Q.Leela and Meeta were partners in a firm sharing profits and losses in the ratio of 5:3. In April 2017 they admitted Om as a new partner. On the date of Om's admission the balance sheet of Leela and Meeta showed a balance of ₹16,000 in general reserve and ₹24,000 (Cr) in Profit and Loss Account. Record necessary journal entries for the treatment of these items on Om's admission. The new profit sharing ratio between Leela, Meeta and Om was 5:3:2.
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Start your 14-day free trial to unlock the full solution →Leela and Meeta transfer the existing General Reserve (₹16,000) and the credit balance of Profit & Loss Account (₹24,000) to their capital accounts in the old profit-sharing ratio (5:3) because these accumulated profits belong to the old partners. Om, as a new partner, has no claim on them.
Concept and Accounting Treatment
When a new partner is admitted, all accumulated profits and reserves appearing in the balance sheet belong exclusively to the old partners. These are undistributed earnings from past periods. The new partner should not share in these because they were earned before they joined the firm.
The accounting rule is: All accumulated profits (credit balances) are transferred to the old partners' capital accounts in their old profit-sharing ratio. The journal entry debits the reserve/profit account (reducing it to zero) and credits the old partners' capital accounts individually.
Why? Because the General Reserve and the Profit & Loss Account (credit balance) represent profits that were not distributed. They are now being distributed to the rightful owners — Leela and Meeta — in the ratio they earned them (5:3). Om gets nothing from these items.
Common Mistake
Do not transfer these balances to the new partner's capital account or to a new reserve. Also, do not use the new profit-sharing ratio (5:3:2) for this distribution. The old ratio (5:3) is the only correct basis.
Solution: Journal Entries
Date: April 2017
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| April 2017 | General Reserve A/c Dr. | 16,000 | ||
| To Leela's Capital A/c | 10,000 | |||
| To Meeta's Capital A/c | 6,000 | |||
| (Being general reserve transferred to old partners' capital accounts in their old profit-sharing ratio 5:3) | ||||
| April 2017 | Profit & Loss A/c Dr. | 24,000 | ||
| To Leela's Capital A/c | 15,000 | |||
| To Meeta's Capital A/c | 9,000 | |||
| (Being credit balance of Profit & Loss Account transferred to old partners' capital accounts in their old profit-sharing ratio 5:3) |
Working Notes
Working Note 1: Distribution of General Reserve (₹16,000)
Old ratio of Leela and Meeta = 5 : 3
- Leela's share = 16,000 × 5/8 = ₹10,000
- Meeta's share = 16,000 × 3/8 = ₹6,000
Working Note 2: Distribution of Profit & Loss Account Credit Balance (₹24,000)
- Leela's share = 24,000 × 5/8 = ₹15,000 …
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