Journal Entries in the Books of the Firm on Sale to a Company

Understand Journal Entries in the Books of the Firm

Key rules to remember

Profit or loss on realisation

Credits (purchase consideration + liabilities and assets taken by partners, if any) − Debits (assets transferred + realisation expenses)

Rearranged the same way as the account balance. A credit balance is profit, a debit balance is loss. Share it in the profit sharing ratio.

Transfer of assets

Realisation A/c Dr. (book value) To Assets taken over

Use book values. Exclude cash and bank if the company does not take them over. Show the assets not taken over separately.

Transfer of liabilities

Liabilities taken over Dr. To Realisation A/c

Credit the book value of the liabilities the company assumes.

Purchase consideration due

Purchaser Company A/c Dr. To Realisation A/c

Record the agreed consideration in total, whether in shares, debentures or cash.

Receipt of consideration

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

Debit each type of consideration at the value stated in the agreement.

Realisation expenses paid by the firm

Realisation A/c Dr. To Bank A/c

If a partner pays them, credit that partner's capital account. If the company bears them, make no entry.

Profit or loss transfer

Realisation A/c Dr. To Partners' Capital A/cs (profit) or the reverse (loss)

Share it in the profit sharing ratio.

Closing partners' capital accounts

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

Close each capital account fully using the consideration received.

How to solve Journal Entries in the Books of the Firm questions

1. 1Read the agreement. List the assets and liabilities taken over, the purchase consideration and its form, and who bears realisation expenses.
2. 2Open the Realisation Account. Debit the book values of assets taken over. Credit the book values of liabilities taken over. Leave out assets and liabilities that are not taken over.
3. 3Credit the purchase consideration to the Realisation Account and debit the Purchaser Company Account.
4. 4Record unrecorded assets and liabilities. An unrecorded asset taken over (or sold) is credited to Realisation only to the extent of what is realised. An unrecorded liability that the company assumes or settles is dealt with the same way.
5. 5Record realisation expenses. Debit Realisation if the firm bears them. If a partner pays them, credit that partner's capital. If the company pays them, no entry.
6. 6Record the receipt of consideration: debit Shares, Debentures or Bank, credit the Purchaser Company Account.
7. 7Find the profit or loss on realisation and share it in the profit sharing ratio through the capital accounts.
8. 8Transfer reserves, accumulated profits, losses and old partner loans to the capital accounts, then close the capital accounts by paying off in shares, debentures and cash. Check that the total of the Purchaser Company Account is nil and the Bank Account is nil.

Quickest way: Four-account shortcut for exam time

Common mistakes in Journal Entries in the Books of the Firm

• Transferring cash and bank, or assets not taken over, to the Realisation Account.

  Students move every asset by habit from dissolution problems.

  Fix: Read the agreement first. Only items the company takes over go to Realisation. Others stay on the books or pass to partners.

• Treating the purchase consideration as a debit to Realisation.

  Confusing the firm's books with the company's books, where the consideration is the amount paid.

  Fix: In the firm's books the consideration is what the firm receives, so it is a credit to Realisation and a debit to the Purchaser Company Account.

• Ignoring unrecorded assets or liabilities.

  They do not appear in the balance sheet, so they are easy to miss in the question text.

  Fix: Scan the notes for words like 'not recorded', 'not appearing in books', or 'unrecorded'. Credit Realisation with the amount received for an unrecorded asset, and pass the matching entry for an unrecorded liability that is paid off.

• Debiting Realisation Account for realisation expenses that the company bears.

  Students assume all expenses belong to the firm.

  Fix: Check who bears them. If the company pays, there is no entry in the firm's books. If the firm pays, debit Realisation. If a partner pays, credit the partner's capital.

• Forgetting to transfer reserves, accumulated profits and losses to partners' capital accounts.

  Students focus on Realisation and stop once the profit is found.

  Fix: Before closing capital accounts, transfer reserves, accumulated profits and losses in the profit sharing ratio.

• Closing capital accounts with an amount that does not match the consideration received.

  Skipping the profit on realisation or expenses paid by a partner.

  Fix: Rebuild each capital account line by line and check that the total paid out equals the total shares, debentures and cash received, adjusted for assets partners take over.

Worked examples