A reserve which maintained to strengthen the financial position of the business without disclosing it in the book is known as secret reserve. Secret reserve is hidden reserve which is not disclosed by the balance sheet. Secret reserve is also known as internal reserve. It is created by showing the figure of net profit less than actual. Its existence makes the financial position of the business better than what the balance sheet is disclosing. Generally, it is maintained by bank, Insurance and other financial institutions.
A secret reserve is created in any of the following ways:
* By depreciating the fixed assets at excessively high rates.
* By undervaluing the current assets.
* By eliminating the assets altogether from the books.
* By over-valuing the liabilities.
* By showing contingent liabilities as real assets.
* By creating excessive amount of reserve for future contingencies.
* By treating capital expenditure as revenue reserve.
* By ignoring accrued income or treating income as liability.
* By undervaluing the current assets.
* By eliminating the assets altogether from the books.
* By over-valuing the liabilities.
* By showing contingent liabilities as real assets.
* By creating excessive amount of reserve for future contingencies.
* By treating capital expenditure as revenue reserve.
* By ignoring accrued income or treating income as liability.
Objectives And Advantages Of Secret Reserve
The following are the objectives and advantages of secret reserve:
* Secret reserve helps in strengthening the financial position of the business.
* Secret reserve gives the sense of financial stability to the shareholders and creditors by equalizing the rate of dividend.
* Secret reserve helps in eliminating unhealthy competition by not showing true profit to the competitors.
* Secret reserve provides additional working capital.
Disadvantages Of Secret Reserve
The following are the disadvantages of secret reserve
* The existence of secret reserve is known to the management only and not to the real owners or shareholders.
* Secret reserve makes the information of financial statements false and inaccurate.
* Secret reserve may be the strong cause of loosing trust and confidence of the shareholders and outsiders.
* Secret reserve may cover up the inefficiency and fraud committed by the managers and directors.
* Secret reserve gives the sense of financial stability to the shareholders and creditors by equalizing the rate of dividend.
* Secret reserve helps in eliminating unhealthy competition by not showing true profit to the competitors.
* Secret reserve provides additional working capital.
Disadvantages Of Secret Reserve
The following are the disadvantages of secret reserve
* The existence of secret reserve is known to the management only and not to the real owners or shareholders.
* Secret reserve makes the information of financial statements false and inaccurate.
* Secret reserve may be the strong cause of loosing trust and confidence of the shareholders and outsiders.
* Secret reserve may cover up the inefficiency and fraud committed by the managers and directors.