Financial Accounting · Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Conversion of Partnership Firm into a Company: Accounting Steps

Updated 10 October 2026 · Fact-checked

Conversion of a partnership firm into a company means the partners move the business into a company and the firm ends. The company takes over the assets and liabilities for a purchase consideration, usually paid in shares. To solve it, fix the purchase consideration, close the firm's books through a Realisation Account, and settle partners' capital.

Understand Conversion of Partnership Firm into a Company

A partnership firm is not a separate legal person. Partners have unlimited liability, and the firm cannot easily raise large funds. A company is a separate legal entity, offers limited liability and can issue shares. When a firm outgrows its form, the partners often move the business into a company. This is called conversion.

Common reasons for conversion:
- Limited liability for the owners.
- Easier access to capital through shares and borrowings.
- Continuity of the business. A company does not end with the death or retirement of a member.
- Shares can be transferred, so ownership is easier to change.
- Tax, credibility and expansion considerations. Section 464 of the Companies Act, 2013 read with the Companies (Miscellaneous) Rules, 2014 prohibits a partnership of more than 50 persons unless it is registered as a company or under another law. So a very large firm cannot continue as an ordinary partnership.

How it happens in practice. In most exam questions, the partners form a new company (or use an existing one). The company agrees to take over the firm's business, fully or partly, and pays a purchase consideration (PC). The firm then closes its books and the partners receive the PC, often as shares, sometimes partly in cash or debentures. In this exam-style treatment, the firm's assets and liabilities are not simply renamed. They are transferred to the company under an agreement of sale.

A firm can also be registered as a company under Chapter XXI of the Companies Act, 2013, which is the statutory route for registration. Exam questions, however, treat conversion as a sale of the business to a company. Check the exact filings against the current Companies Act and its rules.

Options for the partners: convert into a private company, a public company, or an LLP (LLP is a separate topic), or sell the business to an existing company. The partners may take shares for the whole consideration or a mix of shares, debentures and cash. They may also leave out some assets, usually cash or personal items, and settle those among themselves.

Conversion is not amalgamation. In amalgamation of firms, two or more firms combine into a new firm, and the form stays a partnership. In conversion, a partnership becomes a company, so the form of organisation changes. The accounting for conversion uses the Realisation Account in the firm's books and a purchase-of-business entry in the company's books.

Key rules to remember

Purchase consideration (net assets method): PC = Agreed value of assets taken over − Liabilities taken over; Include goodwill only if the agreement values it. Leave out assets and liabilities that the company does not take over.
Purchase consideration (payment method): PC = Shares (number × issue price) + Debentures + Cash paid to the firm; Use the issue price, including any premium, not just the face value. The two methods should give the same PC.
Profit or loss on realisation: Profit = Credits − Debits, where Credits = PC + Liabilities transferred + Cash from assets not taken over, and Debits = Book value of assets transferred + Realisation expenses; PC here is the net amount the company pays. Liabilities taken over are credited only as the transfer of the liability, and the assets are debited at gross book value. A positive result is a profit and a negative result is a loss. Share it in the old profit sharing ratio. As a separate cross-check, use the net form: Profit = PC + Cash from assets not taken over − (Book value of assets transferred − Liabilities transferred) − Expenses. Use one form or the other to get the answer, never both added together.
Partners' final settlement: Opening capital ± Realisation profit/loss ± Other adjustments = Amount due to partner; The amount due is settled by shares, debentures and cash received. Total settlement must equal total amount due.
Company's goodwill or capital reserve: PC − Agreed value of net assets taken over = Goodwill (if positive) or Capital reserve (if negative); Positive means the company paid more than the net assets are worth. Negative means it paid less.
Number of shares issued: Shares = Amount to be paid in shares ÷ Issue price per share; With shares issued at a premium, divide by the issue price. Share capital is the number × face value, and the premium goes to Securities Premium.

How to solve Conversion of Partnership Firm into a Company questions

Use this order for any conversion question. It keeps the firm's books and the company's books separate and catches missing items.

