Valuation Reserve

You run a company that makes TV sets. Technology moves fast, so what represented a cutting-edge TV a couple of years ago...is now something you could only sell at a deep discount to an old-age home.

If your production runs too high and you end up with a significant inventory of finished TVs in your warehouse, the value of that inventory is likely to decline over time. As such, your accountant insists you set up a valuation reserve. It represents an allowance used to offset any declines in the value of an asset.

The category includes a number of types of allowances. In your case, the valuation reserve you set up would be called an allowance for obsolete inventory. However, other types exist. For example, you could set up an allowance for doubtful accounts to offset any customers (like those sneaky old-age homes) who don't end up paying their invoices.

Insurance companies are required to carry valuation reserves for the investments they hold. So if an insurance company owns shares in a public company, they would have to create a valuation reserve to offset any possible market declines. That way, the insurance company can remain financially viable (able to cover customer claims) even if their investments take a hit in a downturn.