2. To know the true financial position of the business.
3. To cover the loss in value of assets.

Secret Reserves

Secret reserve is created to strengthen the financial position of the firm without disclosing reserves to the public. They are not shown in the balance sheet. Such reserves are usually maintained by banks, insurance companies etc. Generally, it is created by showing lower profit than what actual is. It may be done in any of the following ways:

1. By undervaluing the closing stock.
2. By providing excessive depreciation.
3. By overvaluing liabilities.
4. By making excessive provisions or losses.

Advantages:

1. It helps to strengthen the financial position of business.
2. It helps to meet the exceptional losses.

Disadvantages:

1. Profit shown by the financial statement is not accurate.
2. True financial position of the business can not be disclosed.

Reserve for Redemption of Liabilities

The firm requires to manage big amount to redeem long term liabilities like debentures. Thus, a reserve is created out of profit for the redemption of liabilities which is called reserve for redemption of liabilities.

Advantages:

1. Loan can be repaid in specific date which increases the creditability of the business.
2. It helps to avoid the financial crises of repaying liabilities.

Disadvantages:

1. It reduces the amount of divisible profit of shareholders.

Dividend Equilization Fund

It is created for maintaining equal dividend over years. In other words, sometime a company may not have sufficient profit to distribute as dividend. At that time, the company can utilize such fund.

Advantages:

1. It helps to distribute same rate of dividend even there is loss in the business.
2. Due to the uniformity of dividend over years, the market value of shares does not fluctuate abnormally.

Disadvantages:

1. Creation of dividend equilization fund reduces the amount of divisible profit.
2. Small organization having poor financial position may not be able to create such fund.