Meaning Of Secret Reserve
A reserve created with a view to strengthening the financial position of a business without explicitly showing its books of account is called a secret reserve. The hidden reserve is not shown in the balance sheet. It is known as internal reserve. One way of creating it by showing the figure of net profit marks less than actual. Its presence makes the financial position of the business better than what the balance sheet is disclosing. Generally, it is maintained by banks, insurance companies, and other Financial Institutions.
Reserve is created in any of the following ways:
- Providing depreciation on fixed assets at excessively higher rates.
- Undervalue in current assets.
- Limiting the assets altogether from the book.
- Overvaluing liabilities.
- Sewing contingent liabilities as real liabilities.
- Creating excessive amount of Reserve for future contingencies.
- Maintaining the excessive amount of provision for anticipated losses like provision of doubtful debts.
- Treating capital expenditure as revenue expenditure.
- Ignoring accrued income or treating income as a liability.
Objective advantages of secret reserve secret reserve
The following are the important objectives and advantages of secret reserve:
- To help in extending the financial position of the business.
- To give a sense of financial stability to the shareholders and creditors by equalizing the rate of dividend.
- To help in eliminating the healthy competition by showing true profit to the computers.
- To provide additional working capital.
Disadvantages of secret reserve
The following are its main disadvantages
- Its presence is known to management only and not to the owner or not to shareholders of the business.
- It makes the information of financial statements (trading account, profit, and loss account, and balance sheet) false and inaccurate.
- It may be the strong cause of losing trust and confidence of shareholders and outsiders.
- It may cover of the efficiency and fraud committed by the managers and directors.