Reserves Classification
Reserves in a company's balance sheet are classified into capital reserve, securities premium reserve, general reserve, and retained earnings (surplus in profit and loss), each arising from different sources and carrying different restrictions on utilisation and distribution to shareholders.
The 'Other Equity' section of an Ind AS balance sheet replaced the old 'Reserves and Surplus' head and captured the full spectrum of non-share-capital equity. Understanding the composition of other equity was important for assessing the distributable versus non-distributable nature of accumulated equity and for reconciling changes over time.
Capital reserve arose from transactions that were not part of normal profit-generating operations. Under the Companies Act, capital reserve could arise from: the excess of consideration over the net assets in a business combination (bargain purchase gain); profits on forfeiture of shares; profits on the purchase of the company's own debentures or shares below issue price; profits on reissue of forfeited shares; and premium on redemption of preference shares in specific circumstances. Capital reserve was generally not distributable as dividends and could only be utilised for specific purposes such as writing off capital losses or issuing bonus shares in certain circumstances.
Securities premium (securities premium reserve) was the most significant item for many companies — the aggregate excess of issue price over face value across all issuances. When a company with a Rs 2 face value share issued new equity at Rs 500 per share, Rs 498 per share went into the securities premium account. The Companies Act permitted utilisation of securities premium for: writing off preliminary expenses; writing off discount on debentures; providing for premium payable on redemption of preference shares or debentures; and purchasing the company's own shares (buybacks). Securities premium was generally not distributable as cash dividends.
General reserve was an appropriation from retained earnings made at the discretion of management and the board. Pre-2014, a mandatory transfer of a percentage of profits to general reserve was required before paying dividends beyond a certain threshold. Post-2014, this mandatory transfer requirement was removed, and general reserve accumulation became entirely discretionary. Companies that had historically maintained large general reserves retained them on the balance sheet but were no longer required to grow them.
Retained earnings (profit and loss surplus) represented the cumulative post-tax profits not distributed as dividends or transferred to other reserves. It was the primary source of dividends and was freely distributable subject to the provisions of the Companies Act, including the requirement to pay dividends only out of profits and the restrictions on interim dividends.
Other components of Other Equity included items of Other Comprehensive Income (OCI) such as remeasurement gains and losses on defined benefit obligations, fair value changes on equity instruments designated at FVOCI, and the effective portion of cash flow hedges, each accounted for in specific OCI reserve accounts.