Reserve vs provision: why they are not the same

A reserve is part of equity: it belongs to the shareholders and is created by profits, share issues or revaluations, not by a charge against profit. A provision is a liability owed to someone else, recognised under FRS 102 Section 21 only when a past event has created a present obligation. Setting up a “provision” for costs the company merely plans to incur next year confuses the two and is not allowed.

What is the basic difference between a reserve and a provision?

FRS 102 paragraph 22.3 defines equity as the residual interest in the assets of an entity after deducting all its liabilities. Reserves are components of that residual: retained earnings, share premium, revaluation reserve and similar balances. They are not owed to anyone outside the company.

A provision sits on the other side of the line. Paragraph 21.1 describes provisions as liabilities of uncertain timing or amount, and paragraph 21.4A explains that, for Section 21, a liability is a present obligation arising from past events whose settlement is expected to result in an outflow of resources. The company has no realistic alternative to paying.

	Reserve	Provision
Nature	Equity, owned by shareholders	Liability, owed to a third party
Created by	Profits retained, share issues, revaluations, transfers within equity	A charge to profit or loss (or to the cost of an asset)
Needs a present obligation?	No	Yes, from a past event
Where it appears	Capital and reserves	Provisions for liabilities
Movement shown in	Statement of changes in equity	Profit and loss account and provisions note

Where does each appear in the accounts?

The statutory balance sheet formats in Schedule 1 to the accounts regulations put “Provisions for liabilities” (pensions, taxation including deferred tax, and other provisions) above the line and “Capital and reserves” below it. The reserves headings include share premium account, revaluation reserve, other reserves (among them reserves provided for by the articles of association) and the profit and loss account.

A provision is created by recognising an expense: paragraph 21.5 says the provision is recognised as a liability and the amount as an expense, unless another section requires it to be included in the cost of an asset. A transfer between reserves, by contrast, never passes through profit or loss. It appears in the statement of changes in equity, which paragraph 6.3 requires to reconcile each component of equity from the start to the end of the period. The individual reserves are explained in retained earnings and other reserves.

For medium and large companies, paragraph 59 of Schedule 1 to SI 2008/410 requires the opening and closing amounts, transfers and the source and application of transfers to be disclosed in tabular form for reserves and for provisions, with particulars of each material item within “other provisions”.

Why can’t a company provide for costs it plans to incur?

Because there is no obligation yet. Paragraph 21.6 says obligations that will arise from the entity’s future actions do not meet the recognition test, no matter how likely they are to occur. The standard’s own illustration is a business that needs to fit smoke filters to a factory: it can avoid the spending by changing how it operates or selling the factory, so there is no present obligation and no provision.

The appendix to Section 21 gives further examples. Expected future operating losses are not provided for (paragraph 21.11B and Example 1). Retraining staff after a change in tax law is not provided for, because the law change does not oblige the company to retrain anyone (Example 8). HMRC’s guidance at BIM46535 lists provisions that current standards do not permit, including future repairs of plant owned by the business, an approach associated with the Britannia Airways case, and provisions supported only by an unpublished decision of the directors.

Prudence does not rescue these entries. FRS 102 paragraph 2.17 says prudence means assets and income are not overstated and liabilities and expenses are not understated, but equally it does not allow liabilities or expenses to be overstated.

What does the general reserve error look like?

The classic mistake is a year end journal such as “Dr repairs, Cr provision for future repairs” or “Dr overheads, Cr general contingency provision”. The intention is sensible: earmark money for a known future cost and smooth profits. The effect is to understate profit this year, overstate liabilities, and then flatter profit in the year the cost is actually incurred.

If directors want to show that part of retained profits is set aside for a purpose, the right route is a transfer within equity, for example from the profit and loss reserve to a designated reserve. That leaves profit for the year unchanged and makes the earmarking visible to shareholders. Whether those profits can still be paid out is a separate question for company law and the articles.

How might the two treatments compare?

Illustration only. A company owns its office and plans to replace the roof next year at an estimated cost of £30,000. Profit before the adjustment is £80,000.

	Incorrect: provision	Acceptable: reserve transfer
Profit for the year	£50,000	£80,000
Provisions for liabilities	£30,000	Nil
Retained earnings increase	£50,000	£50,000, plus £30,000 in a designated reserve
Next year’s profit	Overstated: roof cost charged against the provision	Roof cost recognised under the normal rules for repairs or capital spending

Change one fact and the answer changes. If the company leased the office and the lease already required it to repair damage that existed at the year end, there would be a present obligation and a provision could be appropriate. BIM46535 recognises this distinction for tenants’ repairing leases, and the details are in dilapidations provisions for leased premises.

Why does the distinction affect dividends?

Under section 830 of the Companies Act 2006, a company may only make a distribution out of accumulated, realised profits, less accumulated, realised losses. Section 841(2)(a) treats provisions of the kinds specified in regulations as realised losses in Companies Act accounts, and paragraph 6 of Schedule 7 to SI 2008/409 specifies provisions for depreciation or diminution in value and provisions for liabilities. In IAS accounts, section 841(2)(b) treats provisions of any kind, other than revaluation provisions, as realised losses.

So a provision reduces the profits available for distribution. A transfer between reserves does not create a loss; it simply relabels part of equity. The distributable profit calculation is set out in distributable reserves under Part 23.

How does the tax treatment differ?

A transfer to a reserve does not pass through profit or loss, so it has no effect on taxable profit. A provision charged to profit or loss is deductible only if it meets the conditions in HMRC’s BIM46510: it must relate to revenue expenditure, comply with GAAP, not conflict with a statutory timing rule and be estimated with sufficient accuracy. A provision for future costs with no present obligation fails the GAAP condition, and HMRC’s view in BIM46535 is that provisions made on a superseded basis cannot be run off for tax on that basis.

Which uses of the words cause confusion?

• “Provision” for depreciation, bad debts or stock. Paragraph 21.3 says these are adjustments to the carrying amount of assets, not liabilities, and Schedule 9 paragraph 2B of SI 2008/410 says provisions must not be used to adjust the value of assets.
• Partnership “tax reserves”. Money held back by a firm to meet partners’ tax bills is a different concept, covered in tax reserves in partnerships and LLPs.
• Charity “reserves”. Charity reporting gives the word its own meaning, explained in charity reserves policy.

What mistakes should reviewers look for?

• Provisions with descriptions such as “general”, “contingency” or “future costs” and no identifiable obligation.
• Provisions that never move, or that are released in good years and topped up in bad ones.
• Reserve transfers posted through the profit and loss account instead of the statement of changes in equity.
• Expenditure charged against a provision that was set up for something else, which paragraph 21.10 prohibits.

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Related Accountapedia entries

• Stamp duty reserve tax
• The capital redemption reserve
• Employed and self employed at the same time
• Provision vs accrual: what is the difference
• Legal claims: provision or contingent liability

Sources

• Financial Reporting Council: FRS 102 September 2024 tmKYWO6
• legislation.gov.uk: SI 2008/410, schedule 1
• legislation.gov.uk: SI 2008/410, schedule 1
• GOV.UK: Manual page BIM46535
• legislation.gov.uk: Act 2006 c. 46, section 830
• legislation.gov.uk: Act 2006 c. 46, section 841
• legislation.gov.uk: SI 2008/409, schedule 7
• GOV.UK: Manual page BIM46510
• legislation.gov.uk: SI 2008/410, schedule 9

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.