Partners' Capital Accounts on Conversion

Where a partner's balance is negative

It happens where the realisation makes a large loss.

He must bring in cash to make good the deficiency, which is debited to cash and credited to his capital.

Where he cannot, the deficiency falls on the solvent partners. A question that intends that will say so, and the rule it applies is a matter for the law of partnership rather than for this module.

What it does NOT mean

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

It is not necessarily the consideration. It is the consideration plus what was retained and distributed.

The account does not close to cash unless the question says so. It closes to shares, debentures and whatever cash there is.

Quick revision

• Four credits: opening capital, current account credit, reserves in the old ratio, realisation profit in the old ratio.
• Debits: realisation loss, drawings, any asset taken over, and the discharge.
• Both reserves and the profit are in the OLD ratio, always, because the old firm earned them.
• Total owed = consideration + what was retained and distributed - what a partner took over.
• Second proof: each partner's shares of the reserve and the profit add back to the whole of each.
• A negative balance is made good in cash.

Test yourself

1. What four things are credited? The opening capital, any credit balance on the current account, the share of reserves and accumulated profits in the old ratio, and the share of the profit on realisation in the old ratio.

2. Why is there no new profit-sharing ratio here? Because the partners do not become partners of another firm; they become shareholders, and their proportions in the company are fixed by the shares they receive rather than by a profit-sharing agreement.

3. L's account closes at Rs 2,60,000 and M's at Rs 2,00,000 against a consideration of Rs 4,50,000. Is that an error? No. The Rs 10,000 excess is the cash retained by the firm after discharging the bills payable and distributed to the partners.

4. State the second proof. That the partners' individual shares of the general reserve add back to the whole reserve and their shares of the realisation profit to the whole profit, which catches an omitted share at once.

5. What happens where a partner's account shows a debit balance? He brings in cash to make good the deficiency, which is debited to cash and credited to his capital account.

Answer in one sentence

How are the partners' capital accounts prepared on conversion? Each partner is credited with his opening capital, with any credit balance on his current account, and with his share of the reserves and of the profit on realisation, both divided in the old profit-sharing ratio because the old firm earned them; he is debited with any share of a realisation loss, with his drawings and with any asset he takes over at the agreed figure; and the account is closed by debiting him with the shares, debentures and cash he receives in the distribution, so that it comes to nil, the total owed to all the partners being the purchase consideration plus the value of anything retained and distributed and less anything a partner took over, with a second proof available in that each partner's shares of the reserve and of the realisation profit must add back to the whole of each.