Accounting for Equity Reserve
Equity reserve is the part of the equity section of the balance sheet which excludes share capital and retains earnings. It presents the balance raised from other transactions such as foreign translation, fair value, and revaluation change.
On the balance sheet, it presents the accounting equation in which the assets are equal to liability plus equity. The balance sheet is one of the three primary financial statements used to assess a company’s overall financial health. It provides a snapshot of a company’s assets, liabilities, and equity at a given point in time. One of the key insights that can be gleaned from the balance sheet is the relationship between a company’s assets and its liabilities plus equity.
The assets on the balance sheet are those resources of a company that will generate economic value in the future and can be measured at a relatively precise amount. These include cash, accounts receivable, inventory, PP&E, intangible assets, and investments. The key to remember with assets is that they provide future economic benefits and are thus vital to a company’s health and success.
Equity represents the value of ownership that shareholders have in the company. The equity on a balance sheet represents the residual value of a company’s assets after liabilities are paid. In other words, it is the portion of the company that would be left over for shareholders if the business were to be liquidated. Equity can be classified as either common stock or preferred stock, retained earnings, and other equity reserves.
The equity reserve can raise from many kinds of transactions such as foreign currency transactions, revaluation gains, fair value, and so on.
Type of Equity Reserve and Journal Entry
There are several types of reserves that raise on the company balance sheet. Some reserves may increase and decrease balance from time to time. For example, the currency translation will change depending on the risk of the foreign exchange rate. On the other hand, the statutory reserve will remain the same for the entire business unless the change in regulation.
Foreign Currency Translation
The company may carry assets or liabilities on balance sheet in foreign currencies other than functional currency. When there are no transactions related to these accounts, their value remains the same in foreign currency. However, if we translate it into local currency, it will change due to the exchange rate. The exchange rate may increase or decrease our assets or liabilities which will impact our equity reserve.
For example, company purchases goods from overseas, and the supplier issue invoice in foreign currency. The company will record the accounts payable base on the exchange rate on the purchase date to record inventory and accounts payable. On the reporting date, the outstanding accounts payable will be translated again with a different exchange rate. The unrealized gain will record on the balance sheet under equity reserve.
Company purchase inventory from overseas costs 1,000 GBP which is equal to $ 1,200. So the company records inventory and accounts payable of $ 1,200.
On the reporting date, the balance of 1,000 GBP is equal to $ 1,100. It means the company needs to reduce $ 100 from accounts payable.
|Foreign Exchange Gain||100|
The foreign exchange gain will be classified as the equity reserve on the balance sheet.
Fair Value Through Other Comprehensive Income
The financial assets and financial liabilities which meet the criteria of fair value through OCI will have an impact on the equity reserve. These financial instruments’ fair value will change over time, and they will impact our balance sheet. However, before they are sold or settled, the gain will be recorded in the equity reserve. The gain from assets will be realized after they are sold while the gain from liability will be realized after settlement.
For example, the company purchases a stock investment of $ 10 million from the capital market. At the end of the year, the stock price increased. The company’s investment increased to $ 12 million. The company has to record unrealized gain by debiting investment of $ 2 million and crediting equity reserve of $ 2 million.
The company initially records the property plan & equipment at cost, subsequently, we have options to record it using the cost model or revaluation model.
In the revaluation model, all PPE must evaluate on every reporting date. There will be a difference between the carrying amount and the revaluation amount at each closing date. All the changes in PPE’s value will be recorded into revaluation surplus (equity reserve). The change will not reflect in income statement until the actual assets are disposed or sold.
When the fixed assets’ fair value increase, company has to record the revaluation surplus. The journal entry is debiting fixed assets and credit equity reserve.
Available for Sale Assets
Available for sale security is the financial instrument that company purchases for the purpose of selling back at a higher price. These assets require to measure at fair value on each reporting date, so all the changes in fair value will record in equity reserve until they are sold. The gain from AFS will be recorded in equity reserve, it will be reversed when AFS is sold and realize the real gain.
Benefit Plan Reserve
Benefit Plan is the retirement plan which the company provides to the employee base on a certain formula which includes average salary, year of services, and so on. The company has to recognize the benefit liability in the balance sheet. There will be a difference between amount recognized and paid. The difference will be accumulated in the equity reserve.
It is the reserve which requires by the local regulations for the specific business type. Mostly the insurance and financial institute require to have a certain level of reserve in order to operate their business. This type of reserve will maintain unless the law change or company decide to change its business.