What is a Valuation Reserve?

A valuation reserve is an allowance that is paired with and offsets an asset. The reserve is designed to absorb any declines in the value of the associated asset. A reserve is created by making a charge to earnings in the amount of any expected losses, thereby accelerating expense recognition into the current reporting period. Valuation reserves are a key element of accrual basis accounting.

Examples of Valuation Reserves

Here are several examples of valuation reserves:

Allowance for doubtful accounts. The allowance for doubtful accounts contains management’s best estimate of the amount of bad debts that will eventually arise from the current trade accounts receivable.
Allowance for obsolete inventory. The allowance for obsolete inventory contains management’s best estimate of the cost of those inventory items that will eventually prove to be obsolete. This obsolescence figure may be based on historical data, as well as an analysis of the age of the various items currently in stock.