Accounting treatment of Accumulated Profits, Reserves, and Losses in case of Dissolution of Firm

Accumulated profit refers to a part of the firm’s net profit that is preserved by the firm for future growth. It is also known as retained earnings or undistributed income. Accumulated profits and reserves show the financial position of the company in the long run in terms of earning, saving, and investing such income. The main purpose of reserving the profit is to expand the business, diversify the business, and beat the competitors in the market. The accumulated profit is preserved in form of reserves like the General Reserve. Such reserves are created to meet the future expenses of the firm. Similarly, Accumulated Losses are the previous year’s losses that have been carried forward by the firm.

Accounting treatment of Accumulated Profits, Reserves, and Losses:

The accumulated profits, reserves, and losses in case of dissolution of a partnership firm are simply distributed among the partners in their profit-sharing ratio.

Treatment of Accumulated Profits: 

Accumulated Profits are distributed among the partners in their profit-sharing ratio.

Journal Entry:

Illustration:

Lal and Mohan were partners in the firm sharing profits in a ratio of 2:3. On 28th February 2022 the firm was dissolved and at that time the Balance Sheet showed a credit balance of ₹ 5,00,000 in the Profit and Loss Account. Pass the Journal Entry showing the treatment of the profit.

Solution:

Treatment of Reserve: 

Different reserves are treated as:

A. General Reserve:

General Reserve is simply credited to the partner’s capital in their profit-sharing ratio. 

Journal Entry:

Illustration:

Ram and Shyam were partners in the firm sharing profits in a ratio of 3:5. On 31st March 2021 the firm was dissolved and at that time the Balance Sheet showed a balance of ₹ 16,00,000 as a General Reserve. Pass the Journal Entry showing the treatment of the General Reserve.

Solution:

B. Workmen Compensation Reserve:

Under the situation of dissolution, any of the following cases may appear and shall be treated accordingly:

Case 1: When no liability against Workmen Compensation Reserve exists:

Under this case, the Workmen Compensation Reserve is simply distributed among the partners in their profit-sharing ratio.

Journal Entry:

Illustration:

Anjali and Sumit were partners sharing profit in a ratio of 3:2. They decided to dissolve the partnership on 31st March 2022. on that day Workmen’s Compensation Reserve showed a balance of ₹4,00,000. Pass the necessary journal entry and show the treatment of the Workmen Compensation Reserve.

Solution:

Case 2:  When the amount of the Workmen Compensation Reserve is equal to the amount of the liability towards it:

The full amount of the Workmen Compensation Reserve is transferred to the credit side of the Realisation Account.

Journal Entry:

Illustration:

Abhay and Vabhay were partners sharing profit in a ratio of 5:3. Their partnership got dissolved on 30th June 2022. On the same day, Workmen’s Compensation Reserve showed a balance of ₹ 80,000. Further, their liability towards the workers also amounted to ₹ 80,000. Pass the necessary journal entry and show the treatment of the Workmen Compensation Reserve.

Solution:

Case 3:  When the amount of liability towards workers is less than the amount of Workmen Compensation Reserve:

The amount equal to the liability is transferred to the realisation account (credit side) and the balance in the reserve is distributed among the partners in their profit-sharing ratio.

Journal Entry:

Illustration:

Abhijeet, Bablu, and Somya were partners sharing profit in a ratio of 3:3:2. Their partnership got dissolved on 31st August, 2022. On this date, Workmen’s Compensation Reserve showed a balance of ₹ 16,00,000. Further, their liability towards the worker also amounted to ₹ 8,00,000. Pass the necessary journal entry and show the treatment of the Workmen Compensation Reserve.

Solution:

Case 4: When the amount of liability towards workers is more than the amount of Workmen Compensation Reserve:

The total amount of the Workmen Compensation Reserve is transferred to the credit side of the Realisation Account.

Journal Entry:

Illustration:

Anil, Sunil, and Akhil were partners for a ratio of 3:2:1. Their firm got dissolved on 30th June 2022 and their liability towards their workers stood ₹ 5,00,000, but the Workmen Compensation Reserve showed a Balance of ₹ 4,50,000. Pass the necessary journal entry and show the treatment of the Workmen Compensation Reserve.

Solution:

C. Investments Fluctuation Reserve:

An Investment Fluctuation Reserve is a provision created corresponding to an investment (asset). Therefore, whenever the investment is transferred to the Realisation Account, the Investments Fluctuation Reserve is also transferred to the Realisation Account.

Journal Entries:

Illustration:

Ajit, Vijeet, and Ranjeet were partners sharing profit in a ratio of 4:3:2. They decided to dissolve the partnership on 30 June, 2022. On the same date, the Balance Sheet of the firm showed an investment of ₹ 5,00,000. The liability side showed an Investment Fluctuation Reserve of₹ 50,000. Pass the necessary journal entry and show the treatment of the Investment Fluctuation Reserve.

Solution:

Treatment of Accumulated Losses and Deferred Revenue Expenditure:

A. Accumulated Losses:

Accumulated Losses if any are to be borne by all the partners in their profit-sharing ratio and so, it is debited to the partner’s capital account.

Journal Entry:

Illustration:

Tina and Rama were partners in the firm sharing profit and losses in a ratio of 3:4. On 10th July 2020, they decided to dissolve the partnership. On the same date, the Profit and Loss Account showed a debit balance of ₹ 14,000. Pass the Journal Entry.

Solution:

B. Deferred Revenue Expenditure:

Any Balance in a Fictitious Asset Account like Deferred Revenue Expenditure is debited to the partner’s capital account in their profit-sharing ratio.

Journal Entry:

Illustration:

Kabira and Jogi were partners in a firm sharing profit in a ratio of 5:3. On 30th November 2022 their firm got dissolved. The Balance Sheet showed a balance of ₹2,00,000 in Advertisement Expenditure. Pass the Journal Entry.

Solution: