Finance

What is Secret Reserve? Meaning, Objective, Advantages, Disadvantages

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by Alex Poudel

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Definition of Secret Reserve

A secret reserve refers to a reserve created by a company by understating its assets or overstating its liabilities in its financial statements. This reserve is not disclosed in the financial statements but is kept secret from external parties such as shareholders, creditors, and tax authorities. The purpose of creating a secret reserve is to provide a cushion against potential losses or to smooth out earnings over time.

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 an internal reserve.

One way of creating it by showing the figure of net profit marks less than the 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.

Secret Reserve

Meaning Of Secret Reserve

  • 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 an excessive amount of Reserve for future contingencies.
  • Maintaining the excessive amount of provision for anticipated losses like the 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 the 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 dividends.
  • 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 the trust and confidence of shareholders and outsiders.
  • It may cover the efficiency and fraud committed by the managers and directors.

FAQs

What is a secret reserve?

A secret reserve in accountancy is a reserve created by a company by understating its assets or overstating its liabilities in its financial statements. This reserve is kept secret from external parties such as shareholders, creditors, and tax authorities.

Why do companies create secret reserves?

The purpose of creating a secret reserve is to provide a cushion against potential losses or to smooth out earnings over time. It can also make a company appear less risky than it actually is, which can be beneficial for obtaining financing or attracting investors.

Is creating secret reserves allowed under accounting standards?

No, creating secret reserves is generally considered unethical and is not allowed under accounting standards. Companies are required to provide a true and fair view of their financial position in their financial statements, and any attempt to conceal information from stakeholders is a violation of accounting principles.

What are the risks of creating secret reserves?

The risks of creating secret reserves include potential legal and regulatory consequences, damage to the company’s reputation, and loss of trust among stakeholders such as shareholders and creditors.

How can stakeholders identify the presence of secret reserves?

Stakeholders can identify the presence of secret reserves by analyzing the financial statements of the company and comparing them to industry benchmarks and other companies in the same sector. They can also look for inconsistencies in the reported financial data or discrepancies between the reported financial data and other information provided by the company.

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