Question Bank

Part A

Q1) What is Purchase Consideration? Explain its methods. (5 marks)

A1) Meaning: On sale or conversion, the limited company takes over the business of the firm for an agreed price. This price is known as “purchase consideration”. It is the price paid for taking over the net assets (assets less liabilities) of the firm. The price may be settled by the company partly by paying cash and partly by allotting its shares and debentures to the partners.

Methods: The amount of purchase consideration may be determined by three methods: (1) Lump Sum Method (2) Payments Method or (3) Net assets Method:

Q2) How are shares or debentures shared among the partners?(5 marks)

A2) The division can be made in any of the following ways:

Specific Ratio: If any specific ratio is given, the shares or debentures are divided in the given ratio. If there is any specific agreement among the partners, the shares or debentures must be divided among the partners in the agreed ratio.

Equitable Approach: If it is stated that the purchase consideration should be distributed equitably (fairly): (a) equity shares should be divided among the partners in their profit-sharing ratio; and (b) preference shares and debentures should be divided among the partners in the ratio of their capitals. This is known as the equitable approach because it is fair and just to all the partners. It ensures that future profits (equity dividends) are shared in the profit-sharing ratio and a fixed return (preference dividend/debenture interest) is assured on the capitals. This method is also used when it is stated that the distribution should be in such a way that there is no effect on the partners’ rights.

Legal Approach: If no instructions are given, shares and debentures should be divided in the ratio of the partners’ capitals. This is known as the legal approach because it is in accordance with the provisions of Section 48 (b) of the Indian Partnership Act, 1932.

Note: Shares or debentures are always issued in whole numbers and not in fractions. If after distribution, a partner is entitled to get 100 and 1/2 shares, he should be given 100 shares and the value of 1/2 share should be paid in cash.

Q3) Distinguish between conversion of firm into company and sale of firm to company. ( 8 marks)

A3) Conversion: A firm may be converted by the partners into a limited company. This is done to take the following advantages: (a) a company is not affected by death or retirement of a member. (b) the liability of shareholders is limited. (c) the shares are easily transferable. (d) there is no limit on  the maximum number of shareholders. (e) a limited company can raise large capital from public and carry on the business on a much larger scale. In fact, the partners themselves are the promoters of the new company. The name of the company may be similar. Thus a firm M/S Tata may become, after conversion, M/S Tata Company Limited.

Sale: In some cases the firm may be sold to an existing limited company. In case of a sale the present partners may not become directors of the company. There may be a change of management.

Chiefly with the objective of limiting the personal liabilities of the partners, an existing partnership firm may sell its entire business to an existing limited company, or may convert itself into a limited company. The former is the case of absorption of a partnership firm by the joint stock company whereas, the latter is the case of flotation of a new joint stock company so as to take over the business of the partnership firm.

In both of these cases, the existing partnership firm is dissolved and all the books of accounts are closed. Thus, when a partnership firm is sold or converted into a company, the same accounting procedure is followed as for simple dissolution of a firm.

The purchase consideration (price) in between the vendor (dissolving) firm and the purchasing company is fixed as mutually agreed upon. It may or may not be specified in a lump sum figure. When it is not specified in a lump sum figure, the difference of agreed values of acquired assets over agreed amount of liabilities are undertaken.

The purchase price is discharged by the purchasing company either in the form of cash or shares (equity or preference) or debentures or a combination of two or more of these. The shares or debentures may be issued by the purchasing company, at par, at a premium or at a discount.

In the absence of any agreement, the shares received from the purchasing company is distributed among partners in the ratio of their final claim i.e. in the ratio of their capital standing after all the adjustments.

Q4) Explain the entries passed in the books of a company taking over a firm. ( 5 marks)

A4) The following entries are passed in the books of the company:

Q5) What do you mean by ‘Distribution’ of Purchase Consideration? (5 marks)

A6) First the shares or debentures received from the company are divided among the partners. Then the final balance in capital accounts is paid in cash in the end. So, there is no question of dividing the cash in any particular ratio. If the partner’s capitals are not in their profit-sharing ratio, the question arises as to how the equity shares etc. Should be divided among the partners. It is to be decided whether the shares etc. should be divided in the profit-sharing ratio or in the ratio of capitals. This decision will have effect on the future rights (equity dividends) of the partners. The division can be made in any of the following ways:

Specific Ratio: If any specific ratio is given, the shares or debentures are divided in the given ratio. If there is any specific agreement among the partners, the shares or debentures must be divided among the partners in the agreed ratio.

