Secret Reserve

This article deals with the basic understanding of Secret Reserve and how and why it has been created and its implications.

What is Secret Reserve?:

• Secret Reserve accounting is one type of creative accounting. It is a special type of reserve which exists but is not shown in the Balance Sheet. It arise by deliberately creating it or by a mere unrecorded appreciation in the value of assets.

How do we create secret reserves:

• Excessive provision for depreciation
• Writing off assets that are still of value
• Treating reserves as provisions
• Creating excessive provisions for bad debts
• Overstating liabilities in the Balance Sheet by including reserves in the liabilities
• Charging capital expenditure to revenue

Why do you think companies want to create secret reserve?

• The main object of creating secret reserves is to enable a company to avoid violent fluctuations in its published profits or dividends.

What do you think might be the impacts if secret reserves being created?

By creating secret reserves,the balance sheet does not present a true and fair view of the state of the company’s affairs

• The Income Statement also does not reflect the correct profit available for dividends. The dividend declared should by right be lesser than would otherwise have been possible if the correct results are shown.
• The market value of the shares may be lower than it might otherwise be.
• Improper dealings in the shares of the company by persons who are aware of the existence of the secret reserves may occur
• Secret reserves accumulated in the past periods may be used to swell the profit figures in that year when the company is doing badly. Hence the true trading results may not be shown.

Fortunately,due to the requirements of the Companies Act and financial accounting standards,all reserves and provisions need to be disclosed under suitable headings in the Balance Sheet and that assessment of the adequacy ( over/under) of provisions are under heavy scrutiny hence creating secret reserves might be more difficult to be created.

• Bonus Issue – Illustration And Accounting Treatment ( Part 2 of 2)
• All Topics Under The Heading Of Financial Accounting Ratio Analysis Or The Interpretation Of Financial Statements In The Annual Report