1Read which assets and liabilities the company takes over, and which stay with the firm (usually cash, bank, and sometimes some liabilities).
2Compute the purchase consideration by the net assets method, then cross-check it with the payment method (shares + debentures + cash).
3In the firm's books, prepare the Realisation Account: debit all assets transferred at gross book value and any expenses; credit the liabilities transferred and the PC (the net figure). The balancing figure is profit or loss.
4Transfer the realisation profit or loss to the partners' capital accounts in the old ratio.
5Record the receipt of PC (shares, debentures, cash) and settle partners' capital accounts. Pay off any remaining cash and close the capital accounts to zero.
6In the company's books, pass the purchase-of-business entry at agreed values, then the settlement entry for shares, premium, debentures and cash. Compute goodwill or capital reserve.
7Check that the firm's accounts balance, the company's entries balance and the total shares given to partners equal the shares issued.

Quickest way: PC first, then three checks

When to use it: Use this when time is short and the question asks for PC, realisation profit or the journal entries only.

Underline what is excluded from the takeover.
Compute PC = agreed assets − liabilities taken over. Write it once and reuse it.
Realisation profit = PC + cash realised from assets not taken over − (book value of assets − liabilities taken over) − realisation expenses. If every asset on the debit side is taken over and there are no expenses, the middle term drops out and it is simply PC − (book value of assets − liabilities taken over). This is the same as crediting the liabilities and PC, and debiting the assets at gross book value. Use book values for the firm's side, and do not add the liabilities twice.
Check 1: capital after profit = shares + cash received.
Check 2: shares issued × issue price = share amount in the PC.
Check 3: total debits = total credits in each journal entry.

Common mistakes in Conversion of Partnership Firm into a Company

Using agreed values instead of book values on the debit side of the Realisation Account.
The question gives both book and agreed values, and the student picks one for everything.
Fix: In the firm's books, debit assets at book value and credit the PC. The company's books use agreed values.
Including cash or bank in the PC when the company does not take it over.
Students total all assets automatically.
Fix: Read the takeover clause. If cash is excluded, leave it out of both the PC and the Realisation Account.
Ignoring the share premium when computing the number of shares.
Students divide the PC by the face value.
Fix: Divide by the issue price. Credit Share Capital at face value and Securities Premium for the difference.
Treating conversion like amalgamation and opening a new partnership firm.
Both topics deal with firms and consideration.
Fix: Remember that conversion ends the firm and starts a company. The firm is closed using a Realisation Account.
Sharing realisation profit in the new ratio or in capital ratio.
Students mix this with admission or retirement.
Fix: Realisation profit or loss is always shared in the old profit sharing ratio unless the question states otherwise.
Forgetting that the firm's liabilities not taken over must be paid by the firm.
Students stop once the company has accepted the main liabilities.
Fix: Show payment of the remaining liabilities and any realisation expenses before settling the partners.

Worked examples

Example 1

A and B share profits equally. Their balance sheet shows: Capital A ₹3,00,000; Capital B ₹2,00,000; Creditors ₹1,00,000. Assets: Land ₹2,00,000; Stock ₹2,00,000; Debtors ₹1,50,000; Cash ₹50,000. XYZ Ltd takes over land, stock, debtors and creditors at ₹2,50,000, ₹1,80,000, ₹1,40,000 and ₹1,00,000 respectively. Cash is not taken over. The PC is wholly paid in equity shares of ₹10 each at par, allotted as agreed: A receives shares worth ₹2,70,000 and B shares worth ₹2,00,000. The firm's cash, which the company does not take over, is distributed to settle the partners' dues. Find the PC, the realisation profit, the partners' final dues and the cash paid to each.

Show the solution

PC = (₹2,50,000 + ₹1,80,000 + ₹1,40,000) − ₹1,00,000 = ₹5,70,000 − ₹1,00,000 = ₹4,70,000.
Shares to be issued = ₹4,70,000 ÷ ₹10 = 47,000 shares. The shares are allotted as per the values given in the question: A ₹2,70,000 ÷ ₹10 = 27,000 shares and B ₹2,00,000 ÷ ₹10 = 20,000 shares. Together they equal the whole PC of ₹4,70,000, so no part of the PC is paid in cash.
Realisation Account, debit side: land ₹2,00,000 + stock ₹2,00,000 + debtors ₹1,50,000 = ₹5,50,000 (assets at gross book value; cash is not transferred). Credit side: creditors transferred ₹1,00,000 + PC from XYZ Ltd ₹4,70,000 = ₹5,70,000.
Profit on realisation = ₹5,70,000 − ₹5,50,000 = ₹20,000. Net form as a cross-check: PC − (₹5,50,000 − ₹1,00,000) = ₹4,70,000 − ₹4,50,000 = ₹20,000. Each partner gets ₹10,000.
A's capital = ₹3,00,000 + ₹10,000 = ₹3,10,000. B's capital = ₹2,00,000 + ₹10,000 = ₹2,10,000. Total = ₹5,20,000.
Shares received: A ₹2,70,000 and B ₹2,00,000. The balance of each partner's dues is paid out of the firm's own cash. Cash to A = ₹3,10,000 − ₹2,70,000 = ₹40,000. Cash to B = ₹2,10,000 − ₹2,00,000 = ₹10,000.
Check: the firm's own cash of ₹50,000 (not taken over by the company) equals cash paid ₹40,000 + ₹10,000. Shares ₹4,70,000 equal ₹2,70,000 + ₹2,00,000. Total settled ₹5,20,000 equals total dues.

