Technically speaking, a reserve differs from an allowance (such as the allowance for impairment or credit losses) in terms of use and purpose and the risks covered by each. By definition:

• Reserve: is a component of equity (relating to shareholders, or non-controlling interest) or quasi-equity (what relates to profit-and-loss taking stakeholders- e.g., unrestricted investment account holders, URIAs). It is created as an appropriation from respective earnings or retained earnings, and also through value adjustments for the sake of respective stakeholders aimed to manage and mitigate the different types of risk associated with equity or quasi-equity balances or off-balance sheet items.
• Allowance: a charge in the profit and loss account (income statement) that aims to cover expected or potential losses arising from doubtful collectibility or impairment of asset values.

A reserve is used for profit smoothing and as a protection against future decline in returns for profit-and-loss taking stakeholders (with respect to mudaraba, musharaka, or investment agency) due to decreasing returns on assets and investments. In this sense, reserves are used to cover equity investment risk, market risk, rate of return risk, and credit risk.

An allowance (provision) for impairment or credit losses is meant to match expected losses with incurred or actual losses that arise from doubtful debts or impaired values of assets. The purpose of an allowance is defined as the ability to meet future liabilities arising from financial commitments and financial guarantee contracts or impairment losses (the amounts by which the carrying amount of an asset exceeds it recoverable amount).