Analyzing Accounting Statements on Reserves

Let's carefully examine each statement provided in the options to determine which one is true.

We need to understand the nature and purpose of different types of reserves in accounting.

Statement 1: Capital Reserve Creation

• The statement says: "Capital Reserve is normally created out of free or distributable profits."
• Capital Reserves are typically created from capital profits, which are profits that do not arise from the normal trading activities of the business. Examples include profit on the sale of fixed assets, premium on the issue of shares, or profit on the revaluation of assets.
• Free or Distributable Profits (also known as Revenue Profits) are profits earned from the ordinary course of business operations. These are the profits from which dividends are normally paid.
• Therefore, Capital Reserves are usually created from capital profits, not free or distributable profits. This statement is false.

Statement 2: Dividend Equalization Reserve Example

• The statement says: "Dividend Equalization Reserve is an example of General Reserve."
• A General Reserve is created out of profits to strengthen the company's financial position but is not set aside for any specific future liability or purpose. It can be used for various general purposes.
• A Dividend Equalization Reserve is a specific type of reserve created with the explicit purpose of maintaining a stable dividend rate year after year, even in periods of low profits.
• Because a Dividend Equalization Reserve is created for a specific purpose (equalizing dividends), it is considered a Specific Reserve, not a General Reserve. This statement is false.

Statement 3: General Reserve Usage

• The statement says: "General Reserve can be used only for some specific purposes."
• As mentioned earlier, a General Reserve is not set aside for any specific purpose. It is a reserve available for general use by the company.
• Uses of General Reserve can include meeting unforeseen contingencies, expanding the business, or even issuing bonus shares. These are not typically considered 'specific purposes' in the way a reserve for a known liability or a specific future project would be.
• Reserves created for specific purposes (like Debenture Redemption Reserve, Investment Fluctuation Reserve, or Dividend Equalization Reserve) are called Specific Reserves.
• Therefore, the statement that General Reserve can be used only for some specific purposes is false. General reserves are available for general use and flexibility.

Conclusion

Based on the analysis of each statement:

• Statement 1 is false because Capital Reserve is created from capital profits.
• Statement 2 is false because Dividend Equalization Reserve is a specific reserve, not a general reserve.
• Statement 3 is false because General Reserve is not limited to specific purposes.

Since all the individual statements (1, 2, and 3) are false, the statement "None of the above" is the true statement in this context.