What is a statutory reserve? Meaning and calculation

A statutory reserve is a mandatory reserve that must be reported on a company’s financial statements. This reserve is intended to protect the company’s equity and absorb certain financial risks. A statutory reserve cannot be freely distributed as dividends. It exists to safeguard creditors and ensure the financial stability of a corporation.

Examples of statutory reserves include reserves for unrealized earnings from subsidiaries or revaluation reserves. In this article, you’ll learn when you are required to hold a statutory reserve, how to calculate it, and how to book it correctly on the balance sheet.

Table of contents:

1. When do you use a statutory reserve?
2. The 6 types of statutory reserves
3. How to calculate the statutory reserve
4. How to record the statutory reserve on the balance sheet
5. When to use a statutory reserve for subsidiaries
6. Streamline your accounts receivable process with Payt

When do you use a statutory reserve?

A statutory reserve is required in situations where U.S. law or regulatory standards mandate that profits cannot be distributed immediately. This can apply, for example, to capitalized start-up or development costs, or retained earnings from investments that haven’t yet been received as dividends.

In regulated sectors such as banking or insurance, statutory reserve requirements may also be imposed by federal or state law (e.g., statutory reserve ratio definition under FDIC or NAIC rules).

Who is required to hold statutory reserves?

Statutory reserves are common for corporations (C-corps and S-corps), LLCs, and especially regulated entities such as banks, credit unions, and insurance companies. These companies are often legally required to retain portions of their equity as non-distributable reserves. These reserves differ from non-statutory reserves, which are voluntary or internally allocated.

The 6 types of statutory reserves

All of these statutory reserves contribute to a transparent and stable equity position on the company’s balance sheet.

How to calculate the statutory reserve

The statutory reserve calculation depends on the nature of the obligation. For subsidiaries, the reserve is based on the difference between the book value of the investment and the actual dividends received. The portion of the profit not yet distributed is added to the reserve.
For other statutory reserves, the statutory reserve formula generally uses the capitalized cost or valuation change of the asset, and that value is allocated into equity as a non-distributable item.

Example:
Let’s say your company owns a subsidiary with a book value of € 100,000. Last year, you received € 25,000 in dividends.

• Book value of investment: € 100,000
• Dividends received: € 25,000
• Statutory reserve: € 75,000

This means € 75,000 must be retained in the statutory reserve section of equity until those funds are realized or distributed.

How to record the statutory reserve on the balance sheet

The statutory reserve is recorded on the liabilities side under the equity section, typically labeled “reserves” or “retained earnings – restricted.” It is important not to confuse this with unrestricted retained earnings, which can be used for dividends or share buybacks.

This reserve is usually booked during the preparation of the annual financial statements, based on data derived from the general ledger and applicable reporting standards (such as GAAP or industry-specific rules).

When to use a statutory reserve for subsidiaries

A statutory reserve related to subsidiaries must be held when your parent company recognizes earnings from a subsidiary but has not yet received them as dividends. This is often required under the equity method of accounting.

How to determine the reserve amount

Calculate the share of earnings included in your net income that has not yet been paid out. This difference is booked under the statutory reserve for subsidiaries. Only once the dividend is actually received can the reserve be released and reclassified as distributable.

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• Timely invoice payments
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By streamlining your internal processes, you’ll always have the right data to correctly calculate and manage reserves – including statutory reserves.
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Frequently asked questions about statutory reserves