Accountancy and Financial Management - III Notes | B.Com. (Accountancy) Semester 3 | Mumbai University | munotes

It is not a merger under the Companies Act. Sections 230 to 240 of the Companies Act 2013 govern schemes of arrangement between companies and require the Tribunal's sanction. A partnership amalgamation is a matter of contract between the partners and needs no court.

What the partners must agree

The deed of amalgamation settles six things, and a question gives them to you as its data:

1. Which assets and liabilities each old firm transfers, and which it retains.
2. At what values they are transferred.
3. The purchase consideration for each old firm, and how it is discharged.
4. The profit-sharing ratio in the new firm.
5. The capital each partner is to have in the new firm, and how any shortfall or excess is settled.
6. The treatment of goodwill, which the last chapter of this module takes up.

Read a question against that list before writing anything. Every one of the six will be in there somewhere, and finding them first is faster than discovering them halfway down a realisation account.

The order of work

Every full problem in this module is worked in the same order, and following it is half the marks:

Steps two, three and four repeat for each old firm. Two firms means two realisation accounts, and running them together in one account is the surest way to lose the question.

What it does NOT mean

The new firm does not continue the old books. It opens its own.

The partners do not receive cash. They receive capital in the new firm, unless the agreement says otherwise.

Not every asset goes across. What is not taken over stays with the old partners, and the entry for it is the one students forget.

Quick revision

• Amalgamation of firms: two or more firms dissolved, one new firm formed, all partners becoming partners of it.
• Three things at once: old firms closed by realisation, a price agreed, new books opened.
• Label whose books you are in. Two old firms means two realisation accounts.
• Reasons: end competition, gain size, pool complementary strengths, cut cost, secure capital, continue a firm whose partners are retiring.
• Not admission, not ordinary dissolution, not conversion into a company, and not a Companies Act merger, which needs the Tribunal.
• The deed settles: what transfers, at what values, for what consideration, in what ratio, with what capitals, and how goodwill is treated.
• Seven steps, in order, and steps two to four repeat per firm.

Test yourself

1. What happens to the old firms on amalgamation? They are dissolved and their books closed through a realisation account, their assets and liabilities passing to the new firm at the agreed values.

2. How does amalgamation differ from ordinary dissolution? In dissolution the assets are realised in cash, the creditors paid and the surplus divided; in amalgamation they are taken over as a going concern by a new firm and the partners are settled by capital in that firm.

3. Why does a partnership amalgamation need no court order? Because it is a matter of contract between the partners, unlike a scheme of arrangement between companies, which requires the Tribunal's sanction under the Companies Act 2013.

4. Name the six things the deed of amalgamation must settle. Which assets and liabilities transfer, at what values, the purchase consideration and its discharge, the new profit-sharing ratio, the capital each partner is to have, and the treatment of goodwill.

5. How many realisation accounts does a problem with two old firms have? Two, one in the books of each old firm; running them together loses the question.

Answer in one sentence

What is amalgamation of firms? It is the combination of two or more partnership firms into a single new firm, in which the old firms are dissolved and their books closed through a realisation account, the assets and liabilities they agree to transfer pass to the new firm at agreed values for an agreed purchase consideration, and the partners of all the old firms become partners of the new one and are settled by capital in it rather than in cash; it is undertaken to end competition, gain size, pool complementary strengths, reduce cost, secure capital or continue a firm whose partners are retiring, and being a contract between partners it requires no order of any court.

Three of the five are about continuity - of ownership, of business, and of measurement - and that is the idea to carry. A merger is a combination in which nothing is really disturbed but the name over the door.

Applying the test where the parties are firms

Conditions (ii) and (iii) speak of equity shares and shareholders, and a firm has neither. The next chapter deals with that squarely. For working a question, translate them:

Say in an answer that you are translating. A sentence such as "the conditions are framed for companies; applied to firms they require that the partners continue as partners and are settled in capital rather than in cash" shows you know what you are doing, and it costs one line.

Why the type matters

Because it decides the method, and the method decides every figure in the new firm's balance sheet.

That table is the answer to the distinguish-between MU is most likely to set, and the chapter after next works both methods on one set of figures so that the differences can be seen rather than recited.

Worked test: which type is it?

State, with reasons, whether each is a merger or a purchase.

Row two is the one students get wrong. Revaluation alone makes it a purchase, even where everything and everybody has come across. Continuity of measurement is a condition, not a detail.

What it does NOT mean

A merger is not a friendly amalgamation and a purchase is not a hostile one. The test is the five conditions, not the mood of the negotiation.

A purchase does not require cash. It requires only that one of the five conditions fails.

"Purchase" here does not mean the purchase consideration. Every amalgamation has a purchase consideration; only some are amalgamations in the nature of purchase.

Quick revision

• Merger satisfies all five conditions; purchase is one that fails any.
• The five: all assets and liabilities pass; 90 per cent of owners continue; consideration wholly in equity; the business is to be carried on; no adjustment to book values.
• Three of the five are about continuity - of ownership, of business, of measurement.
• For firms, translate: all partners continue as partners, and are settled in capital, not cash. Say that you are translating.
• Merger takes pooling of interest, at book values, carrying reserves across; purchase takes the purchase method, at agreed values, throwing up goodwill or capital reserve.
• Revaluation alone makes it a purchase.

Test yourself

1. State the five conditions for a merger. That all the assets and liabilities of the transferor pass to the transferee; that holders of not less than ninety per cent of the face value of the equity shares of the transferor become equity shareholders of the transferee; that their consideration is discharged wholly by the issue of equity shares, apart from cash for fractions; that the business is intended to be carried on; and that no adjustment is made to book values except for uniformity of accounting policies.

2. How is an amalgamation in the nature of purchase defined? Negatively, as one which does not satisfy any one or more of the merger conditions.

3. Two firms combine, everything passes and all partners join, but the buildings are revalued before transfer. Which type is it? A purchase, because the condition against adjusting book values has failed, and the conditions are cumulative.

4. How do you apply conditions (ii) and (iii) to firms? By translating them: the partners of the old firms must all, or substantially all, become partners of the new firm, and their consideration must be credited as capital in the new firm rather than paid out; and the answer should say that the translation is being made.

