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Sale of Partnership Firm to a Company – Accounting Entries

Introduction

Growth often requires conversion. A partnership firm may be sold to a Limited Company to enjoy benefits like Limited Liability and easier capital raising. For the firm, this is a Dissolution. For the purchasing company, it is an Acquisition.

1. Purchase Consideration (PC)

The price paid by the Company to buy the Firm.

Methods of Calculation:

  1. Lumpsum Method: "Company pays ₹10 Lakhs."
  2. Net Asset Method:

    PC = Agreed Value of Assets Taken Over - Agreed Value of Liabilities Taken Over.

  3. Net Payment Method: Sum of Shares + Debentures + Cash given to partners.

2. Accounting Entries (In Books of Firm)

The books are closed similarly to Dissolution (Realisation A/c), but with a twist.

Step 1: Transfer Assets/Liabilities to Realisation

Only those assets/liabilities Taken Over by Company are transferred.

  • If firm keeps an asset (e.g., Furniture), it is sold separately or taken by partners.

Step 2: Record Purchase Consideration Due

Entry:

Purchasing Company A/c ...Dr
    To Realisation A/c
(Being business sold)

Step 3: Receipt of Purchase Consideration

The company usually pays in Shares/Debentures/Cash. Entry:

Shares in Company A/c ...Dr
Debentures in Company A/c ...Dr
Bank A/c ...Dr
    To Purchasing Company A/c

Step 4: Close Realisation A/c

Find Profit/Loss and transfer to Partners' Capital.

Step 5: Final Settlement

Distribute the Shares/Debentures/Cash to Partners (Final Payment). Entry:

Partners' Capital A/c ...Dr
    To Shares in Company A/c
    To Bank A/c

Illustration

Firm X&Y sold to AB Ltd.

  • Assets: 5,00,000. Liabilities: 1,00,000.
  • PC: 6,00,000 (Paid 50% in Shares, 50% in Cash).

Key Entries:

  1. Due: 
    AB Ltd A/c ...Dr                6,00,000
    To Realisation A/c              6,00,000
  2. Receipt: 
    Shares in AB Ltd A/c ...Dr      3,00,000
Bank A/c ...Dr                  3,00,000
    To AB Ltd A/c                   6,00,000
  3. Realisation Profit:
    • Credit Side (PC) 6,00,000. Debit Side (Net Assets) 4,00,000. Profit = 2,00,000.
    • Entry: 
      Realisation A/c ...Dr       2,00,000
    To X's Capital A/c          1,00,000
    To Y's Capital A/c          1,00,000

Exam Notes: Writing the Answer

Question: "How is Purchase Consideration calculated under Net Asset Method?" (5 Marks)

Model Answer:

Under the Net Asset Method, the Purchase Consideration is calculated as the aggregate of the Agreed Value of Assets taken over by the purchasing company MINUS the Agreed Value of Liabilities taken over.

Formula: PC = Total Assets (at Agreed Value) - Total Liabilities (at Agreed Value)

Note: If the question mentions "Amount paid to partners in form of shares/cash," use the Net Payment Method instead, as it is more specific.

Summary

  • Nature: It is a Dissolution. Use Realisation A/c.
  • Buyer: Purchasing Company (Debtor).
  • Payment: Usually in Shares/Cash.
  • Distribution: Shares are distributed to partners in their Final Capital Ratio.

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