Worked Solution
✓ VerifiedConversion of Partnership Firm into a Limited Company — Realisation Account and Partners' Capital Accounts
Step 1 — Goodwill Valuation
Profits given are after setting aside ₹8,000 p.a. to reserve fund (an appropriation, not an expense). Adjusted profits for goodwill:
- 2019: ₹1,20,000 + ₹8,000 = ₹1,28,000
- 2020: ₹1,44,000 + ₹8,000 = ₹1,52,000
- 2021: ₹1,68,000 + ₹8,000 = ₹1,76,000
Average profit = ₹4,56,000 ÷ 3 = ₹1,52,000
Goodwill = 2 years' purchase = ₹1,52,000 × 2 = ₹3,04,000
Step 2 — Purchase Consideration
Assets taken over at agreed values:
Sundry debtors ₹2,40,000 + Bills receivable ₹40,000 + Stock ₹1,44,000 + Patents ₹32,000 + Plant & Machinery ₹96,000 + Land & Building ₹4,00,000 + Goodwill ₹3,04,000 = ₹12,56,000
Less: Liabilities taken over:
Sundry creditors ₹1,92,000 + Loan creditors ₹1,60,000 + Bank overdraft ₹64,000 = ₹4,16,000
Purchase Consideration (equity shares to vendors) = ₹8,40,000
Note: Loan creditors (₹1,60,000) are settled by the company through issue of 7½% Redeemable Preference Shares.
Step 3 — Profit on Realisation
Dr side of Realisation = All book value assets = ₹7,60,000 (goodwill not in balance sheet, so not on Dr side)
Cr side = Liabilities discharged (₹4,16,000) + Company A/c/Purchase Consideration (₹8,40,000) = ₹12,56,000
Profit on Realisation = ₹12,56,000 − ₹7,60,000 = ₹4,96,000 (split equally: ₹2,48,000 each)
Verification: Gain on Plant ₹32,000 + Gain on Land & Building ₹1,60,000 + Goodwill ₹3,04,000 = ₹4,96,000 ✓
Realisation Account (in the books of the firm)
| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| Sundry Debtors | 2,40,000 | Sundry Creditors A/c | 1,92,000 |
| Bills Receivable | 40,000 | Loan Creditors A/c | 1,60,000 |
| Stock in Trade | 1,44,000 | Bank Overdraft A/c | 64,000 |
| Patents | 32,000 | Company A/c (Purchase Consideration) | 8,40,000 |
| Plant & Machinery | 64,000 | ||
| Land & Building | 2,40,000 | ||
| A's Capital A/c (Profit) | 2,48,000 | ||
| V's Capital A/c (Profit) | 2,48,000 | ||
| Total | 12,56,000 | Total | 12,56,000 |
Partners' Capital Accounts
| Dr | A (₹) | V (₹) | Cr | A (₹) | V (₹) |
|---|---|---|---|---|---|
| Equity Shares A/c | 4,20,000 | 4,20,000 | Balance b/d | 1,60,000 | 1,60,000 |
| Reserve Fund A/c | 12,000 | 12,000 | |||
| Realisation A/c (Profit) | 2,48,000 | 2,48,000 | |||
| Total | 4,20,000 | 4,20,000 | Total | 4,20,000 | 4,20,000 |
Each partner (A and V) receives equity shares worth ₹4,20,000. The loan creditors receive 7½% Redeemable Preference Shares of ₹1,60,000 directly from the company.
Write it like this
1The skeleton
- Start your goodwill working note first, before any account — examiners award a separate step mark here; if your goodwill figure is wrong but your method is shown, you still get method marks.
- Add back ₹8,000 reserve fund to each year's profit before averaging — the question says profits are after setting aside ₹8,000, so you must reverse it; show '₹1,20,000 + ₹8,000 = ₹1,28,000' explicitly so the examiner can see your logic.
- In Realisation A/c, Dr side carries only book values — goodwill does NOT appear on Dr side since it was never in the balance sheet; missing this collapses your totals and you lose the balancing mark.
- Credit the Company A/c (Purchase Consideration) at ₹8,40,000 on the Cr side of Realisation — this single line is what makes the account balance; label it exactly 'Company A/c (Purchase Consideration)' not just 'Company A/c'.
- In Partners' Capital Accounts, show Reserve Fund distribution as a separate Cr line (₹12,000 each) — students who skip this get the closing balance wrong and lose the equity shares figure too.
- Add a one-line note on loan creditors — state that ₹1,60,000 is settled by the company via 7½% Redeemable Preference Shares directly; this shows examiner you know it does NOT reduce the purchase consideration.
2Examiner-rewarded phrases
3Common trap
The single biggest killer here is forgetting to add back the reserve fund when computing goodwill — most students take the profits as given (₹1,20,000 / ₹1,44,000 / ₹1,68,000) and average them directly, landing on ₹1,44,000 average instead of ₹1,52,000. That one slip cascades: wrong goodwill → wrong purchase consideration → wrong realisation profit → wrong capital account closing balances — you can lose 6-8 marks from one missed add-back.