Retained Earnings And Reserves are very confusing accounting term because there is a minor difference in between them. Some thinks them synonymous. However, lets have a brief discussion on this two topics first before making difference in between them.
‘Reserves‘ is the generic term for all equity accounts other than contributed equity. A major component is the retained earnings account. This account accumulates the annual profit or loss earned by an entity, and is the primary account from which appropriations are made in the form of dividends.
The paragraph 88 of IAS 1 (Presentation of Financial Statements) requires that all items of income and expense recognized in a period to be included in profit or loss unless another standard requires otherwise. Hence, the retained earnings account will accumulate the profit or loss earned over the life of the entity.
However, as paragraph 89 of IAS 1 also notes that other standards require some gains and losses to be reported directly as changes in equity. Some examples are:
• revaluation of property, plant and equipment
• particular foreign exchange differences
• re-measurements of available-for-sale financial assets
These gains and losses are then recognized as part of reserves. Entities are required to disclose movements in these accounts as other comprehensive income for the period.
Retained Earnings :
‘Retained earnings’ has the same meaning as ‘retained profits’ and ‘accumulated profit or loss’. The key change in this account is the addition of the profit or loss for the current period. The main other movements in the retained earnings account are:
• dividends paid or declared
• transfers to and from reserves
• changes in accounting policy and errors
Major Differences Between Retained Earnings and Reserves
1. R/Es are retained after paying dividends to the shareholders while Reserves are transferred before declaring and paying the dividend.
2. Reserves are created out of Retained Earnings but R/Es are not parts of Reserves.
3. Retained Earnings makes sure the solvency of the company but Reserves helps in refilling losses or sudden cash shortage.
4. Retained Earnings require no further classification, whereas Reserves are classified into Revenue and Capital Reserves.