Distribution of Reserves & Accumulated Profits

Introduction

At the time of admission, the Balance Sheet may show General Reserve, Profit & Loss A/c (Credit), or Workmen Compensation Reserve. These are profits earned by the Old Partners in the past. Hence, they must be distributed to Old Partners in the Old Ratio before the new partner joins.

1. Items to be Distributed (The "Free" Reserves)

These are undistributed profits available for distribution:

1. General Reserve
2. Profit & Loss A/c (Credit Balance)
3. Workmen Compensation Reserve (Excess over claim)
4. Investment Fluctuation Reserve (Excess over fall in value)

Journal Entry (For Transfer of Profit):

General Reserve A/c ...Dr      (Amount)
Profit & Loss A/c ...Dr        (Amount)
    To Old Partners' Capital A/c   (Amount)

(Distributed in Old Profit Sharing Ratio)

2. Items to be Written Off (Accumulated Losses)

The Balance Sheet asset side may show "Fictitious Assets" or Losses:

1. Profit & Loss A/c (Debit Balance)
2. Advertisement Suspense A/c (Deferred Revenue Exp)

Journal Entry (For Transfer of Loss):

Old Partners' Capital A/c ...Dr (Amount)
    To Profit & Loss A/c            (Amount)
    To Advertisement Suspense A/c   (Amount)

(Written off in Old Ratio)

3. Special Reserves: Specific Treatment

A. Workmen Compensation Reserve (WCR)

Reserve created to pay compensation to employees.

• Case 1: No Claim: Distribute full WCR to Old Partners.
• Case 2: Claim < Reserve: Pay claim, distribute Balance.

  WCR A/c ...Dr                  (Total Reserve)
      To Prov for Claim              (Actual Claim)
      To Old Partners' Cap A/c       (Balance)
  

• Case 3: Claim > Reserve: Full reserve used + Revaluation Loss used.

B. Investment Fluctuation Reserve (IFR)

Reserve created to handle fall in market value of investments.

• If Book Value = Market Value: Distribute full IFR.
• If Market Value falls: Adjust loss against IFR, distribute balance.

Illustration

Balance Sheet of X and Y (Ratio 2:1):

• Liabilities: General Reserve ₹30,000.
• Assets: P&L (Loss) ₹15,000.

Adjustments on Admission of Z:

1. For General Reserve (Profit):

   General Reserve A/c Dr 30,000
       To X's Cap (2/3) 20,000
       To Y's Cap (1/3) 10,000
   

2. For P&L Loss:

   X's Cap Dr 10,000
   Y's Cap Dr 5,000
       To P&L A/c 15,000
   

Exam Notes: Writing the Answer

Rule of Thumb: "Past profits belong to Past Partners."

• Who gets it?: Only Old Partners.
• Which Ratio?: Always Old Ratio.
• Note: New Partner gets NO share in General Reserve.
• Exception: If partners decide NOT to close the reserve account but carry it forward (Memorandum Revaluation approach), then an adjusting entry (Gaining to Sacrificing) is passed. (Rare in B.Com exams).

Summary

• General Reserve: Credit to Partners.
• P&L (Asset Side): Debit to Partners (Loss).
• WCR/IFR: Specific reserves; distribute only the "free" portion after covering liabilities/losses.
• Timing: Must be done BEFORE calculating New Partner's capital adjustments.

Quiz Time! 🎯

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