5. Why does the type matter? Because it decides the method: a merger is accounted for by pooling of interest at book values with the reserves carried across, and a purchase by the purchase method at agreed values with the difference on the consideration going to goodwill or capital reserve.

Answer in one sentence

Distinguish the two types of amalgamation. An amalgamation in the nature of merger is one satisfying all five conditions - that all assets and liabilities pass, that holders of at least ninety per cent of the equity continue as owners, that their consideration is discharged wholly in equity, that the business is to be carried on, and that book values are not adjusted except for uniformity of policies - so that ownership, business and measurement all continue; an amalgamation in the nature of purchase is one that fails any of those, so that in substance one business has been bought; and the distinction decides everything that follows, since a merger is recorded by the pooling of interest method at existing book values with the reserves carried across, while a purchase is recorded by the purchase method at agreed values with any excess of consideration over net assets becoming goodwill and any shortfall a capital reserve.

How to write it in an answer

One sentence does the whole job, and it earns marks rather than costing them:

The two methods take their names and their content from AS 14, Accounting for Amalgamations, which states that it is directed principally to companies; applied to the amalgamation of firms the conditions are read as requiring that the partners continue as partners of the new firm and are settled by capital in it rather than in cash.

What that sentence does. It shows you know the source, it shows you know its limits, and it tells the examiner you are applying the test by analogy deliberately rather than by mistake.

What to avoid. Do not write "as per AS 14, this amalgamation of the firms is in the nature of merger", flatly, as though the standard governed. It does not, and the sentence is checkable.

Where AS 14 does govern

It governs the amalgamation of companies, and that is Financial Accounting - III on this same line, in Semester V, where the transferor and transferee are companies and the consideration is discharged in shares.

Keep the two apart. This module's firms have partners, capital accounts and a realisation account. That paper's companies have shareholders, share capital and an amalgamation adjustment. The methods share their names and little else about the paperwork.

What it does NOT mean

The standard is not irrelevant. It supplies the vocabulary MU examines and the content of both methods.

Its text is not off limits. It is notified and therefore Gazette matter, so it may be quoted with attribution.

The five conditions are not useless for firms. They are translated, and the answer says it is translating.

Quick revision

• AS 14 states that it "is directed principally to companies" although some requirements also apply to other enterprises.
• Two of its five merger conditions are impossible for a firm: ninety per cent of equity shareholders, and discharge wholly by the issue of equity shares.
• Take from it: the names of the two methods; the content of each, pooling at existing carrying amounts and purchase on normal purchase-of-assets principles; and the idea of continuity.
• Do not take from it: the claim that it governs. Say you are applying the test by analogy.
• It does govern the amalgamation of companies, which is a different paper.

Test yourself

1. What does AS 14 say about its own scope? That it is directed principally to companies, although some of its requirements also apply to the financial statements of other enterprises.

2. Which two merger conditions cannot be satisfied by a firm, and why? The condition requiring holders of ninety per cent of the face value of the equity shares to become equity shareholders of the transferee, and the condition requiring the consideration to be discharged wholly by the issue of equity shares, because a firm has neither shares nor shareholders.

3. What may properly be cited from the standard? The names of the pooling of interests and purchase methods, the content of each, and the underlying idea of continuity of ownership, business and measurement.

4. Write the sentence that should appear in an answer. That the two methods take their names and content from AS 14, which states that it is directed principally to companies, and that applied to firms its conditions are read as requiring the partners to continue as partners settled by capital rather than cash.

5. Where does AS 14 actually govern? The amalgamation of companies, which is examined in Financial Accounting - III in Semester V, where there are shareholders and shares to issue.

Answer in one sentence

What is the standing of AS 14 in this module? It supplies the vocabulary and the content that MU examines, the names of the pooling of interests and purchase methods and the description of each, and the underlying test of continuity in ownership, business and measurement; but it states in its own opening words that it is directed principally to companies, and two of its five merger conditions, requiring ninety per cent of equity shareholders to continue and the consideration to be discharged wholly by the issue of equity shares, are impossible for a partnership firm which has neither shares nor shareholders, so the standard is cited for what it says and the test is applied to firms by an analogy that the answer should state it is making.

A liability taken over at an agreed value is deducted at the AGREED value. The rule that agreed values govern is not confined to assets. Where the buyer takes creditors of Rs 96,000 at Rs 82,000, the consideration deducts Rs 82,000, and the Rs 14,000 rebate raises the consideration by that much.

Worked, and it checks itself.

A firm's books show building Rs 2,00,000, stock Rs 1,00,000 and debtors Rs 60,000, besides cash which is not taken over, and creditors Rs 96,000. The buyer values the building at Rs 2,40,000, the stock at Rs 90,000 and the debtors at Rs 54,000 after a ten per cent provision, and agrees to take over the creditors at Rs 82,000.

And the realisation account still uses BOOK values on both sides, which is the point students miss.

Prove it the other way.

The two agree, and they must. The rebate is a gain to the old firm's partners, and it reaches them through a larger consideration, not through a separate entry.

Method two: net payment

Add up everything the new firm agrees to give the partners of the old firm.

Three rules.

Take the amounts actually agreed, not what the net assets happen to be worth.

Ignore the values of the individual assets and liabilities entirely. Under this method they do not enter the computation; they enter the entries afterwards.

Include payments to the partners only. A payment the new firm makes to a creditor of the old firm is the discharge of a liability it assumed, not a payment for the business.

Which method to use

The question decides, and it decides by what it gives you.

Where the question names the method, use the one it names even if the other looks easier. The marks are for the method as much as the figure.

When the two differ

Where the question gives enough for both and the answers differ, that is not an error; it is the point.

Under the purchase method those two words are where the difference lands. Under pooling there is no such difference to land, because both sides are recorded at existing book values and any adjustment goes to reserves.

The four items students get wrong

What it does NOT mean

The purchase consideration is not the total of the old balance sheet. It is the net of what was taken over.

It is not the amount paid to creditors. It is the amount given to the partners.

The two methods are not alternatives to choose between at will. The question's data decide.

Quick revision

• Consideration = the aggregate of everything given to the owners, in any form.
• Net assets method: agreed value of assets taken over less agreed value of liabilities taken over.
• Net payment method: capital credited plus cash plus anything else given to the partners.
• Only what is taken over counts, on either side.
• Never deduct partners' capitals or reserves.
• Where both can be computed and they differ: payment above assets is goodwill, payment below assets is capital reserve.
• Payments to creditors are the discharge of a liability assumed, not consideration.