Answer: PC = ₹4,70,000 (47,000 shares of ₹10, all paid in shares). Realisation profit = ₹20,000 (₹10,000 each). Final dues: A ₹3,10,000 and B ₹2,10,000. Paid out of the firm's own cash: A ₹40,000 and B ₹10,000.

Example 2

P and Q's firm is sold to Beta Ltd. The company takes over machinery at an agreed ₹2,80,000, stock at ₹1,00,000 and creditors of ₹80,000. The PC is ₹4,00,000, payable as 30,000 equity shares of ₹10 each issued at ₹12 per share, and the balance in cash. Pass the journal entries in the company's books and find goodwill.

Show the solution

Net assets taken over = ₹2,80,000 + ₹1,00,000 − ₹80,000 = ₹3,00,000.
Goodwill = PC − net assets = ₹4,00,000 − ₹3,00,000 = ₹1,00,000. It is a positive figure, so it is goodwill.
Shares value = 30,000 × ₹12 = ₹3,60,000. Cash = ₹4,00,000 − ₹3,60,000 = ₹40,000.
Share capital = 30,000 × ₹10 = ₹3,00,000. Securities premium = 30,000 × ₹2 = ₹60,000.
Entry 1 (purchase of business): Machinery A/c Dr ₹2,80,000; Stock A/c Dr ₹1,00,000; Goodwill A/c Dr ₹1,00,000; to Creditors ₹80,000; to Vendors (P and Q) ₹4,00,000. Debits total ₹4,80,000 and credits total ₹4,80,000.
Entry 2 (settlement): Vendors A/c Dr ₹4,00,000; to Equity Share Capital ₹3,00,000; to Securities Premium ₹60,000; to Bank ₹40,000. Credits total ₹4,00,000.

Answer: Goodwill = ₹1,00,000. Entry 1 debits machinery ₹2,80,000, stock ₹1,00,000 and goodwill ₹1,00,000, crediting creditors ₹80,000 and vendors ₹4,00,000. Entry 2 debits vendors ₹4,00,000, crediting share capital ₹3,00,000, securities premium ₹60,000 and bank ₹40,000.

Exam tips

Write the PC calculation as a separate working note. Step marks are given for it even if a later figure is wrong.
Label the firm's books and the company's books clearly. Mixing them is a frequent way to lose marks.
In MCQs, check for hidden exclusions such as cash or a particular liability not taken over, and for shares issued at a premium.
For theory, give reasons for conversion and the difference from amalgamation in short points. A two-column comparison is easy to mark.
Close with a quick proof: capital balances after realisation equal the shares and cash received.

Practice questions from Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Conversion of Partnership Firm into 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: frequently asked questions

What is the difference between conversion and amalgamation of partnership firms?

In conversion, a partnership firm becomes a company, so the legal form changes and the firm is closed. In amalgamation, two or more firms join to form a new partnership firm, so the form remains a partnership. The accounting also differs: conversion uses a Realisation Account and company entries, while amalgamation uses revaluation and a new firm's opening entries.

Why do partners convert their firm into a company?

Partners usually want limited liability, easier fundraising through shares, and continuity of the business beyond the partners. Shares can be transferred, which makes changes in ownership simpler. Also, a partnership of more than 50 persons is prohibited under Section 464 of the Companies Act, 2013 unless it is registered as a company or under another law.

How is the purchase consideration calculated on conversion?

The usual method is agreed value of assets taken over minus liabilities taken over. You can cross-check it by adding the shares at issue price, debentures and cash payable. Both methods must give the same figure.

Is the realisation profit shared in the new or old profit ratio?

It is shared in the old profit sharing ratio, as the firm is being closed. The new company has no relevance to the partners' profit ratio. A different ratio applies only if the question explicitly says so.