Investment Fluctuation Reserve in Partnership Accounts

Meaning of Investment Fluctuation Reserve

Meaning of Investment

We all earn income and make expenses. We all save some part of our income for future for known or unknown expenses. Suppose Mr A earns Rs 10 Lakhs every year and spends Rs 8 Lakhs every year on meeting his own and family expenses. So every year he is saving Rs 2 Lakhs. After 5 years he will be having Rs 10 lakhs with him. Now if he keeps this money with himself only then even after 5, 10 or 20 years this Rs 10 lakhs will remain Rs 10 lakhs only. (Understand its just currency notes and they will remain Rs 10 lakhs only)

Instead he can invest this Rs 10 lakhs somewhere. If he invests this Rs 10 lakhs somewhere then this money can grow to becomes Rs 11 Lakhs, Rs 12 Lakhs, etc. after few years

So What is Investment?

• Investment means using your money
  • a) in purchasing some other asset or
  • b) lending this money to someone else who in turn will purchase some asset out of this money.
  • c) Invest in business. Money grows due to profits earned in business

Example - Mr A can purchase Gold from his Rs 10 lakhs. Now if the market value of Gold increases to Rs 11 Lakhs then Mr A's Rs 10 lakhs has become Rs 11 Lakhs. We all know that most of the commodities become costly with time. If we keep our money in the form of such commodities instead of currency then our money will grow.

Example - Mr A can deposit his Rs 10 Lakhs in bank account. Bank pays interest on deposits and so Mr. A will get more money than Rs 10 lakhs. From where does bank gets extra money to pay to Mr. A ? When we deposit our savings in bank then bank lends that money to some other person from whom banks gets extra money on repayment.

Investment can be made in various ways like buying precious metals like gold and silver, buying property like land and buildings, put money in bank fixed deposits, buy shares or debentures of some company, invest money in related business (Trade Investments), Invest money in non related business (Non-trade investments)

Meaning of Fluctuation

If the value of something changes frequently then it is called fluctuation. Example - the temperature in your city changes regularly. Sometime it is 30 degrees, after few hours it may be 32 degrees and then after some time it may become 29 degrees. So we say that temperature is fluctuating.

Your mood can fluctuate. Sometimes you are happy and sometimes you are sad.

Meaning of Investment Fluctuation

As discussed above investment can be made in various modes. The market value of investments usually keep on changing. It can increase as well as decrease. The continuous changes in the market value of investments is called investment fluctuation.

Compared to market value the book value of investment is fix. It is the purchase price or the cost price of the investment. In other words the price at which we purchased the investment is called its book value.

Lets take a simple example. Suppose I purchased a land in 2022 for Rs 10 Lakhs. The the book value of land is Rs 10 lakhs. Now the market value of land keeps on changing every year. In 2023 the market value of that land becomes Rs 11 Lakhs. It means I can earn a profit of Rs 1 Lakh (11 - 10) if I sell that land today.

On the contrary suppose the market value of land becomes Rs 8 Lakhs in 2023 then I will suffer a loss of Rs 2 Lakhs if I sell the land today.

So when we make investment then we can earn profits as well as incur losses on our investment. Also note that no one can foresee whether there will be a profit or a loss. This takes us to the requirement of having an investment fluctuation reserve which is discussed next

Meaning of Investment Fluctuation Reserve

As we cannot foresee whether our investment will result into profit or loss so we keep aside some part of profit to meet any loss arising due to fluctuation in the market value of investments.

The profits so kept separately is known as Investment Fluctuation Reserve.

Accounting Treatment of Investment Fluctuation Reserve

When the reserve is created

Journal Entry

• Profit and Loss Appropriation A/c Dr...
  • To Investment Fluctuation Reserve A/c

Investment Fluctuation Reserve has a credit balance and is shown on the liabilities side of the balance sheet.

When the reserves are closed on reconstitution

Whenever there is reconstitution of partnership firm , then all the reserves and accumulated profits/losses accounts are closed. For more details please refer to this article.

Here we will discuss the accounting treatment of closure of investment fluctuation Reserve.

We need three main numbers as on the date of reconstitution (as per question) for this purpose a) Amount of investment fluctuation reserve b) Book Value of Investments c) Market value of investments

Step 1 - Find the profit or loss on investments. It is calculated by the formula (Market value - Book Value) of Investments. Suppose book Value if Rs 1 lakhs and Market value is

• a) Rs 11 Lakhs - There will be profit of Rs 1 lakhs (11 - 10)
• b) Rs 10 Lakhs - There is no profit and no loss (10 - 10)
• c) Rs 7 Lakhs - There is a loss of Rs 3 Lakhs. (7 - 10)

Step 2 - In case of profits there is no need of reserve. But in case of loss investment fluctuation reserve is required to meet the loss. So we have to compare the value of loss with the amount of investment fluctuation reserve.