Test yourself

1. Define purchase consideration. The aggregate of the capital credited, shares or securities issued and payments made in cash or other assets by the acquiring firm to the partners of the old firm for the business taken over.

2. Under the net assets method, is a bank loan the new firm refuses to take deducted? No. Only liabilities actually taken over are deducted; one that is not taken over is left with the old firm and discharged in its realisation account.

3. Why are partners' capitals never deducted? Because they are the owners' own claim on the firm and not a liability to an outsider, so deducting them computes something that is not the consideration.

4. The net payment is Rs 5,00,000 and the net assets Rs 4,80,000. What is the difference? Goodwill of Rs 20,000, because the new firm has agreed to give more than the net assets taken over are worth.

5. Which method do you use if the question gives the agreed values of the assets? The net assets method; if it gives the capital to be credited and the cash to be paid, the net payment method; and if it gives both, compute both, because the difference is goodwill or capital reserve.

Answer in one sentence

How is the purchase consideration computed? It is the aggregate of everything the new firm gives to the partners of the old firm, and it is arrived at either by the net assets method, taking the agreed value of the assets taken over and deducting the agreed value of the liabilities taken over, counting only what actually passes and never deducting the partners' own capitals or reserves, or by the net payment method, adding the capital credited to each partner, the cash paid and anything else given, ignoring the individual asset and liability values entirely; the question's data decide which applies, and where both can be computed the excess of the payment over the net assets is goodwill while the shortfall is a capital reserve.

Which figure the entries use

This is where students go wrong after getting both numbers right.

In the OLD firm's books, the purchase consideration is the figure the new firm owes it, and that is the net payment, Rs 5,00,000. It is debited to the new firm and credited to realisation.

In the NEW firm's books, the assets and liabilities come in at their agreed values, and the balancing figure is goodwill. So the opening entry is:

The entry balances because goodwill is the plug, and that is precisely what the two methods together have computed.

The check to run

Add the debits and the credits of the opening entry. They come to Rs 5,90,000 each. If they do not, one of three things has happened: an asset not taken over has been included, a liability not taken over has been assumed, or the goodwill has been computed against the wrong consideration.

In short

• Net assets method: Rs 5,70,000 of assets less Rs 90,000 of creditors = Rs 4,80,000.
• Net payment method: Rs 3,30,000 plus Rs 1,70,000 = Rs 5,00,000.
• The difference of Rs 20,000 is goodwill.
• Cash and the bank loan are excluded from everything, because neither was taken over.
• Reserves and capitals are never deducted.
• The old firm's books use the net payment; the new firm's books use the agreed values with goodwill as the balancing figure.

Answer in one sentence

Compute the purchase consideration and explain the difference between the methods. By the net assets method it is the agreed value of the assets taken over, Rs 5,70,000, less the creditors taken over, Rs 90,000, giving Rs 4,80,000, the cash and the bank loan being excluded because neither passes and the reserve and capitals being excluded because they are the partners' own claim; by the net payment method it is the capital credited to the partners, Rs 3,30,000 to P and Rs 1,70,000 to Q, giving Rs 5,00,000; and the excess of Rs 20,000 that the second shows over the first is goodwill, being the amount the new firm has agreed to give for the business over and above the value of the things it received, which appears as the balancing debit in the opening entry of the new firm.

Why the method exists

Because in a genuine pooling there is no transaction to record. Nobody sold anything and nobody bought anything; two groups of owners who each had a business now jointly have both. Recognising goodwill in those circumstances would be recognising a gain on doing nothing, and revaluing the assets would be restating them on an event that did not change them.

That is the argument to give when a question asks why the method is used, and it is better than saying "because it is a merger", which restates the rule rather than explaining it.

The consequences, which examiners ask about

The third row is the one worth an extra sentence in an answer. A firm that pools carries its plant at the old written-down value and charges depreciation on that; a firm that uses the purchase method carries it at the higher agreed value and charges more. The method chosen changes reported profit for years afterwards.

What it does NOT mean

Pooling is not an option to choose. It is confined to amalgamations that meet the merger conditions.

"No adjustment" is not absolute. Accounting policies may be made uniform.

The reserves are not the partners' capital. They cross as reserves and stay reserves.

A difference is not goodwill. It is adjusted in reserves.

Quick revision

• Assets, liabilities and reserves cross at existing carrying amounts.
• The only permitted adjustment is to make accounting policies uniform.
• No goodwill arises, and any difference on the capital is adjusted in reserves.
• The opening entry balances without a plug.
• Use is confined to amalgamations meeting the merger conditions.
• Consequences: reserves survive, later profits are higher than under purchase, the balance sheet total is lower, and the figures stay comparable.

Test yourself

1. At what values are assets and liabilities recorded under pooling? At their existing carrying amounts in the books of the transferor, with the only permitted adjustment being to adopt a uniform set of accounting policies.

2. What happens to the reserves of the old firms? They are carried across and appear as reserves of the new firm, because nothing has been distributed.

3. Where does a difference on the capital go? It is adjusted in reserves, not treated as goodwill or shown as a capital reserve on the face of the statement.

4. Why does no goodwill arise? Because nothing has been bought: in a genuine pooling the same owners jointly hold both businesses, so recognising goodwill would recognise a gain on a transaction that did not occur.

5. How does the choice of method affect later profits? Under pooling the assets carry their old lower book values, so depreciation is lower and reported profit higher than under the purchase method, and the effect lasts for the life of the assets.

Answer in one sentence

Explain the pooling of interest method. It is the method confined to amalgamations in the nature of merger, under which the assets, liabilities and reserves of the old firms are recorded by the new firm at their existing carrying amounts, the only permitted adjustment being the adoption of a uniform set of accounting policies where the old firms' policies conflicted, so that no asset is revalued, the accumulated reserves survive the amalgamation because nothing has been distributed, no goodwill arises because nothing has been bought, and any difference between the capital credited to the partners and the capital they previously held is adjusted in reserves; the consequence is a new balance sheet that is simply the old ones added together, with a lower total, comparable figures and, because the assets carry their old values, lower depreciation and higher reported profit in the years that follow than the purchase method would give.

