CMA Intermediate · Financial Accounting

Conversion and Sale of Partnership Firm to a Company

When a partnership firm is sold to a company, the company pays a purchase consideration, usually in shares, debentures or cash. To solve it, compute the purchase consideration, close the firm's books through a Realisation Account, record the purchase in the company's books, then settle the partners' capital accounts.

What this chapter covers

This chapter deals with a partnership firm that is taken over by a company. The firm stops its business, sells assets and liabilities to the company, and receives a purchase consideration. Two sets of books are involved: the firm's books, which are closed, and the company's books, which record the takeover.

You work through a fixed sequence. First you calculate the purchase consideration. Then you pass entries in the firm's books using a Realisation Account, a Purchasing Company Account and the partners' capital accounts. Then you pass entries in the company's books, including the goodwill or capital reserve that arises, and draw up the opening Balance Sheet in Schedule III format. Finally you distribute the shares received among the partners and close their accounts.

The chapter links to several other parts of the paper. It reuses the Realisation Account from dissolution of partnership, and the capital account adjustments from admission and retirement. It also draws on company accounts: issue of shares and debentures, premium and discount, and the Balance Sheet presentation. Revising those first makes this chapter far easier.

This chapter is a good source of numerical questions, because one problem can test purchase consideration, firm entries, company entries and a Balance Sheet together. A single question often carries many step marks, so you can score well even if one part goes wrong. It also appears as MCQs on the purchase consideration methods and on whether goodwill or capital reserve arises. The format is mechanical once learned, so the effort you put in pays back reliably.

Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company: topics in the order to study them

1Conversion of Partnership Firm into a CompanyStart with the idea: why firms convert, what is sold, and which books are affected, so later entries make sense.
2Purchase Consideration and Its Methods of CalculationEvery entry depends on this figure, so learn the net payment method and the net assets method before anything else.
3Journal Entries in the Books of the FirmOnce you have the consideration, you can record the sale through the Realisation Account and close the firm's books.
4Journal Entries and Balance Sheet in the Books of the CompanyThe company's side uses the same consideration, and its entries show goodwill or capital reserve and feed the Balance Sheet.
5Distribution of Shares and Closing of Partners' AccountsThis is the last step: it ties the firm's closing balances to the shares received and checks your whole answer.

How to prepare Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Treat this chapter as a fixed procedure. If you learn the order of steps, most problems become routine.

Revise the Realisation Account from partnership dissolution and basic share and debenture issue entries from company accounts.
Learn the two methods of purchase consideration: the net payment method (sum of what the company pays) and the net assets method (agreed value of assets taken over minus liabilities taken over). Practise computing both for the same data and see that they agree.
Write the firm's entries in a fixed order: transfer assets and liabilities to Realisation, record the consideration due from the company, record receipt, pay off excluded items, then close the partners' capital accounts.
Write the company's entries next: record assets and liabilities taken over at agreed values, credit the vendors, and find the difference between consideration and net assets. Excess is goodwill; shortfall is capital reserve.
Prepare the opening Balance Sheet in Schedule III format, showing share capital, reserves, and the assets and liabilities taken over, and make sure it balances.
Finish with the share distribution. Divide shares and other consideration among partners according to the agreed basis, usually their final capital balances, and close their accounts to nil.
Solve full past questions under time limits and check each step against your working, as examiners give marks per step.

Common mistakes in Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Taking the wrong value of assets and liabilities in the company's books
Fix: Underline the agreed values in the question. Use those in the company's entries and book values only in the firm's Realisation Account.
Including assets or liabilities that the company did not take over in the consideration
Fix: List separately what is taken over and what is left with the firm. Compute consideration only from the taken-over items.
Ignoring share premium or discount when valuing shares given as consideration
Fix: Value shares at the issue price stated. Then credit share capital at face value and the difference to securities premium, or debit discount.
Mixing up goodwill and capital reserve
Fix: Remember: consideration greater than net assets means goodwill; consideration less than net assets means capital reserve.
Leaving partners' accounts unbalanced after distribution
Fix: Follow the basis given in the question and check that each capital account closes to nil before finishing.
Forgetting the expenses and the Realisation Account items
Fix: Read the question line by line and tick off each item. Record who bears each expense before posting.

Last-day revision: Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Purchase consideration is what the company agrees to pay the firm for the business taken over.
Net payment method: add up shares, debentures, cash and other payments to the firm.
Net assets method: agreed value of assets taken over minus liabilities taken over.
Shares are valued at issue price, so premium or discount affects the consideration.
In the firm's books, assets and liabilities taken over go to Realisation Account.
The firm debits the Purchasing Company Account with the consideration and credits Realisation Account.
Assets not taken over are dealt with by the firm separately, not through the company.
Realisation profit or loss is shared by partners in their profit sharing ratio.
In the company's books, consideration above net assets is goodwill; below is capital reserve.
Credit share capital with face value and securities premium with any premium, and debit discount where shares are issued at a discount.
Partners' capital accounts must close to nil after shares and cash are given.
The company's Balance Sheet follows Schedule III and must balance.

Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company practice questions

Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company: frequently asked questions

What is purchase consideration in conversion of a firm into a company?

It is the amount the company agrees to pay the firm for the assets and liabilities it takes over. It can be paid in shares, debentures, cash or a mix. It is the starting figure for all entries in both sets of books.

What are the methods of calculating purchase consideration?

The two main methods are the net payment method and the net assets method. The net payment method adds up all payments the company makes. The net assets method takes the agreed value of assets taken over minus liabilities taken over. Both should give the same answer if the data is consistent.

When does goodwill or capital reserve arise in the company's books?

Compare the purchase consideration with the net assets taken over at agreed values. If consideration is higher, the difference is goodwill. If it is lower, the difference is capital reserve.

Do I need the Balance Sheet of the company for this chapter?

Yes. Questions often ask for the opening Balance Sheet after the takeover. Prepare it in Schedule III format and check that both sides balance.