De Paula defines capital reserve thus :
“Capital Reserves represent Capital items that are not free for distribution”.
The Companies Act has defined the term “capital reserve” negatively as “a reserve which shall not include any amount regarded as free for distribution through the Profit and Loss Account”. In other words, capital reserve is a reserve of a corporate enterprise which is not available for distribution as dividend and is not created by debiting Profit and Loss Appropriation Account.
How is Capital Reserve Created ?
Capital reserve is created out of the following incomes:
(1) Profits prior to incorporation.
(2) Appreciation in the book value of assets after revaluation,
(3) Profit earned by selling a fixed asset at a higher price than fixed as its book value.
(4) Premiums received on the issue debentures in the reissue at a discount.
(5) Profit made on the redemption
(6) Credit balance in the Forfeited Shares Account after of forfeited shares.
(7) The excess of the net value of the assets taken over the purchase price paid to a vendor. the normal course of business.
(8) Profits of exceptional nature which have not been Feuanrdnedaft:
(9) Credit balance of the Asset Replacement Reserve replacement of the asset being made.
Uses of Capital Reserve
Capital reserve may be utilised in the following ways:
(1) Issue of Bonus Shares if the Articles of Association permit to do so.
(2) For writing off intangible assets like Goodwill, Preliminary Expenses, Cost of the Issue of Debentures.
(3) Amounts received on account of share premium and credited to Capital Reserve Account can be utilised for the purposes stated in Section 78 of the Companies Act:
(a) Issue of unissued shares of the company to its members as fully-paid bonus shares.
(b) Writing off Preliminary Expenses.
(c) Writing off commission or expenses or discount on the issue of shares or debentures.
(d) Providing for the premium payable on redemption of redeemable preference shares or debentures. Auditor’s Duty relating to Capital Reserve The duties of the auditor in connection with capital reserve are to see (a) that capital profits which have been transferred to Capital Reserve Account are really surplus of capital over the assets and liabilities; (b) that the capital reserve is utilised according to the Articles and the Company Law; (c) that capital reserve as distinguished from revenue reserve is shown separately in the Balance Sheet, and that any additions and deductions since the last Balance Sheet have been clearly shown,_ (d) whether capital reserve is invested other in the business itself or outside the business in easily realisabie securities.