Equitable Approach: If it is stated that the purchase consideration should be distributed equitably (fairly): (a) equity shares should be divided among the partners in their profit-sharing ratio; and (b) preference shares and debentures should be divided among the partners in the ratio of their capitals. This is known as the equitable approach because it is fair and just to all the partners. It ensures that future profits (equity dividends) are shared in the profit-sharing ratio and a fixed return (preference dividend/debenture interest) is assured on the capitals. This method is also used when it is stated that the distribution should be in such a way that there is no effect on the partners’ rights.

Legal Approach: If no instructions are given, shares and debentures should be divided in the ratio of the partners’ capitals. This is known as the legal approach because it is in accordance with the provisions of Section 48 (b) of the Indian Partnership Act, 1932.

Note: Shares or debentures are always issued in whole numbers and not in fractions. If after distribution, a partner is entitled to get 100 and 1/2 shares, he should be given 100 shares and the value of 1/2 share should be paid in cash.

Q6) Explain the entries passes in the books of the firm on sale to company. (8 marks)

A7) The entries in the books of the firm are passed in the following manner:

Step 1: Transfer all recorded assets and liabilities(whether or not taken over by the purchasing company) to the Realization account, except cash and bank balance if not taken over by the purchasing company.

1.1 For transferring recorded assets:

Realization A/C..................Dr.

To sundry assets

1.2 For transferring recorded liabilities

Sundry liabilities..................Dr.

To Realization A/C

Step 2: Make purchase consideration(price) due.

2.1 For purchase price due:

Purchasing company...........Dr.

To Realization A/C

Step 3: If, there remain any assets(whether or not recorded) not taken over by the purchasing company, it may be sold, or may be taken by one of the partners or may be shared among the partners.

3.1 On sale of assets not taken over by the purchasing company:

Bank A/C..................Dr.

To realization A/C

3.2 Such assets taken over by any one of the partners:

Partner's capital A/C...............Dr.

To Realization A/C

3.3 On sharing such assets among the partners:

Partners' capital A/C(capital ratio)............Dr.

To realization A/C

Note: If such unsold assets are considered worthless, they should be shared among the partners in profit sharing ratio.

Step 4: The liabilities (whether or not recorded) by the purchasing company may be discharged or may be assumed by any one of the partners, or must be shared by the partners in their capital ratio.

4.1 On discharge of any liability not taken over by the purchasing company:

Realization A/C .............Dr.

To Bank A/C

If such liability assumed by one of the partners:

Realization A/C...............Dr.

To Partner's capital A/C

If such liability has to be assumed by all partners:

Realization A/C................Dr.

To Partners' capital A/C(capital ratio)

Step 5: When the realization expenses is paid, Realization account is debited.

5.1 For payment of realization expenses:

Realization A/C.............Dr.

To Bank

Step 6: Close the realization account by transferring the balance(profit or loss) to the capital of the partners in profit sharing ratio.

6.1 For profit on realization account:

Realization A/C..............Dr.

To Partners' capital A/C(profit sharing ratio)

6.2 For loss on realization account:

Partners' capital A/C............Dr.

To realization A/C

Step 7: On the receipt of purchase consideration(price), cash/bank account, equity shares in purchasing company or preference shares in purchasing company at their issue prices are debited and purchasing purchasing company's account is credited.

7.1 For the receipt of purchase price:

Cash/bank A/C....................................Dr.

Equity share in purchasing Co...........Dr.

Preference share in purchasing Co....Dr.

Debentures share in purchasing Co...Dr.

To purchasing Co.

Step 8: Transfer all accumulated reserves/profits/losses to the capital accounts of partners in profit sharing ratio.

8.1 For accumulated reserves, profits:

Reserve A/C.................Dr.

Profit and loss A/C.......Dr.

