- For example, if some stock (asset) is stolen, the value of the stock in the Balance Sheet is reduced.
The same thing must happen if a prudent view is that an asset has lost some of its value.
- For example, if some of the stock is obsolete and unlikely to sell for full value.
- Normally, the Balance Sheet will just show the reduced value, which will be explained with notes.
The creation of a stock reserve reduces the profit.
- If it is subsequently found that the reserve was not necessary, the asset is restored to its full value and the profit is correspondingly increased in a later period.
Bad debt reserve
It is often necessary to create a bad debt reserve to cover money that may not be collectable from customers.
- This bad debt reserve reduces the profit.
- For example, loan loss reserve or provision by the banks.