Question

State whether the following statement is true.

Capital reserves are created from capital profits.

Answer 1

This statement is true.

Explanation:

Capital reserves are created strictly from capital profits, which are non-recurring gains earned from transactions outside the regular daily business operations. Unlike revenue profits from normal sales, capital profits come from specific activities such as the profit from selling fixed assets, the premium received on the issue of shares or debentures, or the profit from the forfeiture of shares. Because these profits are not earned through routine trading, they are transferred directly to a capital reserve account and cannot be used to distribute regular dividends to shareholders.