When a partnership is converted into a limited company, the partnership business is transferred to a legally separate company. The company may take over selected assets and liabilities and settle the purchase consideration with cash, shares, loan notes or a combination of these.
This guide explains the accounting process in the partnership’s books, the calculation of purchase consideration, the realisation account and the settlement of partners’ capital accounts. Legal and tax consequences vary by jurisdiction, so professional advice may be required in practice.
Why Convert a Partnership into a Limited Company?
Common reasons include:
- limiting the owners’ personal liability;
- raising finance through shares or company borrowing;
- creating a more permanent ownership structure;
- supporting growth and succession;
- separating ownership from management; and
- improving commercial credibility with some customers and suppliers.
Conversion is not merely a change of name. The company is a separate legal entity, and the transfer normally involves an agreement identifying the assets, liabilities and consideration.
Key Accounting Terms
Purchase consideration
Purchase consideration is the amount the company agrees to give for the net business acquired. It may consist of cash, ordinary shares, preference shares, loan notes or other consideration.
Realisation account
The realisation account is used in the partnership books to record the transfer or sale of assets and liabilities and calculate the profit or loss on realisation.
Partners’ capital accounts
After the realisation result and all remaining balances are posted, each partner’s capital account shows the amount due to or from that partner. Consideration received from the company is then distributed according to the agreement.
Step 1: Agree What the Company Will Take Over
The transfer agreement should state:
- which assets the company will acquire;
- the values assigned to those assets;
- which liabilities it will assume;
- the purchase consideration;
- how that consideration will be settled; and
- the effective date of transfer.
Some assets or liabilities may remain with the partners. These are not transferred to the realisation account as assets or liabilities taken over by the company unless the agreement provides otherwise.
Step 2: Calculate Purchase Consideration
Purchase consideration can be stated directly or calculated from the agreed values of assets and liabilities taken over.
A common calculation is:
Purchase consideration = Agreed value of assets taken over − Agreed value of liabilities assumed
However, the contract may specify a different amount, including an agreed value for goodwill.
Step 3: Transfer Assets to the Realisation Account
Assets taken over by the company are normally transferred at their book values:
Debit Realisation Account
Credit Individual Asset Accounts
Cash and bank are normally excluded if they are retained by the partnership to settle expenses or distribute balances, unless the company takes them over.
Step 4: Transfer Liabilities Assumed by the Company
Liabilities taken over are normally transferred as follows:
Debit Individual Liability Accounts
Credit Realisation Account
This removes the liability from the partnership’s books and credits the realisation account.
Step 5: Record Purchase Consideration Due
When the company agrees to acquire the business:
Debit Purchasing Company Account
Credit Realisation Account
The purchasing company account represents the amount receivable from the new company.
Step 6: Record Realisation Expenses
Legal fees, professional charges and other transfer expenses paid by the partnership are normally:
Debit Realisation Account
Credit Bank
If the company agrees to pay the expenses, the accounting depends on the terms of the agreement.
Step 7: Calculate Profit or Loss on Realisation
The balance on the realisation account is the profit or loss from transferring the net assets.
- A credit balance is a profit on realisation.
- A debit balance is a loss on realisation.
The profit or loss is transferred to partners’ capital accounts in their agreed profit-sharing ratio unless the partnership agreement provides otherwise.
For a profit:
Debit Realisation Account
Credit Partners’ Capital Accounts
For a loss:
Debit Partners’ Capital Accounts
Credit Realisation Account
Step 8: Receive the Consideration
When the company settles the amount due, the partnership records the assets received. For example:
Debit Cash / Shares in New Company / Loan Notes
Credit Purchasing Company Account
If shares are issued directly to individual partners rather than to the partnership, the entries should reflect the legal form of the settlement and the agreed allocation.
Step 9: Distribute Cash, Shares and Other Consideration
The assets received from the company are distributed to partners according to their final capital-account balances or the transfer agreement.
For shares distributed to a partner:
Debit Partner’s Capital Account
Credit Shares in New Company Account
For cash paid to a partner:
Debit Partner’s Capital Account
Credit Bank
All partners’ capital accounts should close when the winding-up entries are complete.
Worked Example
Assume that A and B share profits 3:2. Their partnership has the following book values:
| Item | Book value | Agreed transfer value |
|---|---|---|
| Property | $120,000 | $150,000 |
| Inventory | $40,000 | $36,000 |
| Trade receivables | $30,000 | $28,000 |
| Trade payables | ($26,000) | ($26,000) |
The agreed net assets are $188,000:
$150,000 + $36,000 + $28,000 − $26,000 = $188,000
If the company agrees to pay $208,000, the excess of $20,000 represents goodwill included in the purchase consideration.
Ignoring expenses, the book value of net assets transferred is:
$120,000 + $40,000 + $30,000 − $26,000 = $164,000
The profit on realisation is therefore:
$208,000 − $164,000 = $44,000
A receives $26,400 and B receives $17,600 of the realisation profit in their 3:2 ratio.
Illustrative Realisation Account Logic
| Debit side | Credit side |
|---|---|
| Book values of assets transferred | Book values of liabilities transferred |
| Realisation expenses paid by partnership | Purchase consideration due from company |
| Profit transferred to partners | Loss transferred from partners |
Accounting in the New Company
The company records the assets and liabilities acquired according to the applicable accounting requirements and the legal agreement. A simplified entry may debit the identifiable assets acquired, credit liabilities assumed, credit share capital or other consideration issued, and recognise goodwill or a gain where appropriate.
The values used in the company’s books are not automatically the old partnership book values. They depend on the acquisition terms and the applicable financial-reporting framework.
Important Practical Issues
- tax on asset transfers and gains;
- stamp duties or registration costs;
- transfer of licences and contracts;
- employee obligations;
- ownership of property and intellectual property;
- settlement of partnership debts;
- treatment of goodwill;
- valuation of shares issued; and
- continuity of bank and customer arrangements.
Common Errors
- using agreed transfer values instead of book values when opening the partnership realisation account;
- transferring assets the company did not agree to acquire;
- forgetting liabilities assumed by the company;
- allocating the realisation result in the wrong ratio;
- confusing purchase consideration with net cash paid;
- failing to close the purchasing company account; and
- assuming legal and tax treatment is identical in every country.
Frequently Asked Questions
Is the partnership automatically the same entity after incorporation?
No. The company is a separate legal entity. The business assets and liabilities must be transferred according to the incorporation and sale arrangements.
Why is a realisation account used?
It collects the book values of assets and liabilities transferred, the purchase consideration and transfer expenses so that the profit or loss on the transaction can be calculated.
Can partners receive shares instead of cash?
Yes. Shares, cash, loan notes or a combination may be used, subject to the agreement and applicable law.
How is realisation profit shared?
It is normally shared using the partnership’s profit-sharing ratio unless the partners agree to another treatment.
Related Accounting Guides
Conclusion
Converting a partnership into a limited company requires the partnership books to be closed carefully and the transfer consideration to be recorded accurately. The realisation account calculates the gain or loss, while the partners’ capital accounts determine how cash, shares and other consideration are distributed. Legal, valuation and tax advice should be integrated with the accounting work.
Authoritative references: ACCA — Accounting for partnerships, ACCA — Partnership accounts, and ACCA — Starting a business.