what is meant by appropriation of profits in case of reserves?

It is said that reserves are made out of profits in the business and it is an appropriation of profits. Here, what is meant by appropriation of profits? It is said that reserves reduce the divisible profits and can be invested in outside securities. sir, what does this mean?

asked Aug 15, 2015 in Depreciation, Provisions and Reserves. by kajol kumari (22 points) 1,655 views

1 Answer

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As reserves are created to meet the needs of future growth of the business or meet some unknown future contingencies.  Reserves are created out of divisible profits.  The word 'Appropriate' means  to 'set aside a part' of profits.  For example a business has earned Rs.100000 in the current year and it decides to keep Rs.20000 in the Reserves and distribute Rs.80000 as dividends.  This keeping aside of Rs.20000 is called Appropriation of profits.

     For example if a company feels that after 10 years it will need to upgrade its plant.  For this purpose it will require Rs.500000 at that time.  The company has two options: (a) create a reserve and keep the money in business only and (b) to invest the amount of reserve in securities outside business.

    It may happen at the end of 10 years that the amount kept aside as reserves is tied up in business and can not be taken out to upgrade the plant.  To avoid such a situation, it is always better to invest the amount of reserves in outside securities and sell them when you need them for the intended purpose (for example to upgrade the plant).
answered Aug 15, 2015 by jbsclasses (3,971 points)