Accounting Treatment of Accumulated Profits and Reserves: Change in Profit Sharing Ratio
When the firm is reconstituted all the accumulated profit, reserves and losses are transferred to Partner’s Capital Accounts (if capitals are fluctuating) or Current Accounts (if capitals are fixed) in their old profit-sharing ratio. This is done because the reserves or accumulated profits/losses belong to the partners before the reconstitution of the firm (or change in profit-sharing ratio). Accumulated profit/losses, and reserves are distributed among the old partners in the old profit sharing ratio.
Accounting Treatment of Accumulated Profits and Reserves (Journal Entries):
1. When Reserves and Accumulated Profit Accounts are closed:
A. For Transfer of Reserves, Accumulated Profits etc.:
B. For Transfer of Accumulated Losses:
J,K and L are partners sharing profit and losses in the ratio 4:2:1. On 1st April 2021, they decided to share profit and loss in the ratio of 5:3:2. On that date, the Profit and Loss Account had a credit balance of ₹24,000, General Reserve amounted to ₹59,000, Workmen Compensation Reserve amounts to ₹83,600 and Advertisement Expenditure is ₹18,200. Pass the necessary journal entries assuming that the accounts are closed.
2. When Reserves and Accumulated Profit accounts are not closed:
On 1st April,2021, partners D and E decided to share their profit and losses equally from the old ratio 4:3. On that date, the Profit and Loss Account showed a credit balance of ₹14,600 and the General Reserve amounted to ₹27,400. They decided not to close the accounts. Pass the necessary journal entries in the books on that date.
Notes to Accounts:
Accumulated Profit = Profit and Loss Account + General Reserve
= ₹14,600 + ₹ 27,400
Sacrificing Share = Old Share – New Share
Due to a change in the profit-sharing ratio, there is a gain of 1/14th to E, but D will sacrifice 1/14.
Hence, D’s Capital will be credited by 1/14th of the balance in Accumulated Profit, i.e., , and
E’s Capital Account will be debited.
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