Meaning of Adjustment of Reserves and Accumulated Profits on Admission of a New Partner
When a new partner is admitted into a firm, they are entitled only to the future profits of the business and not to the profits or reserves earned before their admission. Therefore, before admitting the new partner, the existing partners must adjust all accumulated profits, reserves, and losses among themselves in their old profit-sharing ratio.
If, at the time of admission, there are any balances in reserves, accumulated profits, or losses appearing in the Balance Sheet, these amounts are transferred to the old partners’ capital accounts in their old profit-sharing ratio.
Why Is Adjustment Needed?
Reserves and accumulated profits or losses belong solely to the existing partners, as these amounts were earned before the new partner’s admission. Therefore, they must be distributed or adjusted among the old partners before the new partner enters the firm.
These reserves and accumulated profits or losses relate to earlier accounting periods, i.e., periods prior to the new partner’s admission. Since the new partner did not contribute to earning these amounts, they have no right over them. Hence, the balances are distributed among the old partners in their old profit-sharing ratio.
Journal Entries for Adjusting Reserves and Accumulated Profits on Admission of a New Partner
When Reserves and Accumulated Profits Are Transferred to Old Partners (in Old Ratio)
Journal Entry:
Profit & Loss A/c (Cr. Balance) Dr.
General Reserve A/c Dr.
Workmen Compensation Reserve A/c Dr.
Investment Fluctuation Reserve A/c Dr.
To Old Partners’ Capital A/c (in old ratio)
Effect: In the new Balance Sheet, the balances of General Reserve, Profit & Loss A/c (Credit), and other reserves will not appear, as they have been fully transferred to the old partners.
When Accumulated Losses Are Transferred to Old Partners (in Old Ratio)
Journal Entry:
Old Partners’ Capital A/c Dr.
To Profit & Loss A/c (Debit Balance)
To Deferred Revenue Expenditure A/c (e.g., Advertisement Expense)
Effect: These losses will also not appear in the new Balance Sheet, as they have been adjusted against the old partners’ capital accounts.
Illustration - (Distribution of General Reserve and Accumulated Losses)
A and B are partners in a firm sharing profits and losses in the ratio of 5: 3. C was admitted for 1/3rd share in the profits. On the date of C’s admission, the Balance Sheet of A and B showed:
- General Reserve = ₹60,000
- Profit & Loss A/c (Dr./Loss) = ₹20,000 on the assets side
Pass necessary journal entries on the treatment of these items on C’s admission.
Solution: Journal Entries
|
Date |
Particulars |
L.F. |
Dr. |
Cr. |
|
General
Reserve A/c ……Dr. |
60,000 |
|||
|
To
A’s Capital A/c |
37,500 |
|||
|
To
B’s Capital A/c |
22,500 |
|||
|
(Being the
general reserve divided between the old partners in old ratio) |
||||
|
|
A’s
Capital A/c ……Dr. |
|
12,500 |
|
|
|
B’s
Capital A/c ……Dr. |
|
7,500 |
|
|
|
To Profit and Loss A/c |
|
|
20,000 |
|
|
(Being the
accumulated losses distributed between the old partners in old ratio) |
|
|
|
FAQ's
What is adjustment of reserves and accumulated profits?
Before the new partner joins, any existing reserves or accumulated profits/losses belong only to the old partners (because these were earned before the new partner joined). These are transferred out of the firm’s books and shared among the old partners in their old profit-sharing ratio.
How are reserves distributed on admission?
Reserves such as general reserve or profit-and-loss credit balances are transferred to the old partners’ capital accounts in the old profit-sharing ratio, because the new partner is not entitled to past earnings.
What happens to accumulated losses on admission?
Accumulated losses are adjusted against the old partners’ capital accounts in the old profit-sharing ratio before the new partner joins. This ensures the new partner does not share pre-admission losses.
Does the new partner share in past profits or losses?
No. Because reserves, accumulated profits, and pre-admission revaluation gains or losses relate to periods before the new partner joined, they are shared only by old partners in their old profit-sharing ratio, and the new partner’s capital or entitlement is adjusted accordingly.
Practical Insight: Before a new partner joins, all reserves, accumulated profits, and losses are shared only among the existing partners in their old profit-sharing ratio, because these amounts belong solely to them and were earned before the new partner’s admission the new partner does not have rights over past profits or reserves.
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