Goodwill and capital reserve never appear together in the same entry for the same firm. One or the other, or neither where the figures agree exactly.

Where two old firms are taken over, compute the difference separately for each. One may throw up goodwill and the other a capital reserve, and they are not netted before being recorded, though they may appear on the same balance sheet.

Realisation profit in the old firm

A point students miss. Under the purchase method the assets are taken over at values different from book values, so the old firm's realisation account shows a profit or loss on realisation, which goes to the old partners in their old profit-sharing ratio.

That profit is not the same thing as goodwill. Realisation profit belongs to the old firm and increases its partners' capitals; goodwill belongs to the new firm and is the excess of what it agreed to pay over what it received. Two different accounts, in two different sets of books.

Why the method exists

Because a purchase has occurred and a purchase is recorded at its price. Where the owners have changed, or the business has been bought to be reorganised, or the parties themselves have struck new values, the old book figures no longer describe anything, and carrying them forward would report a business at numbers nobody agreed to.

The consequences

What it does NOT mean

The purchase method is not only for hostile takeovers. It applies whenever any one merger condition fails, including a mere revaluation.

Goodwill is not the realisation profit. Different books, different meaning.

Capital reserve is not a mistake. It is what a bargain purchase looks like.

Agreed value is not always fair value. It is what the parties agreed, and the question supplies it.

Quick revision

• The object is to apply the same principles as a normal purchase of assets.
• Assets and liabilities enter at agreed values; the old firms' reserves do not cross.
• Consideration above net assets = goodwill; below = capital reserve.
• Compute the difference separately for each old firm.
• The old firm shows a realisation profit or loss in the old ratio; that is not goodwill.
• Consequences: higher balance sheet total, lower later profits through higher depreciation, and a break in comparability.

Test yourself

1. State the object of the purchase method. To account for the amalgamation by applying the same principles as are applied in the normal purchase of assets.

2. What happens to the old firms' reserves? They are not carried across; the partners have been paid for their whole interest, reserves included, in the consideration, so carrying them over as well would credit the same amount twice.

3. The consideration is Rs 4,60,000 and the net assets taken over Rs 4,80,000. What is recorded? A capital reserve of Rs 20,000, the firm having acquired more than it gave.

4. Distinguish goodwill from the realisation profit. Goodwill arises in the new firm's books as the excess of the consideration over the net assets it received; realisation profit arises in the old firm's books as the excess of the consideration over the book value of what it gave up, and it is credited to the old partners in their old ratio.

5. How does the method affect profits in later years? It lowers them, because the assets are carried at higher agreed values and therefore attract higher depreciation than they would have under pooling.

Answer in one sentence

Explain the purchase method. It is the method used for an amalgamation in the nature of purchase, and its object is to account for the transaction by applying the same principles as a normal purchase of assets, so the new firm records the assets and liabilities it takes over at their agreed values rather than at book values, does not carry across the old firms' reserves because the partners have already been paid for their whole interest in the consideration, and recognises the difference between the consideration and the net assets received as goodwill where it paid more and as a capital reserve where it paid less, that difference being computed separately for each old firm and being a different thing from the profit or loss on realisation which arises in the old firm's own books and belongs to its partners in their old ratio.

Three things to notice here too.

The general reserves have gone. They were part of what the partners were paid for, and the consideration includes them.

The capitals are no longer the old capitals. They are the consideration, split between the partners of each old firm in their old ratio.

Goodwill appears, at Rs 29,000.

The reconciliation

The two totals differ by Rs 50,000, and every rupee of it can be accounted for.

Run that reconciliation whenever a question asks for both. It proves the two answers against each other, and it is the difference between an answer that produced two statements and one that understood them.

The comparison, drawn out

The last row is the one to close an answer on. The choice of method is not a presentational preference; it changes the depreciation charge, and therefore the reported profit, for as long as the assets are held.

In short

• Merger: add the two balance sheets. Reserves survive, capitals unchanged, no goodwill, total Rs 3,80,000.
• Purchase: assets at agreed values, reserves gone, capitals replaced by the consideration, goodwill Rs 29,000, total Rs 4,30,000.
• Goodwill is computed firm by firm, Rs 17,000 and Rs 12,000, and added only for presentation.
• The difference of Rs 50,000 reconciles exactly as revaluation surplus of Rs 21,000 plus goodwill of Rs 29,000.
• The method chosen changes depreciation, and therefore profit, for years.

Answer in one sentence

Compare the two methods on the same amalgamation. Under the pooling of interest method nothing is revalued, so the two balance sheets are simply added, the general reserves of Rs 20,000 and Rs 10,000 survive as Rs 30,000, each partner's capital stands unchanged, no goodwill arises and the total is Rs 3,80,000; under the purchase method the assets enter at their agreed values, the reserves disappear because the partners have been paid for them in the consideration, the capitals are replaced by that consideration of Rs 2,10,000 and Rs 1,50,000, goodwill of Rs 17,000 and Rs 12,000 is computed separately for each firm and shown as Rs 29,000, and the total is Rs 4,30,000; and the difference of Rs 50,000 reconciles exactly as the revaluation surplus of Rs 21,000 plus the goodwill of Rs 29,000, with the consequence that the higher asset values will carry a higher depreciation charge, and so a lower reported profit, for as long as the assets are held.

The profit is shared in the OLD ratio, equally here, because it was earned by the old firm before the new one existed.

The same account for C & Co

C & Co showed building Rs 70,000, stock Rs 50,000, debtors Rs 30,000, cash Rs 10,000, creditors Rs 30,000, reserve Rs 10,000, capital C Rs 80,000 and capital D Rs 40,000. Its consideration was Rs 1,50,000, and C and D share equally.

Two accounts, two sets of books, two profits. They are never combined, and a candidate who adds C & Co's building to A & Co's inside one realisation account has produced something that cannot be marked.

The check that proves it

The profit on realisation equals the consideration less the net book value of what passed.

Run that in a working note. If it disagrees with the balancing figure in the account, something has been entered at the wrong value or left out.

The five situations that change the entries

One: a liability is NOT taken over. It stays with the old firm, which must pay it. Debit realisation and credit cash when it is discharged. It is never credited to realisation as a liability taken over.