To partners' capital A/C

8.2 For accumulated losses:

Partners' capital A/C.............Dr.

To profit and loss A/C

Step 9: Transfer the current account, if any, in the books, to the capital accounts of the partners.

9.1 For transferring current account to the capital account:

Partners' current Account................Dr.

To partners' capital Account

Step 10: Pay off the partner's loan if any.

10.1 For the payment of partner's loan account:

Partner's loan A/C ..............Dr.

To bank A/C

Step 11: Make final settlement by paying off balances in capital accounts. In the absence of an agreement as to the division of shares(from purchasing company) among partners, such shares are distributed in the ratio of their final claims(i.e. in the ratio of capitals after all the adjustments).

11.1 For final settlement:

Partners' capital A/C ...........Dr.

To equity shares in purchasing Co.

To preference shares in purchasing Co.

To bank A/C

Entries in the books of purchasing company

Assets Account...........................Dr.

Goodwill Account........................Dr.

To liabilities

To share capital

To share premium

(Being assets and liabilities taken over)

Note: In case debit higher than credit, capital reserve is credited.

Q7) Write short note on Net Assets Method of Purchase Consideration. (8 marks)

A8) As per this method, the purchase consideration is calculated by finding out the difference between the assets and liabilities of the company. The sum of liabilities is deducted out of the sum of assets to find out the purchase consideration.

Under this method:

Example: X Ltd. Agrees to take over the Y Ltd. Which has following assets and liabilities:

Fixed assets: 6,50,000; Current Assets: 1,40,000; Goodwill: 10,000; Debentures: 1,00,000; Current Liabilities: 1,00,000.

As per this method, the purchase considerations will be calculated as follows:

Fixed Assets                       :6,50,000

Current Assets                  :1,40,000

Goodwill                              :10,000

Less: Debentures             :(1,00,000)

Less: Current Liabilities :(1,00,000)

Purchase Considerations               :6,00,000

On the basis of value of shares exchanged

Under this method, purchase consideration is calculated on the basis of the value of shares of the two companies involved.

Example: The Y Ltd. Has Rs. 20,000 share capital. X Ltd. Wants to take over the business of Y Ltd. By paying shares of Rs. 20 each. The purchase consideration will be calculated by calculating the number of shares to be issued.

20,000/20=1,000 shares

Q8) What does Transfer of Assets mean? (5 marks)

A9) The various asset accounts shown in the balance sheet on the date of takeover are transferred as follows:

1. All the Real Assets, whether taken over by the company or not, are transferred to the Realisation A/c. The Journal entry is:

Realisation A/c Dr. Total

To Various Assets A/cs Balance as per B/S

(1)    If the cash or bank balance is taken over by the company, it is also transferred to the Realisation A/c.

(2)    If the cash or bank balance is not taken over by the company, it is not transferred to the Realisation A/c. It appears as the opening balance on the debit side of the Cash/Bank Account opened in step No. (2) above.

(3)    Gross Value of Debtors is transferred to the debit of the Realisation A/c. Amount of Reserve/Provision for Doubtful Debts is transferred separately to the credit of the Realisation A/c.

(4)    If Goodwill A/c appears in the balance sheet, it too is transferred along with other assets.

2. Fictitious Assets like Profit & Loss A/c (Debit) balance which indicates the accumulated losses and Deferred Revenue Expenditure not written off are transferred, not to the Realisation A/c, but to the partners’ capital accounts in their profit-sharing ratio. The Journal Entry is:

Q9) Write short note on Liabilities in conversion. (5 marks)

A10) Liabilities Not Taken Over by Company: The liabilities not taken over by the company may be

(a)    paid in cash or (b) taken over by a partner at an agreed value or (c) settled by giving an asset in exchange.

(a)    Paid in Cash:

Realisation A/c Dr.     Amount

To Cash A/c

(b)   Taken over by Partner:

Realisation A/c Dr.     Agreed

To Partner’s Capital A/c

(c)    Asset given Against Liability: If an asset is given in full settlement of a liability, no entry is passed. If an asset is given in part settlement of a liability, the agreed amount of asset is deducted from the liability. The balance paid in cash is accounted an in a) above.

