Investment Fluctuation Reserve
Understanding Accounting Treatment on partnership reconstitution
Comprehensive Guide for Accounting Students
What is Investment Fluctuation Reserve?
Investment Fluctuation Reserve (IFR) is a reserve, created to meet the losses, that may occur in the future, due to a fall in the value of investments. It acts as a buffer against unforeseen losses and protecting the partnership firm's financial position when value of investment decrease.
Why is IFR Important?
- Protects against unexpected drops in investment values
- Ensures stability in financial statements
- Prevents sudden impacts on profit and loss accounts for one year
- Provides a systematic approach to handle changes in value of investments
- A prudent financial management policy
Creating the Reserve
When an Investment Fluctuation Reserve is created, we make the following journal entry:
This entry transfers an amount from profits, to create a reserve, for meeting potential fall in value of investments in future.
Key Points:
- IFR is created from profits during good financial periods
- Appears on the liabilities side of the balance sheet
- Used only when investments market value becomes lower than book value
- Not needed when market value is equal to or above book value
Solving IFR Questions
When solving problems involving Investment Fluctuation Reserve, you'll typically be given:
IFR Amount
The current balance of the Investment Fluctuation Reserve account
Book Value (BV)
The value of investments as recorded in the books
Market Value (MV)
The current market value of investments as on the date of reconstitution of partnership firm
Example Values:
Step-by-Step Process
Solving Investment Fluctuation Reserve Questions
Compare Market Value (MV) and Book Value (BV)
For MV < BV: Compare Loss and IFR
Pass Appropriate Journal Entries
Key Decision:
IFR is needed only when MV < BV and there is a loss. Otherwise, the reserve is distributed among the old partners in their old ratio.
Accounting Treatment Cases
Based on the relationship between Market Value and Book Value, we have five possible cases:
Market value is higher than book value, indicating a profit.
1. Distribute IFR:
IFR A/c Dr. 100,000
To Old Partners' Capital A/c 100,000
(In old ratio)
2. Revalue investments:
Investment A/c Dr. 200,000
To Revaluation A/c 200,000
(Asset Value increase so Investment Debit, Profit so Revaluation A/c Credit)
Market value equals book value, no profit or loss.
Distribute IFR:
IFR A/c Dr. 100,000
To Old Partners' Capital A/c 100,000
(In old ratio)
Market value is lower than book value, but loss is less than IFR.
Use IFR for loss and distribute remainder:
IFR A/c Dr. 100,000
To Investment A/c 40,000 (Asset Dec- Cr)
To Old Partners' Capital A/c 60,000
(In old ratio)
Market value is lower than book value, and loss equals IFR.
Use entire IFR for the loss:
IFR A/c Dr. 100,000
To Investment A/c 100,000 (Asset Dec- Cr)
Market value is lower than book value, and loss exceeds IFR.
Use IFR and charge remaining loss:
IFR A/c Dr. 100,000
Revaluation A/c Dr. 30,000
To Investment A/c 130,000 (Asset Dec- Cr)
(Loss on Revaluation so Revaluation A/c - Debit,
Distribution to Old Partners
When distributing the Investment Fluctuation Reserve, "old partners" refers to different groups based on the situation:
All Partners
When partners change their profit-sharing ratio, all existing partners are considered "old partners" for IFR distribution.
Excluding New Partner
When a new partner is admitted, "old partners" refers only to the partners who were there before admission.
All Remaining Partners
When a partner retires or passes away, "old partners" includes all partners including retired or deceased partner.
Important Note:
a) In all cases, IFR distribution is always done in the old profit-sharing ratio that existed before the change event occurred.
b) IFR accounting treatment is same in all cases of reconstitution like admission, retirement, death and change in profit ratio You need not learn the accounting treatment again Only difference is in the partners to whom the extra reserves are distributed
Key Takeaways
Summary of Investment Fluctuation Reserve
Purpose
IFR acts as a financial buffer to absorb losses from declining investment values.
Accounting Treatment
Accounting treatment varies based on the Market Value and Book Value of investments.
Critical Rule
IFR is only utilized when MV < BV. In all other cases, it's distributed to partners.
Calculation
Always start by comparing Book Value and Market Value
Distribution
When not used for losses, IFR is distributed to partners in their old profit-sharing ratio.
Journal Entries
Different journal entries are required for each case based on the loss amount relative to IFR balance.
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