Two: an asset is NOT taken over. Three possibilities, and the question says which: sold for cash, credit realisation with the proceeds; taken over by a partner, debit his capital account and credit realisation with the agreed figure; simply retained, it never enters realisation at all and passes to the partners.

Three: realisation expenses. Debited to realisation if the old firm bears them. If the new firm bears them, they do not enter the old firm's books at all.

Five: a liability taken over at OTHER than its book value. Added by the past-paper check. MU sets it as a rebate on creditors, or as creditors of Rs 96,000 taken over at Rs 82,000. The realisation account is not affected: the liability still leaves the old firm's books at BOOK value, because that is what stood in them. The agreed figure belongs in the computation of the purchase consideration, where the smaller deduction makes the consideration larger, and the gain reaches the partners through the realisation profit. Never credit realisation with the agreed figure and the difference separately; that counts the rebate twice.

Four: an unrecorded asset or liability. An unrecorded asset realised is credited to realisation; an unrecorded liability paid is debited. Neither had a book value, so both affect the profit in full.

What it does NOT mean

The realisation account is not a revaluation account. Revaluation adjusts a continuing firm's books; realisation closes a firm that is ending.

The profit is not goodwill. Goodwill arises in the new firm's books.

The agreed values do not appear here. They appear on the other side of the transaction.

Quick revision

• One realisation account per old firm, in that firm's own books.
• Debit: all assets transferred at book value, including cash if it passes; cash paid on liabilities not taken over; realisation expenses borne by the old firm.
• Credit: liabilities taken over at book value; the purchase consideration; proceeds of assets sold.
• Never in it: partners' capitals, reserves, and the new firm's goodwill.
• Reserves go straight to the capital accounts in the old ratio.
• Profit or loss on realisation is shared in the OLD ratio.
• Check: consideration less net book value transferred equals the profit.
• An asset taken by a partner is debited to his capital account.

Test yourself

1. At what values do assets enter the realisation account? At their book values in the old firm's balance sheet; the agreed values belong to the new firm's books, and the difference between the two is what the realisation profit measures.

2. Where does the general reserve go? Straight to the partners' capital accounts in the old profit-sharing ratio; it never enters the realisation account.

3. A & Co transfers net assets of Rs 1,80,000 at book value for Rs 2,10,000. What is the realisation profit and how is it shared? Rs 30,000, credited to the partners in their old ratio, so Rs 15,000 each where they share equally.

4. What happens to a bank loan the new firm refuses to take over? It stays with the old firm, which discharges it; realisation is debited and cash credited when it is paid, and it is never credited to realisation as a liability taken over.

5. How many realisation accounts does an amalgamation of two firms need? Two, one in each old firm's books; combining them produces an account that cannot be marked.

Answer in one sentence

Explain the realisation account on amalgamation. It is the account through which an old firm is closed, opened in that firm's own books and never shared with another firm's, and it is debited with every asset transferred at its book value including cash where the cash passes, with any cash paid to discharge a liability the new firm did not take over, and with realisation expenses the old firm bears; it is credited with the liabilities taken over at book value, with the purchase consideration due from the new firm, and with the proceeds of any asset sold; the partners' capitals, the reserves and the new firm's goodwill never enter it, the reserves going straight to the capital accounts in the old ratio; and the balancing figure is the profit or loss on realisation, which equals the consideration less the net book value of what passed and is shared among the partners in their old profit-sharing ratio.

And one more before them all where there are reserves:

General Reserve A/c Dr, to each partner's capital account, in the old ratio.

Entry five is the one that closes both remaining accounts at once. The new firm's account, debited in entry three with the consideration, is credited in entry five with the capitals, and it closes to nil. If it does not close to nil, the consideration and the capitals disagree.

Where cash comes in

Sometimes a partner's closing balance is not what the new firm will credit him with, because the partners have agreed on capitals in a fixed ratio.

Two cases, and the question will say which.

Where the agreed capital is less than his closing balance, the excess is paid to him in cash, or transferred to his loan account. Debit his capital, credit cash.

Where the agreed capital is more, he brings in the shortfall. Debit cash, credit his capital.

But note where that happens. Adjusting capitals to an agreed ratio is a transaction of the new firm, not the old one, so it belongs in the new firm's books after the opening entry. The old firm's books close on the closing balances.

What it does NOT mean

The closing balance is not the opening capital. Reserves and realisation profit have been added.

The old ratio governs, not the new one. Reserves and realisation profit were earned by the old firm.

The account does not close to cash. It closes to capital in the new firm.

Quick revision

• Credit: opening capital, share of reserves, share of realisation profit, and any current account credit.
• Debit: realisation loss, any asset taken over personally, drawings, and finally the capital in the new firm.
• Reserves and realisation profit are shared in the OLD ratio.
• The closing balances added together equal the purchase consideration. If not, look upstream.
• Five closing entries, and the fifth closes the new firm's account to nil.
• Adjusting capitals to an agreed ratio happens in the new firm's books.

Test yourself

1. What four things are credited to a partner's capital account here? His opening capital, his share of the reserves and accumulated profits, his share of the realisation profit, and any credit balance on his current account.

2. In which ratio are the reserves and the realisation profit divided? The old profit-sharing ratio, because both were earned by the old firm before the new one existed.

3. State the check that proves the old firm's working. That the partners' closing capital balances, added together, equal the purchase consideration exactly.

4. A's closing balance is Rs 1,25,000 but the agreed capital in the new firm is Rs 1,00,000. What happens? He is paid Rs 25,000 in cash or it is transferred to his loan account, and the adjustment is made in the new firm's books after the opening entry, not in the old firm's.

5. Why must the new firm's account close to nil? Because it was debited with the consideration and is credited with the capitals the partners take, and the two are the same amount viewed from opposite ends.

Answer in one sentence

How are the partners' capital accounts closed on amalgamation? Each partner is credited with his opening capital, with his share of the reserves and accumulated profits and with his share of the profit on realisation, both divided in the old profit-sharing ratio, and with any credit balance on his current account; he is debited with any share of a realisation loss, with any asset he takes over personally at the agreed figure and with his drawings; and the balance remaining is closed by debiting his capital account and crediting the new firm with the capital he receives there, so that the partners' closing balances added together equal the purchase consideration exactly and the new firm's account closes to nil, any difference between a partner's closing balance and the capital agreed for him in the new firm being settled in cash in the new firm's own books.

