Any profit that arises in a company in special circumstances is called capital reserves. In other words, any profit or gain that arises other than routine business activities is treated as capital reserves. Following are the example of capital reserves:-
- Profit prior to incorporation of company:- Every limited company is legal and independent entity and does not come in to existence till the certificate of incorporation is received from the registrar of companies. But any profit earned by the company before its incorporation, shall be treated as capital reserves.
- Profit on sale of fixed assets :- Any company who sells any fixed assets and earns any profit on sale of the fixed assets, shall be treated as capital reserves.
- Premium of issue of shares :- When shares are issued at a price of more than its face value then the extra money received is called share premium. This share premium is also transferred in capital reserves account.
- Premium of issue of debentures:- When Debentures are issued at a price of more than its face value then the extra money received, shall be transferred in capital reserves account.
- Profit on purchase of a business:- When any company purchases any existing business and the purchase price is less than its net assets of the business firm then the difference between purchase price and net assets value, shall be treated as capital reserves account.
- Profit on redemption of debentures:- When any profit is earned by a company at redemption of debenture then this profit also shall be transferred to capital reserves account.
Accounting Treatment of Capital Reserve Account
The capital reserve is not an ordinary profit. The capital reserves are used only for special purposes and these reserves are generally not distributed among the share holders as dividend. It is shown separately in liability side of balance sheet.
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