Reserve Fund

by Lena
(Ottawa, ON, Canada)

My client is a private company. They put "aside" a reserve fund for future major capital investments (5% of total income). Is that a balance sheet or a profit and loss item?

Lena,

When questions like this arise, you need to stop and think your way through the transaction. I developed my cheat sheet for exactly this kind of question.

That said, reserve fund accounting is not complex. Generally, you debit retained earnings and credit the reserve fund (also an equity account). All this does is set the funds aside for a specific purpose.

For presentation purposes, the reserve fund account can be a separate account or a sub-account in the equity section of your balance sheet.

Some businesses take the capital reserve funding a bit further and actually open up a separate bank account for the funds to ensure they will be available when needed and not spent on general operating expenses.

This means that every time you have a reserve fund transaction there will be two entries - one entry to account for the cash and the other entry to account for the reserve fund sitting in the equity section of the balance sheet.

For example:

Debit Capital Reserve Savings (a current asset account)
Credit Operating Account (a current asset account)

To transfer cash from the operating account to the reserve savings account.

Debit Retained Earning (an equity account)
Credit Capital Reserve Fund (an equity account)