Statutory Reserve/ Legal Reserve: is a reserve that is stipulated in the Companies Law, and 5% of the year earnings are deducted every year for a purpose until the statutory reserve reaches 50% of the issued capital and can be used to counter the losses of the company or increase the capital but is not used in the dividend and the statutory reserve is considered as a reserve requirement.

Legal reserves and other reserves are set-up via profit distribution. The legal reserves are compulsory for all companies and must reach 20% of the companies’ share capital, with an annual distribution of 5% from the profits until the reserve reaches the 20% threshold.

Reserve accounting prevents these funds from being used for other things like buying back shares or paying dividends. The money in the reserve should be used for what it was intended for. But technically, there are no legal restrictions on what a company can use reserve funds for.

Reserves, otherwise known as retained earnings, are any profits that have been set aside for future use. A business can use them for any number of things, as there are no legal restrictions on using funds designated as reserves.

From a literal reading of the Law, the legal reserve must be construed as a profit-based account (“each year at least one-twentieth of the net profits shall be allocated to the creation of a reserve; this allocation shall cease to be compulsory when the reserve has reached an amount equal to one-tenth of the corporate capital, but shall again be compulsory if the reserve falls below such one-tenth”).