The method, in three steps.

Step one: fix the total capital. Either the question states it, or it is taken as the total of the capitals already credited.

Step two: divide it in the new ratio. That gives each partner's required capital.

Step three: bring in or pay out the difference.

Suppose the four partners agree that the total capital of Rs 3,60,000 shall be held equally.

The cash column nets to nil, because the total was unchanged; only its division moved. Where the question fixes a total different from what was credited, the cash column will not net to nil, and the difference passes through the bank.

Assets and liabilities the new firm did not take

They never enter the new firm's books at all. They were dealt with in the old firm: sold, taken over by a partner, or paid off. A candidate who debits the new firm with a building it did not buy has produced a balance sheet describing a firm that does not exist.

What it does NOT mean

The new firm does not continue the old ledger. It opens fresh accounts.

The opening entry is not a purchase entry in the ordinary sense. There is no cash paid to a vendor; the credit goes to the partners.

A capital adjustment is not part of the opening entry. It follows it.

Quick revision

• One opening entry per old firm, or one combined, at that firm's agreed values.
• Debit the assets and, if any, goodwill; credit the liabilities, any capital reserve, and the partners with the consideration.
• The entry must balance without a plug. Goodwill is not a plug; it was computed.
• Goodwill is computed firm by firm and added only for presentation.
• Capitals are adjusted afterwards: fix the total, divide in the new ratio, settle the difference in cash.
• What was not taken over never appears.

Test yourself

1. At what values do assets enter the new firm's books? At the agreed values, except in a merger accounted for by pooling of interest, where the book values are carried across unchanged.

2. With what are the partners credited? With the purchase consideration for their old firm, divided as their capital accounts in that firm closed, not with their old capital balances.

3. Why must the opening entry balance without a plug? Because the goodwill or capital reserve was computed as exactly the difference between the consideration and the net assets taken over, so any imbalance means a value is wrong or an item is missing.

4. How are capitals adjusted to the new ratio? By fixing the total capital, dividing it in the new profit-sharing ratio to find each partner's requirement, and settling the difference in cash, the adjustment being made in the new firm's books after the opening entry.

5. What happens to an asset the new firm did not take over? Nothing, in the new firm's books; it was sold, taken over by a partner or retained in the old firm, and it never appears in the new firm at all.

Answer in one sentence

How are the books of the new firm opened? By an opening entry for each old firm which debits every asset taken over at its agreed value, together with goodwill where the consideration exceeded the net assets received, and credits every liability taken over at its agreed value, any capital reserve where the net assets exceeded the consideration, and each partner with his share of that firm's purchase consideration as his capital account closed; the entry balances without a plug because the goodwill or capital reserve was computed as exactly that difference, firm by firm; and the capitals are then adjusted, in the new firm's own books, by fixing the total capital, dividing it in the new profit-sharing ratio and settling each partner's excess or shortfall in cash.

Step two: written off in the new ratio, which is equal, so one quarter each.

The entry:

A's Capital Dr 7,250; B's Capital Dr 7,250; C's Capital Dr 7,250; D's Capital Dr 7,250; To Goodwill 29,000.

Step three: the capitals after the write-off.

Who gained and who paid

This is the sentence that turns an arithmetic answer into an understanding one.

A & Co brought Rs 17,000 of goodwill, of which A and B were credited half each, that is Rs 8,500 apiece. Each of them then bore Rs 7,250 of the write-off. A and B each gained Rs 1,250.

C & Co brought Rs 12,000, so C and D were credited Rs 6,000 apiece and each bore Rs 7,250. C and D each paid Rs 1,250.

The net column sums to nil, as it must: nothing was created or destroyed, and Rs 2,500 simply moved from the C & Co partners to the A & Co partners. That happened because A & Co's business was worth more in goodwill than C & Co's, while the four now share equally.

The effect on the balance sheet

Both sides fall by Rs 29,000, which is the definition of a write-off against capital.

What it does NOT mean

Goodwill is not the realisation profit. That arose in the old firm and belongs to its partners in the old ratio.

Writing it off is not compulsory. It is done when the partners so decide.

The write-off does not change the total capital of the business as an economic matter. It changes the recorded capital, and it redistributes value between the partners.

Capital reserve is not negative goodwill to be written off. It stands on the credit side.

Quick revision

• Goodwill arises only under the purchase method, as consideration less net assets taken over, computed firm by firm.
• Three treatments: retained, written off entirely, or written down to a stated figure. Retain unless told otherwise.
• Credited in the OLD ratio through the consideration; written off in the NEW ratio.
• The write-off entry debits all partners' capitals and credits Goodwill.
• The asymmetry of the two ratios transfers value between partners, and the net gains and losses sum to nil.
• Writing it off reduces both sides of the balance sheet by the same amount.

Test yourself

1. How does goodwill arise on amalgamation? As the excess of the purchase consideration for an old firm over the agreed value of the net assets taken over from it, computed separately for each old firm, and only under the purchase method.

2. In which ratios is goodwill credited and written off, and why do they differ? Credited in the old ratio, because it forms part of the consideration the old firm earned; written off in the new ratio, because losses of the new firm fall in the new ratio.

3. Goodwill of Rs 29,000 is written off among four equal partners. What is the entry? Each partner's capital account is debited with Rs 7,250 and Goodwill is credited with Rs 29,000.

4. A was credited with Rs 8,500 of goodwill and bears Rs 7,250 of the write-off. What has happened? He has gained Rs 1,250, and the gains and losses of all the partners together sum to nil, because the write-off redistributes value rather than creating or destroying it.

5. Must goodwill be written off? No. It is an asset the new firm paid for, and the default is to retain it; it is written off only where the partners decide not to carry it.

Answer in one sentence

How is goodwill arising on amalgamation treated? It arises only under the purchase method, as the excess of the purchase consideration over the agreed value of the net assets taken over, computed separately for each old firm, and it may be retained in the books, written down to a stated figure, or written off entirely; where it is written off, the partners' capital accounts are debited in the new profit-sharing ratio and Goodwill is credited, and because the goodwill reached the partners through their old firms in the old ratio the two ratios differ, so the write-off transfers value from those whose share of the new firm exceeds the goodwill they brought to those whose share falls short of it, the gains and losses summing to nil while both sides of the balance sheet fall by the amount written off.

