The term reserve refers to the amount. set aside out of profits and other surplus which are not designed to meet any liability or diminution in value of assets known to exist at the date of the Balance Sheet.

The Indian Companies Act has not given any clear definition of the term 'Reserve'. It states, however, that "the expression 'reserve' shall not…….include any amount written off or retained by way of providing for depreciation, renewal or diminution in value of an asset, ,or retained by way of providing for any known liability.

In other words, any amount set aside out of profits to meet unexpected future losses and liabilities is called reserve. Not only that if any amount retained by way of providing for any known liability in excess of the amount actually needed for the purpose, shall also be treated as reserve and not a provision Reserves are created by debiting their amounts to the Profit and Loss Appropriation Account. But reserve is not a compulsory charge on profits. It is purely voluntary and is regarded as an appropriation of profits.

It means that reserve represents an undistributed portion of net profit and not a loss or expense which ought to have been charged before calculating the net profit, as is done in case of the provisions.