What are Balance Sheet Reserves?
Balance sheet reserves, also known as 'claims reserves', are accounting entries that reflect money a company sets aside to pay future obligations.
How Do Balance Sheet Reserves Work?
Let's assume Company XYZ has to recall one of its products and issue refunds to customers. It expects customer returns to trickle in over the next six months. To ensure that it has enough money ready to issue refunds, it creates a balance sheet reserve of $10,000. As customers request refunds, Company XYZ reduces the $10,000 reserve.
Insurance companies often set up balance sheet reserves to ensure they have enough set aside to pay out claims. The reserves often equal the value of claims that have been filed but not paid out yet.
Why Do Balance Sheet Reserves Matter?
Balance sheet reserves are recorded as liabilities on the balance sheet. In some industries, such as insurance, regulators set standards for how and when to set up balance sheet reserves.