Unrecorded Liabilities: There may be an unrecorded liability e.g. a contingent liability now becoming an actual liability, which does not appear in the balance sheet. If such unrecorded liabilities are settled (paid in cash or taken over by a partner on an asset is given in exchange) the same entries as in (9) above are passed. Thus, the amount paid or agreed value of such unrecorded liabilities is directly debited to the Realisation A/c.

Part B

Q10) Amit and Asit were in partnership sharing profit and losses: Amit two-thirds; Asit one-third. The summarized partnership balance sheet as on 31st December, 2014 was as under;

The fixed assets included two cars having book values of 8,000 and 6,000 respectively.

The partners desiring to retire from business, accepted the offer of Western India Limited to acquire stock and fixed assets, other than motor cars at an agreed purchase price of 1,60,000/-.

The purchase consideration was to be satisfied by a cash payment of 56,000, the allotment by the company of the partners of 400, 5% preference shares of 100 each, and the balance by the allotment by  the allotment by the company to the partners of 900 equity shares of 100 each.

The Debtors realized 61,000/- and Creditors are settled for 51,000/-.

The partners agreed that the following should be the basis of distribution on dissolution of the partnership.

You are required to prepare:

(a)    The realization account;

(b)    The bank account; and

(c)    The partners, capital accounts showing the final settlement between them. (8 marks)

A1) Calculation of Purchase Consideration

Lumpsum given = 1,60000

Creditors A/c

Asits Loan A/c

Partners’ Capital A/c

Realisation A/c

Cash/Bank A/c

Western India Ltd. A/c

Equity Share of Purchasing Co.A/c

Preference Share of Purchasing Co, A/c

Q11) Ram and Sham sharing profits equally wanted to convert their partnership into limited company. Their Balance Sheet on 31st Dec., 1914 was as under:

(a)   The goodwill of the firm was to be valued on the basis of twice the average profits calculated on the prevous three years’ profits which were in 2012 20,000, in 2013 23,000 and in 2014

26,000 after setting aside 5,000 to reserve each year and charging 1,500, 1,800 and

2,100 respectively in respect of income tax.

(b)   The land and buildings and plant & machinery, were taken over at a revaluation of 75,000/- and

15,000 respectively.

(c)   10% Debentures of 1,00,000 were issued at a discount of 5%.

(d)   Partners were issued 15,000 equity shares of 10 each towards purchase consideration and paid cash for the balance. Shares are to be distributed in the profit-sharing ratio.

(e)   The purchasing company immediately pays off sundry creditors, and bank overdraft and issues 10% preference shares of 100 each to loan creditor for 25,000.

You are required to give:

Opening Balance Sheet of the new company.

A2)          Calculation of Purchase Consideration (Net Assets Method)

Revised value of assets taken over:

Partner’s Capital A/c’s

Realisation A/c

Calculation of Goodwill

In the Books of Purchasing Co.

Balance Sheet as on...

Q12) Amar, Akbar and Anthony carry on business in partnership under the style of M/s. ‘A’ & Co. Sharing profits and losses in the ratio of 5:3:2. They have floated ‘A’ Pvt. Ltd. For the purpose of take over of their business. The following is the Balance sheet of the firm as on 30th September, 2014.

M/s. A & Co. Balance Sheet as on 30.9.1983

On that day ‘A’ Pvt. Ltd. Took over the business for a total consideration of 5,00,000. The purchase consideration was to be discharged by the allotment of equity shares of 10 each at par in the profit sharing ration and 15% debentures of 100/- each at par for surplus capital.

The directors of ‘A’ Pvt. Ltd. Revalued the fixed assets of ‘A’ Co. At 4,00,000. You are asked to

(a)    State the number of equity shares & debentures allotted by ‘A’ Pvt. Ltd. To Amar, Akbar and Anthony by showing your workings.

(b)    Show journal entries in connection with the above transactions in the book of ‘A’ Pvt. Ltd. (8 marks)

A3)                                                  Partners’ Capital A/c

Realisation A/c

Purchasing Co. A/c

Equity Share of Purchasing Co A/c

15% Debenture of Purchasing Co. A/c

Working Note:

Statement of Surplus Capital

In the Books of M/s A & Co.

