Which of the following statement is true?

Question

Accepted Answer

The correct option is 1:
The statement correctly defines a **Provision** in accordance with standard accounting principles. A provision is an amount that is set aside and charged against the Profit and Loss Account to meet a liability or an expected loss for which the exact amount cannot be determined with certainty, but the existence of the obligation is known. For instance, creating a provision for bad and doubtful debts is a perfect example: the business knows that some debts will likely turn bad (a known liability/loss), but the precise amount of the loss is an estimate, hence the need for a provision. This is a mandatory charge against profit, ensuring the financial statements adhere to the Prudence Principle by not overstating assets or profits.

The incorrect options are 2, 3, and 4:
Option 2 is incorrect because an amount set apart to meet a known liability is called a provision, not a reserve. **Reserves** are created by appropriating profits for general purposes or known future expansions, and they do not relate to a specific known liability or diminution in asset value. Option 3 incorrectly states that provisions are for **unknown** liabilities; provisions are created for *known* liabilities whose *amount* cannot be precisely measured. Setting aside an amount for an unknown liability or general future contingency is the purpose of a General Reserve. Finally, Option 4 is false because a **Secret Reserve** is an undisclosed reserve created by deliberately understating assets or overstating liabilities, meaning it is *not* shown as a separate or distinct item on the Balance Sheet; if it were shown separately, it would cease to be a secret reserve.