Q.Record necessary journal entries in the following cases:
The journal entries record the settlement of creditors by transferring assets (Investments, Machinery, Buildings) at their agreed values, with any difference between the creditor's claim and the asset's value being a gain or loss on realisation (credited/debited to the Realisation Account).
Concept and Accounting Treatment
When a partnership firm is dissolved, all assets are sold and liabilities are paid off. The Realisation Account is the central account used to record this process. It is debited with the book value of all assets (except cash/bank) and credited with the book value of all liabilities (except partner's capital and loan accounts). When a liability is settled by transferring an asset directly to the creditor (instead of selling the asset for cash and then paying the creditor), the entry is:
- Debit the liability account (e.g., Creditors A/c) with the book value of the liability.
- Credit the asset account (e.g., Investment A/c, Machinery A/c) with the agreed value at which the asset is transferred.
- The difference between the book value of the liability and the agreed value of the asset is a gain or loss on realisation. This is recorded by:
- Debiting the Realisation A/c (if the asset's agreed value is less than the liability — a loss).
- Crediting the Realisation A/c (if the asset's agreed value is more than the liability — a gain).
The key rule: The Realisation Account absorbs the difference between the book value of the liability and the agreed value of the asset used to settle it. The asset is always removed from the books at its agreed value (the price at which it is effectively 'sold' to the creditor), not its book value.
Solution: Journal Entries
Case (a): Creditors worth ₹85,000 accepted ₹40,000 cash and Investment worth ₹43,000.
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Creditors A/c Dr. | 85,000 | |||
| To Cash/Bank A/c | 40,000 | |||
| To Investment A/c | 43,000 | |||
| To Realisation A/c (Gain) | 2,000 | |||
| (Being creditors settled by paying cash and transferring investments; gain on realisation credited) |
Working Note 1: Gain on Realisation
- Book value of liability (Creditors): ₹85,000
- Total payment made: Cash (₹40,000) + Investment (agreed value ₹43,000) = ₹83,000
- Gain = ₹85,000 – ₹83,000 = ₹2,000 (credited to Realisation A/c)
Common Mistake
Do not debit the Realisation Account with the book value of the Investment. The Investment is credited with its agreed value (₹43,000), not its book value. The difference between the book value of the Investment and its agreed value is not recorded here; it is already accounted for when the asset was transferred to the Realisation Account at its book value at the start of dissolution.
Case (b): Creditors were ₹16,000. They accepted Machinery valued at ₹18,000.
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Creditors A/c Dr. | 16,000 | |||
| Realisation A/c (Loss) Dr. | 2,000 | |||
| To Machinery A/c | 18,000 | |||
| (Being creditors settled by transferring machinery; loss on realisation debited) |
Working Note 2: Loss on Realisation
- Book value of liability (Creditors): ₹16,000
- Agreed value of Machinery transferred: ₹18,000
- Loss = ₹18,000 – ₹16,000 = ₹2,000 (debited to Realisation A/c)
Shortcut
When the asset's agreed value exceeds the liability, the difference is a loss (debit Realisation A/c). When the liability exceeds the asset's agreed value, the difference is a gain (credit Realisation A/c). Think of it as: the firm is 'paying' more (in asset value) than it owes, so it's a loss.
Case (c): Creditors were ₹90,000. They accepted Buildings valued ₹1,20,000 and paid cash to the firm ₹30,000.
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Creditors A/c Dr. | 90,000 | |||
| Cash/Bank A/c Dr. | 30,000 | |||
| Realisation A/c (Loss) Dr. | 0 | |||
| To Buildings A/c | 1,20,000 | |||
| (Being creditors settled by transferring buildings; excess cash received from creditor credited to Realisation A/c) |
Working Note 3: No gain or loss on realisation here
- Book value of liability (Creditors): ₹90,000
- Agreed value of Buildings transferred: ₹1,20,000
- Cash received from creditor: ₹30,000
- Net payment by firm: ₹1,20,000 (asset given) – ₹30,000 (cash received) = ₹90,000
- Since net payment equals the liability, there is no gain or loss. The Realisation A/c is not affected by this transaction.
Key Insight
The cash received from the creditor (₹30,000) is not a gain. It simply reduces the net cost of settling the liability. The Buildings are still credited at their full agreed value (₹1,20,000), and the cash received is debited to the Cash/Bank account. The Realisation Account is only affected if the net payment (asset value minus cash received) differs from the liability's book value.
The journal entries for the three cases are recorded above. In case (a), a gain of ₹2,000 is credited to the Realisation Account. In case (b), a loss of ₹2,000 is debited. In case (c), there is no gain or loss on realisation because the net payment (₹1,20,000 – ₹30,000 = ₹90,000) exactly equals the creditors' claim.
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