Q13) John, James and Jack are partners of Jill and Co. Sharing profits and losses in the ration of 2:2:1. On 30th June 2014, their Balance sheet was as under:

On that day they floated Jill & Co. Pvt. Ltd. Which took over the working capital at 2,00,000 and the goodwill of the firm at 50,000. It discharged the purchase consideration in the form of 9% debentures in respect of ultimate surplus capital, 10% redeemable preference shares in respect of the balance of initial surplus capital and equity shares for the balance, all issued at par. John took over the building at an agreed valuation of 40,000. James took over the machinery at an agreed valuation of 50,000. Jill & Co. (P) Ltd. Agreed to pay monthly rent of 40,000. James took over the machinery at an agreed valuation of 50,000. Jill & Co. (P) Ltd. Agreed to pay monthly rent of 1,000 to John for the occupation of the building and monthly compensation of 2,000 to James for the use of machinery.

The formation expenses of Jill & Co. Pvt. Ltd. Amounted to 6,000 which were agreed to be paid by the new company to Jack, the partner who was in charge of promotion, by 30th September, 2014.

You are required to:

(a)    Close the books of partnership;

(b)    Prepare a statement showing the allotment of various types of capital amongst the partner;

(c)    Pass the opening journal entries in the books of Jill & Co. Pvt. Ltd. As on 1.7.2014. (8 marks)

A4) Calculation of Purchase Consideration (Net Assets Method)

Revised Value of Assets Taken Over

In the Books of Jill & Co. Pvt. Ltd.

Working Notes: Statement of Excess Capital

Partners’ Capital A/c’s

Realisation A/c

Purchasing Co. Ac

Q14) M, B and G were in partnership sharing profits and losses equally. Their balance sheet on 31st Dec., 2014 was as follows:

They decided to sell their business to MBG Ltd. As G who was the working partner, was found to be mismanaging the affairs of the firm. A sum of 5,000 reveived from the firm’s debtors was not credited to their accounts but was misapropriated by him. Stocks were overstated by 3,750.

Repairs to machinery amounting to 3,000 had been wrongly capitalised, during 2012 the rate of 10% of the diminishing balance.

MBG Ltd. Acquired all the partnership assets except the investments, which B agreed to take at

1,250. For the purpose of sale, the assets were valued as follows:

Goodwill 1,250, Furniture 1,625, Stock 12,500 Machinery at book value Debtors at book value less 5% M agreed to discharge the creditors. For the purpose of paying the bills payable, M and B introduced cash in their profit-sharing proportion.

G being insolvent, is unable to meet an deficiency that may arise.

The purchase consideration was settled by the allotment at a premium of 10 per share, of sufficient fully paid equity shares of Face value of 100 each in MBG Ltd., B agreed to take 200 shares and the balance was to be given to M.

Prepare necessary ledger accounts in the books of Partnership Firm. 

A5)                                    Calculation of P.C.

(Net assets method) Revised Value of Assets

Partners’ Capital A/c.

Profit/Loss Adj. A/c.

Journal Entries for Rectification

Realisation A/c

Creditors A/c.

Bills Payable A/c.

Cash/Bank A/c.

Purchasing Co.

Equity Share of P. Co.

Q15) Asha and Bina are in partnership and share profits losses in equal proportion. On 30th September, 2014, they sold their assets to Ashawadi Ltd.

Balance Sheet as on 30.9.14 Stood as Under

The buyer, Ashwadi Ltd. Agree as follows:

(i) To pay 1,59,300 for sundry assets and 30,000 as goodwill.

(ii)   To deposit 50,000 immediately to enable payments to creditors and the balance on completion of all formalities on 31.12.14. They agree to pay interest at 5% p.a. On the balance of purchase price.

Asha and Bina are to be allowed interest at 10% p.a. On their opening capital. Sagar loan account is to be credited with interest at 12% p.a.

Show necessary ledger accounts in the books of vendors, ignore fractions. (8 marks)

A7)

(1)    Calculation of P.C. (Net Assets Method) Revised value of Assets taken Sundry Assets              1,59,300

Goodwill 30,000