What is an example of general reserve?

General reserve is the part of profits or money kept aside to meet future uncertainties and obligations of the entity.  General reserve is created out of revenue profits for unspecified purposes and therefore is also a part of free reserves.

General reserve forms a part of the Profit & Loss Appropriation account and is created to strengthen the financial position of the entity and serves as a sources of internal financing. It is upon the discretion of the management as to how much of a reserve is to be created. No reserve is created when the entity incurs losses.

General reserve is shown in the Reserves & Surplus head on the liability side of the balance sheet of the entity and carries a credit balance.

Suppose, an entity, ABC Ltd engaged in the business of electronics earns a profit of 85000 in the current financial year and has an existing general reserve amounting to 100000. The management decides to keep aside 20% of its profits as general reserve.

Then the amount to be transferred to general reserve will be = 85000*20% = 17000.

In the financial statements it will be shown as follows-

Now, in the next financial year, the entity incurs losses amounting to 45000. In this case, no amount shall be transferred to the general reserve of the entity and will be shown in the financial statement as follows-

The creation of general reserve can sometimes be deceiving since it does not show the clear picture of the entity and absorbs losses incurred.