Four: is every agreed value used? A building shown at its old book value when the question revalued it is the commonest single error in this module, and it will make the statement balance while being wrong.

Where cash comes from

A point that confuses students in the capital-adjustment questions.

The cash on the new firm's balance sheet has up to three sources: cash taken over from the old firms, cash brought in by partners short of their agreed capital, and cash paid out to partners with an excess.

Show the net figure, and put the working in a note. A question that asks for the balance sheet wants one cash line, not three.

What it does NOT mean

It is not a Schedule III balance sheet. That format belongs to companies and to Module IV.

It is not the two old balance sheets added, unless the amalgamation is a merger accounted for by pooling.

A capital reserve is not a liability. It sits on the liabilities side because it is part of the owners' claim, not because anyone is owed it.

Quick revision

• Horizontal form: liabilities and capital left, assets right. Not Schedule III.
• Each partner's capital on its own line.
• Goodwill heads the assets where it is retained; reserves appear only under pooling.
• Four checks: does it balance; do the capitals reconcile to the considerations; is anything present that should not be; is every agreed value used.
• Cash may come from three sources; show one net line and put the working in a note.

Test yourself

1. Why is this not a Schedule III balance sheet? Because Schedule III of the Companies Act 2013 prescribes the form for a company's financial statements, and this is a partnership firm; the horizontal form is what applies.

2. Should each partner's capital be shown separately? Yes. A single combined line loses the marks for the individual balances, which is what the question was testing.

3. State the check that links the balance sheet to the earlier work. That the partners' capitals, before any goodwill write-off or capital adjustment, add back to the purchase considerations for their respective old firms.

4. An asset appears at its old book value although the question revalued it. Will the balance sheet still balance? Yes, which is what makes the error dangerous; it must be caught by checking every agreed value rather than by relying on the totals.

5. Where do the old firms' general reserves appear? Only where the amalgamation is a merger accounted for by pooling of interest; under the purchase method they have been settled with the old partners through the consideration and do not appear.

Answer in one sentence

How is the balance sheet of the new firm prepared? In the horizontal partnership form rather than the Schedule III form used for companies, showing on the liabilities side every liability the new firm took over at its agreed value, each partner's capital on a line of its own, and any capital reserve that arose, and on the assets side goodwill where it is retained, followed by the fixed and current assets at the values at which they were taken over and by the cash; nothing the new firm did not take over appears at all; and the statement is proved by four checks, that it balances, that the partners' capitals reconcile to the purchase considerations for their old firms, that nothing is present which should have stayed behind, and that every agreed value has actually been used, the last mattering most because an asset carried at its old book value will still let the statement balance.

Worked, where the total is fixed at a different figure

The same standing balances, but the total capital of the new firm is fixed at Rs 4,50,000 in the same ratio.

Now the two columns do not agree, and the difference is the point.

And Rs 50,000 is exactly the increase in the total capital, from Rs 4,00,000 to Rs 4,50,000. That is the check. If the net cash movement does not equal the change in the total capital, one of the required capitals is wrong.

The firm's cash on the balance sheet rises by Rs 50,000, so the balance sheet total rises by Rs 50,000 as well, capital and cash together.

Where the adjustment is not made in cash

Read the clause. Some questions say the difference is to be transferred to the partners' current accounts instead of settled in cash. Then:

Nothing enters or leaves the firm, so the cash is unchanged and the balance sheet carries current account balances on both sides as the case requires.

Which one you do is decided by the question and by nothing else. "Any adjustment to be made in cash" means cash. Silence usually means cash too, but say in one line which you have assumed.

What it does NOT mean

It is not a revaluation. No asset changes, no goodwill is created, and the realisation profit is already settled. Only the capitals move.

It is not the same as the goodwill write-off. The write-off is debited in the new profit sharing ratio and reduces the capitals; this step is a transfer between the partners and the firm's cash, and it comes after.

The required capital is not each partner's share of the purchase consideration. The consideration was settled by the old firms. This is the new firm's own arrangement.

Quick revision

Test yourself

1. The capitals stand at X Rs 2,00,000 and Y Rs 1,00,000. They share profits equally and the total capital is fixed at Rs 3,00,000 in that ratio, adjusted in cash. What are the entries?
2. In question one, does the firm's cash balance change?
3. The same capitals, but the total is fixed at Rs 3,60,000. How much net cash comes into the firm?
4. When in the order of work does this step come, and why not earlier?
5. What does "any adjustment to be made in cash" exclude?

Answer in one sentence

1. Each requires Rs 1,50,000, so Y brings in Rs 50,000 and X withdraws Rs 50,000: debit cash and credit Y's capital with 50,000, then debit X's capital and credit cash with 50,000.

2. No, because the total capital is unchanged, so the same Rs 50,000 comes in and goes out.

3. Each requires Rs 1,80,000. X stands at Rs 2,00,000 and Y at Rs 1,00,000, so X withdraws Rs 20,000 and Y brings in Rs 80,000, a net Rs 60,000 in, which is the rise in the total capital from Rs 3,00,000 to Rs 3,60,000.

4. Last, because the opening entries and the goodwill write-off both change the capital balances this step is measured against.

5. The alternative treatment through the partners' current accounts, which would leave the firm's cash untouched.

Step three: the partners' capital accounts

In the books of A & Co

Each account is closed by a debit "To Capital in ABCD & Co" of the same amount.

In the books of C & Co

The check. A plus B is Rs 2,10,000, the consideration for A & Co; C plus D is Rs 1,50,000, the consideration for C & Co. Both agree, so the old firms' working is sound.

Step four: the opening entries in ABCD & Co

For A & Co

For C & Co

Both balance without a plug, because the goodwill was computed as exactly the difference.

Step five: the balance sheet

Balance Sheet of ABCD & Co as at 1 April 2027

The checks, run

If the question adds a goodwill write-off

One further step, and it comes last. Where the partners decide goodwill shall not appear, debit each capital account with one quarter of Rs 29,000, that is Rs 7,250, and credit Goodwill.

The balance sheet total then falls to Rs 4,01,000 on both sides.

