Reserve in accounting

What is a Reserve in Accounting?

A reserve is an allowance that is set aside for expected losses or financial requirements. This approach is only used under the accrual basis of accounting; it is not used under the cash basis of accounting. A reserve may also be used to set aside a portion of a firm’s retained earnings, which signals to investors that the company plans to use the funds for specific future purposes, such as the purchase of fixed assets or an expansion into a new geographic region, rather than paying out the funds as dividends.

Examples of Accounting Reserves

As an example of an accounting reserve, a business could create a reserve for bad debts, which approximates the amount of bad debt that is expected from the trade receivables on hand. Or, a business could set up a reserve for obsolete inventory, in expectation of some items in stock being identified as not sellable.