Statutory reserve
In one sentenceA part of net profit the business sets aside each year under the Companies Law or its articles of association; it appears within equity and is not distributed as ordinary profit.
Simply put
Once you know the year's net profit, not all of it is available for distribution. The law or the articles of association set a percentage that is transferred to the statutory reserve account first.
Its purpose is to protect the business and its creditors, so part of the profit stays inside it to absorb losses or support capital. Always check your company's articles to know the percentage and its limit.
Worked example
A contracting business made a net profit of 400,000 SAR, and its articles of association require setting aside a percentage of profit (we assume 10% for illustration only).
Net profit for the year400,000 SAR
Assumed reserve percentage10%
Dr Retained earnings40,000
Cr Statutory reserve40,000
Transferred to the reserve = 400,000 × 10%40,000 SAR
Formula: Net profit × the percentage set by the law or the articles of association
Don't confuse it with
Retained earningsRetained earnings are available for distribution by the owners' decision, while the statutory reserve is held back by the law or the articles.