Various situations that can arise are shown in the below diagram :

Following abbreviations are used. Market Value - MV, Book Value - BV, Investment Fluctuation Reserve - IFR

Now we will discuss accounting treatment and the journal entries in each case one by one.

Case 1 - When Market Value = Book Value, there is no profit and no loss

Since no loss exists so there is no use for the reserve existing in the books of accounts. hence the whole reserve will be distributed among the old partners in the old ratio

Journal entry

• Investment Fluctuation Reserve A/c Dr... (Amount of IFR)
  • To Old Partners Capital/Current A/c ( In the old ratio)

Note : Capital A/c will be used if fluctuating method is followed and current A/c is used if fixed capital method is followed.

Note : If the market value of investments is not given in the question then we will assume market value equal to book value and so case 1 will apply in this case also

Case 2 - When Market Value > Book Value, there is profit on investments

Since no loss exists so there is no use for the reserve existing in the books of accounts. hence the whole reserve will be distributed among the old partners in the old ratio

Journal entry

• Investment Fluctuation Reserve A/c Dr... (Amount of IFR)
  • To Old Partners Capital/Current A/c (In the old ratio)

Note : Capital A/c will be used if fluctuating method is followed and current A/c is used if fixed capital method is followed.

Since the MV > Book Value so there is profit so entry will be passed for profit on revaluation :

• Investment A/c Dr.. (MV - BV)
  • To Revaluation A/c (MV - BV)

Then revaluation profit will be distributed among the old partners in the old ratio

• Revaluation A/c Dr..
  • To Old Partners Capital A/c (In the old profit sharing ratio)

Case 3 - When Market Value < Book Value, there is loss and Loss < IFR

There is loss on investments which will be written off from IFR. But since loss < reserve so the excess reserves left s is of no use. Hence the balance reserve will be distributed among the old partners in the old ratio

• Investment Fluctuation Reserve A/c Dr.. (Amount of IFR)
  • To Investments A/c (Amount of Loss)
  • To Old Partners Capital/Current A/c ( In the old ratio)

Note : Capital A/c will be used if fluctuating method is followed and current A/c is used if fixed capital method is followed.

Case 4 - When Market Value < Book Value, there is loss and Loss = IFR

There is loss on investments which will be written off from IFR. Since loss = reserve so no excess reserves left. Hence nothing will be distributed among the old partners.

• Investment Fluctuation Reserve A/c Dr.. (Amount of IFR)
  • To Investments A/c (Amount of Loss)

Case 5 - When Market Value < Book Value, there is loss and Loss > IFR

There is loss on investments which will be written off from IFR. Since loss > reserve so no excess reserves left. Hence nothing will be distributed among the old partners. However the excess loss over IFR will be debited to revaluation A/c

• Investment Fluctuation Reserve A/c Dr.. (Amount of IFR)
• Revaluation A/c Dr.. (Loss - IFR)
  • To Investments A/c (Amount of Loss)

• Old Partners Capital A/c Dr.. (In the old ratio)
  • To Revaluation A/c

Note : Capital A/c will be used if fluctuating method is followed and current A/c is used if fixed capital method is followed.

Key Points to easily remember journal entries

• Investment Fluctuation Reserve is Debited in all the cases with its full value
• Investment A/c is credited only in cases market value < Book Value and hence there is loss
• Where reserve is higher then loss then the excess amount(reserve - loss) is always credit to old partners capital/current A/c in old ratio.
• Revaluation profit or loss (if any) will be distributed among the old partners in the old ratio

Example Question

A and B are partners sharing profits equally. Suppose investment Fluctuation Reserve = Rs 200, Book Value of Investments = Rs 1000 as per question.

Case 1 - When Market Value = Book Value, there is no profit and no loss, As per question MV = Rs 1000

Case 2 - When Market Value > Book Value, there is profit on investments, As per question MV = Rs 1100

Case 3 - When Market Value < Book Value, there is loss and loss < IFR, As per question MV = Rs 900

Case 4 - When Market Value < Book Value, there is loss and loss = IFR, As per question MV = Rs 800

Case 5 - When Market Value < Book Value, there is loss and loss > IFR, As per question MV = Rs 700

IFR Treatment in different types of reconstitution

The accounting treatment of investment fluctuation reserve is similar in all case of reconstitution (change in profit sharing ratio, admission, retirement and death) with minor differences. The difference lies in only one thing i.e. excess reserves are distributed among which partners.

All the rest of the accounting treatment is same for all the chapters and you need not study it again and again for each chapter. However practice few questions from each chapter to get a flavor of difference in treatment as described above