Reconstitution of a Partnership Firm – Admission of a Partner – Class 12 Accountancy Chapter 2 Notes & NCERT PDF

Introduction

A partnership is an agreement, so any change in that agreement reconstitutes the firm: a new agreement replaces the old, though the firm continues. This chapter deals with the most common reconstitution, the admission of a new partner. A new partner brings capital or skills but takes part of future profits. Accountants must therefore settle old matters (goodwill, reserves, revaluation of assets and liabilities) so that the old partners are compensated fairly and the new partner neither gains nor loses from events before his entry.

Key Concepts

2.1 Modes of Reconstitution

A firm is reconstituted by: (a) admission of a new partner, (b) change in profit sharing ratio among existing partners, (c) retirement of a partner, (d) death of a partner, and (e) amalgamation of two firms.

2.2 Admission of a New Partner

Under the Partnership Act a new partner can be admitted only with the consent of all existing partners. He acquires two rights: a share in the assets and a share in future profits. On admission the following adjustments are needed: new profit sharing ratio, sacrificing ratio, goodwill, revaluation of assets and reassessment of liabilities, distribution of accumulated profits (reserves) and losses, and adjustment of capitals.

2.3 New Profit Sharing Ratio

New share of an old partner = Old share − Share surrendered to the new partner. If nothing is stated, the new partner is assumed to take his share from the old partners in their old ratio, so the old partners' ratio among themselves stays the same.

2.4 Sacrificing Ratio

Sacrificing ratio = Old share − New share. It shows the proportion in which old partners give up profit, and it is used to share the new partner's premium for goodwill. When the new partner takes his share in the old ratio, sacrificing ratio = old ratio.

2.5 Goodwill

Goodwill is the value of the reputation of a firm which enables it to earn more than normal profits. It is an intangible (not fictitious) asset. Factors affecting it: nature of business, location, efficiency of management, market situation, special advantages (licences, cheap power, import quotas) and business connections.

The need to value goodwill arises when the profit sharing ratio changes, a partner is admitted, retires or dies, or the firm is dissolved or sold.

Methods of valuation:

Treatment of goodwill on admission (AS 26: only purchased goodwill is recorded):

2.6 Adjustment for Accumulated Profits and Losses

General reserve, balance of P&L (credit) and workmen compensation reserve belong to the old partners and are credited to them in the old ratio. Accumulated losses (debit balance of P&L, deferred revenue expenditure) are debited to them in the old ratio.

2.7 Revaluation of Assets and Reassessment of Liabilities

Changes in values are recorded through a Revaluation Account (Profit and Loss Adjustment Account). Increase in assets and decrease in liabilities are credited; decrease in assets and increase in liabilities (and unrecorded liabilities) are debited. The profit or loss on revaluation is transferred to the old partners' capital accounts in the old ratio. Assets and liabilities then appear at revised values in the new Balance Sheet.

2.8 Adjustment of Capitals

Capitals may be adjusted to be proportionate to the new ratio. Usually the new partner's capital is the base: Total capital = New partner's capital ÷ his share. Old partners' required capitals are compared with their adjusted capitals; a shortage is brought in cash and a surplus withdrawn (or transferred to current accounts). Alternatively, the new partner's capital can be found from the old partners' combined adjusted capital.

2.9 Change in Profit Sharing Ratio among Existing Partners

Without any admission, partners may change their ratio. The gaining partner compensates the sacrificing partner for goodwill: Gaining Partner's Capital A/c Dr / To Sacrificing Partner's Capital A/c. Reserves and revaluation are handled in the old ratio, as on admission.

Worked Examples

Example 1 – New ratio (Illustrations 1–3). Anil and Vishal (3:2) admit Sumit for 1/5 taken in the old ratio: Anil 3/5 × 4/5 = 12/25, Vishal 2/5 × 4/5 = 8/25, Sumit 5/25 → 12:8:5. If Dinesh takes 1/5 equally from Akshay and Bharati (3:2): 6/10 − 1/10 = 5/10 and 4/10 − 1/10 = 3/10 → 5:3:2. If Jyoti takes 2/10 from Anshu and 1/10 from Nitu (3:2): 4:3:3.

Example 2 – Sacrificing ratio (Illustration 6). Rohit and Mohit (5:3), new ratio 4:2:1 with Bijoy. Rohit 5/8 − 4/7 = 3/56; Mohit 3/8 − 2/7 = 5/56 → sacrificing ratio 3:5 (not the old ratio).

Example 3 – Goodwill valuation.

Example 4 – Premium for goodwill (Illustration 16). Sunil and Dalip (5:3) admit Sachin for 1/5; he brings ₹20,000 capital and ₹4,000 goodwill.

Bank A/c Dr ₹24,000

To Sachin's Capital A/c ₹20,000

To Premium for Goodwill A/c ₹4,000

Premium for Goodwill A/c Dr ₹4,000

To Sunil's Capital A/c ₹2,500

To Dalip's Capital A/c ₹1,500

Example 5 – Hidden goodwill. A and B (equal, capitals ₹45,000 each) admit C for 1/3 with ₹60,000. Implied total capital 60,000 × 3 = 1,80,000; actual 1,50,000; goodwill ₹30,000; C's share ₹10,000.

C's Current A/c Dr ₹10,000

To A's Capital A/c ₹5,000

To B's Capital A/c ₹5,000

In Illustration 21 (Hem 80,000, Nem 50,000, 3:2; Sam brings 60,000 for 1/5) goodwill = 3,00,000 − 1,90,000 = ₹1,10,000; Sam's share ₹22,000, credited Hem ₹13,200 and Nem ₹8,800.

Example 6 – Reserves and capital adjustment. Rajinder and Surinder (4:1) have general reserve ₹20,000 and a P&L debit balance ₹10,000 (Illustration 22).

General Reserve A/c Dr ₹20,000

To Rajinder's Capital A/c ₹16,000

To Surinder's Capital A/c ₹4,000

Rajinder's Capital A/c Dr ₹8,000

Surinder's Capital A/c Dr ₹2,000

To Profit and Loss A/c ₹10,000

In Illustration 25, A and B (2:1) admit C for 1/4 with ₹20,000: new ratio 2:1:1; total capital 80,000; A needs 40,000 (has 45,000, withdraws ₹5,000) and B needs 20,000 (has 15,000, brings ₹5,000).

Key-Facts Sheet

Board Exam Focus

Common questions: new and sacrificing ratio (3 marks), goodwill valuation by the three methods (3–4 marks), journal entries for premium (4 marks) and a full question with revaluation account, capital accounts and new Balance Sheet (6–8 marks).

Answer outline 1 – "Distinguish sacrificing ratio from new ratio." Meaning; formula (old − new vs old − sacrifice); purpose (sharing goodwill vs sharing future profits); who is affected (old partners only vs all partners).

Answer outline 2 – "Full admission question." Revaluation A/c → transfer to old partners in old ratio → reserves in old ratio → goodwill premium in sacrificing ratio → capital accounts → capital adjustment (bring in/withdraw) → Bank balance → new Balance Sheet.

Answer outline 3 – "What is goodwill? State factors affecting it." Definition as the reputation value enabling above-normal profits; list five factors with a one-line example each; note it is intangible, not fictitious.

Key Terms

Common Mistakes