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Admission of a New Partner

Treatment of Reserves

Reserves are the amount of profits, which is set aside until there is a need for money for some purpose. In terms of accounting, we refer to this as appropriation. The name of a reserve account indicates its purpose or use. Reserve account is a part of a company’s net worth. Therefore we can say reserve is an amount that appears on the liability side of the statement of financial position. Let us learn Treatment of Reserves in detail.

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Treatment of Reserves

By definition, a reserve is that part of the profit that is not distributed among the partners but retained in the business.

Browse more Topics under Admission Of A New Partner

Need for Reserves in Business

If we credit entire profits to partner’s current accounts, the partners become entitled to withdraw it, in cash or kinds. This shows all earnings by the firm are related to partners.

This situation can seriously affect firm operations. One should understand that making a profit and having surplus cash are two fairly different things.

A situation may arise where a firm may make a decent profit and may still not have adequate cash to actually pay out to partners.

A business usually re-invests profits by way of acquiring assets. It may be current assets like stocks and receivables or any fixed assets. Where a firm allows partners to withdraw all the profits from the firm, there is no possibility of any growth in the volume of business.

Therefore, it is prudent not to distribute the entire amount of profit made in a year among the partners. The business retains some part of the profit in the business for its growth and continued successful existence in the near future.

Thus we open a Reserve Account in the books. After ascertaining the net profit for a particular year  (i.e. after the preparation of Profit and Loss Account), a  portion of the net profit which the partners agree to retain in the business is known as Reserves. Reserves are created as follows:

  • Debited to the Profit and Loss Appropriation Account, and
  • Credited to the Reserve (or General Reserve) Account.

Treatment of Reserves

Accounting treatment of reserves in case of admission of a partner:

In case of admission of a new partner, we need to transfer the reserves or accumulated profits and losses in the balance sheet to the old partners capital accounts.

Since all reserves showing in the balance sheet on the date of admission are earned by old partners. Therefore, we transfer them to old partners capital accounts in the old profit sharing ratio.

Understand the concept of Revaluation Account here in detail.

Following  is the journal entry:

Date Particular   Amount (Dr.) Amount (Cr.)
 

 

Reserve/Profit&loss A/c  Dr.  XXX
     To Old Partner’s capital A/c  Cr.  XXX
(Being reserve transferred to Partner’s capital accounts in old profit sharing ratio))

 

Solved Question on Treatment of Reserves

Micky, Mili, and Krish are partners in a firm sharing profits and losses in the ratio 2:2:1. a balance sheet of a firm as on 31st March 2017 is as below:

Liabilities    Amount Assets  Amount
Trade payables 6,425 Land and buildings 12,500
Outstanding liabilities 7,50 Furniture 3,250
General reserve 3,250 Inventory of goods 5,875
Capital account: Trade receivables 2,750
Ms.Micky 6,000 Cash in hand 70
Ms.Mili 6,000 Cash in bank 480
Mr. Krish 2,500 14,500
24,925 24,925

The partners have agreed to take Ms.sakshi as a partner with effect from 1st April 2017 on the following terms:

  • Sakshi shall bring ₹2,500 towards his capital.
  • Increase the value of inventory by ₹1,250 and depreciate furniture by 10%
  • Reserve for bad and doubtful debts should be provided at 10% of the trade receivable.
  • Enhance the value of land and building by 20% and fix the value of the goodwill at ₹ 7,500
  • Transfer the General reserve to the partner capital accounts
  • The new profit sharing ratio shall be Micky 5/15, Ms.Mili 5/15, Mr. Krish 3/15 and Ms. Sakshi 2/15

The outstanding liabilities include₹500 due to Mr. Jain which has been paid by Ms. Micky. Necessary entries were not made in the books.

Prepare (i) Revaluation account,(ii) The capital accounts of the partners (iii) Balance sheet of the firm after the admission of Ms. Sakshi.

Ans:

Revaluation Account

 Particulars  Amount  Particulars    Amount
To provision for doubtful debts 275 By inventory in trade 1,250
Furniture and fittings 325 By Land and Building 2,500
To Partner’s Capital A/c: 3,150
Micky 1260
Mili 1260
Krish 630
3,750 3,750

Partner’s Capital Account

Particulars Micky Mili Krish Sakshi Particulars Micky Mili Krish Sakshi
To Micky      –     –     – 500 By Balance b/d 6,000 6,000 2,500    –
To Mili      –     –     – 500 By General Reserve 1,300 1,300 650     –
To Balance c/d 9,560 9,060 3,780 1,500 By cash     –     –    – 2,500
By Sakshi 500 500    –     –
By outstanding liabilities 500    –    –     –
By Revaluation A/c 1,260 1,260 630     –
9,560 9,060 3,780 2,500 9,560 9,560 3,780 2,500

A balance sheet of M/s.  Micky, Mili, Krish, and Sakshi  as on 1-4-2017

Liabilities Amount Assets Amount
Trade payables 6,425 Land and building 15,000
Outstanding liabilities 250 Furniture 2,925
Capital account of partners Investors of goods 7,125
Ms.Micky 9,560 Trade receivables 2,750
Ms.Mili 9,060 Less: Provisions (275) 2,450
Mr. Krish 3,780 Cash in hand 70
Ms.sakshi 1,500 23,900 Cash at Bank 2,980
30,575 30,575

Working note:

Calculation of sacrificing ratio

Partners New share Old share Sacrifice Gain
Micky 5/15 2/5 -1/15
Mili 5/15 2/5 -1/15
Krish 3/15 1/5 No gain no loss
Sakshi 2/15 2/15

Sacrifice by Ms.Mili=₹15,000×1/15 =₹1000 each

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Pawan Kumar

New ratio of question no. 5 is 17:16:8 among all three partners. Please check your answer

Pawan Kumar
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Pawan Kumar

Sory 17:15:8

Rtdyy
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Rtdyy

1/8X7/8=4/32 how?

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