In short

• Order: goodwill, realisation accounts, capital accounts, opening entries, balance sheet.
• Book values in realisation; agreed values in the new firm's books.
• Reserves and realisation profit in the OLD ratio; goodwill written off in the NEW one.
• Goodwill firm by firm: Rs 17,000 and Rs 12,000, presented as Rs 29,000.
• The proof: capitals of Rs 1,25,000 and Rs 85,000 add to the consideration of Rs 2,10,000; Rs 95,000 and Rs 55,000 add to Rs 1,50,000.

Answer in one sentence

Work a complete amalgamation. Compute the goodwill firm by firm as the excess of each purchase consideration over the agreed value of the net assets taken over from that firm, Rs 17,000 and Rs 12,000 here; open a realisation account in each old firm debiting its assets at book value and crediting the liabilities taken over and the consideration due, so that the balancing figure is the profit on realisation, Rs 30,000 and Rs 20,000, shared in the old ratios; carry the reserves and that profit to the partners' capital accounts in the old ratios, whose closing balances of Rs 1,25,000 and Rs 85,000 and of Rs 95,000 and Rs 55,000 add back to the two considerations and so prove the working; pass an opening entry in the new firm for each old firm, debiting the assets at agreed values and the goodwill and crediting the liabilities and the partners; and draw the balance sheet, which totals Rs 4,30,000, falling to Rs 4,01,000 if the partners choose to write the goodwill off against their capitals in the new ratio.

(b) Answer in one sentence each: (5)

1. In which ratio is the profit on realisation shared?
2. Where does the general reserve of an old firm go?
3. What arises where the net assets taken over exceed the purchase consideration?
4. At what values do assets enter the realisation account?
5. What check proves that an old firm's working is correct?

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Answers

Answer 1

Step one: the goodwill.

Cash is absent from both columns, because neither firm's cash was taken over.

Step two: the realisation accounts.

In the books of X & Co

Two things to notice. The bank loan is credited to realisation as a liability transferred and then debited when it is paid out of cash, so it nets to nil and the profit is unaffected. And the cash never enters as an asset transferred, because it was not transferred.

In the books of Y & Co

Step three: the partners' capital accounts.

X & Co, reserves and realisation profit in 3:2

P plus Q is Rs 3,10,000, the consideration for X & Co, so both are closed by a debit "To Capital in XY & Co" of those amounts. X & Co's cash went entirely on the bank loan, so nothing is paid to the partners.

Y & Co, reserves and realisation profit equally

Here the total is Rs 2,40,000 against a consideration of Rs 2,30,000, and the difference of Rs 10,000 is exactly the cash that was not taken over. Each partner receives Rs 5,000 in cash and the balance as capital in the new firm:

Step four: the balance sheet.

Balance Sheet of XY & Co as at 1 April 2027

There is no cash, because neither firm's cash was taken over. A candidate who has cash on this balance sheet has taken over something the question expressly kept back.

Answer 2

(a) The five conditions are that all the assets and liabilities of the transferor pass to the transferee; that holders of not less than 90 per cent of the face value of the equity shares of the transferor become equity shareholders of the transferee; that their consideration is discharged wholly by the issue of equity shares, apart from cash for fractions; that the business is intended to be carried on; and that no adjustment is made to book values except to make accounting policies uniform. They are cumulative: failing any one makes it an amalgamation in the nature of purchase.

Applied to firms, the second and third cannot be satisfied as written, because a firm has neither shares nor shareholders. They are read as requiring that all or substantially all the partners of the old firms become partners of the new firm, and that their consideration is credited to them as capital in the new firm rather than paid out. Say in the answer that you are translating, and add that AS 14 states of itself that it is directed principally to companies, so it supplies the vocabulary and the test but does not govern the transaction.

(b) The purchase method applies. Condition (v) has failed, because the book values were adjusted, and the conditions are cumulative; the fact that everything and everybody came across does not save it. Revaluation alone makes it a purchase.

The difference to the balance sheet is that the buildings appear Rs 50,000 higher, and the new firm's total is correspondingly larger. Because the partners were credited with capital equal to their old capitals rather than with the higher net assets, the consideration falls short of the net assets by Rs 50,000 and a capital reserve of that amount arises on the liabilities side.

The difference to later profits is that depreciation is charged on the higher figure, so reported profit is lower for as long as the buildings are held. Under pooling the same buildings would have carried their old value and a lower charge. The choice of method is therefore not presentational; it changes reported profit for years.

Answer 3

(a) Short notes

1. Purchase consideration and its two methods. It is the aggregate of everything the new firm gives to the partners of the old firm, in capital, cash or other assets. Under the net assets method it is the agreed value of the assets taken over less the agreed value of the liabilities taken over, counting only what actually passes and never deducting the partners' own capitals or reserves. Under the net payment method it is the capital credited plus the cash and anything else given to the partners, ignoring the individual asset values. The question's data decide which applies; where both can be computed, the excess of the payment over the net assets is goodwill and the shortfall a capital reserve.

2. Treatment of goodwill. It arises only under the purchase method, as the excess of the consideration over the net assets taken over, computed firm by firm. It may be retained, written down to a stated figure, or written off entirely, and the default is to retain it. Where it is written off, the partners' capital accounts are debited in the new profit-sharing ratio. Because it reached them through their old firms in the old ratio, the write-off transfers value between the partners, the gains and losses summing to nil.

3. The realisation account. It is opened in each old firm's own books to close that firm. It is debited with every asset transferred at book value, with cash paid on any liability not taken over, and with realisation expenses the firm bears; it is credited with the liabilities transferred at book value, with the purchase consideration, and with the proceeds of any asset sold. The partners' capitals, the reserves and the new firm's goodwill never enter it. The balancing figure is the profit or loss on realisation, shared in the old ratio.

(b) Answers in one sentence

1. In the old profit-sharing ratio, because it was earned by the old firm before the new one existed.

2. Straight to the partners' capital accounts in the old ratio; it never enters the realisation account.

3. A capital reserve, the new firm having acquired more than it gave.

4. At their book values in the old firm's balance sheet, the agreed values belonging to the new firm's books.

5. That the partners' closing capital balances added together equal the purchase consideration, adjusted for anything settled in cash.

Marking yourself