Reconstitution of a Partnership Firm – Admission of a Partner

A partnership firm undergoes reconstitution whenever a change occurs in its structure — such as when a new partner is admitted, a partner retires, or a partner dies. This chapter focuses on the admission of a new partner.

Why is a New Partner Admitted?

• A new partner may be admitted to:
• Bring in additional capital
• Contribute expertise or skill
• Expand the business

Rights of the New Partner

1. 1.On admission, the new partner acquires the right to:
2. 2.Share of future profits — as agreed
3. 3.Share of assets — including goodwill and revalued assets

New Profit-Sharing Ratio

When a new partner is admitted, the old partners sacrifice a portion of their share in favour of the new partner. The ratio in which old partners give up their share is called the Sacrifice Ratio.

Sacrifice Ratio = Old Ratio - New Ratio (for each old partner)
New Ratio = Old Ratio - Sacrifice Ratio

Treatment of Goodwill

• Goodwill is the reputation and value of the firm that enables it to earn above-normal profits. On admission:
• New partner must compensate old partners for their sacrifice — this is done through premium for goodwill.
• Goodwill A/c = NOT raised (as per Accounting Standards, goodwill is raised only when consideration is paid)

Case 1 — Premium brought in cash:
Cash/Bank A/c Dr (with amount of premium)
To Sacrificing Partners' Capital/Current A/c (in sacrifice ratio)

Case 2 — Premium NOT brought (adjusted through capital accounts):
New Partner's Capital A/c Dr
To Sacrificing Partners' Capital/Current A/c

Case 3 — Goodwill already exists in books:
Old Partners' Capital A/c Dr (in old ratio)
To Goodwill A/c (written off)
Then new partner's share is dealt with as per Cases 1 or 2.

Revaluation of Assets and Liabilities

• On admission, assets and liabilities are revalued to their current market value. A Revaluation Account (or Memorandum Revaluation Account) is prepared:
• Assets increase → Credit Revaluation A/c; Assets decrease → Debit Revaluation A/c
• Liabilities increase → Debit Revaluation A/c; Liabilities decrease → Credit Revaluation A/c
• Profit on revaluation → credited to Old Partners' Capital A/cs in old ratio
• Loss on revaluation → debited to Old Partners' Capital A/cs in old ratio

Adjustment for Accumulated Profits and Losses

At the time of admission, accumulated profits (General Reserve, P&L Credit balance) and losses (P&L Debit balance, Deferred Revenue Expenditure) must be transferred to old partners' capital accounts in their old profit-sharing ratio before the new partner joins.

Capital Adjustment (Hidden Goodwill)

Sometimes goodwill is not explicitly stated. If the new partner's capital is given and total capital of the firm is to be based on the new partner's contribution:
Total Capital of firm = New Partner's Capital / New Partner's share
Adjusted Capital of each old partner = Total Capital x their new ratio
Difference between adjusted and actual capital of old partners = amount to be brought in or withdrawn.

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· Steps: · C's share = 1/5. Sacrifice by A = 1/10, Sacrifice by B = 1/10 (equal sacrifice)
A's New Ratio = 3/5 - 1/10 = 6/10 - 1/10 = 5/10
B's New Ratio = 2/5 - 1/10 = 4/10 - 1/10 = 3/10
C's share = 1/5 = 2/10
New ratio = 5:3:2

· Steps: · Z's share = 1/4. Each sacrifices 1/8.
X's New Ratio = 3/4 - 1/8 = 6/8 - 1/8 = 5/8
Y's New Ratio = 1/4 - 1/8 = 2/8 - 1/8 = 1/8
Z = 2/8
New Ratio: 5:1:2. Sacrifice Ratio of X:Y = 1:1.

· Steps: · R's share of goodwill = 1/4 x 90,000 = Rs 22,500
Cash A/c Dr 22,500
To P's Capital A/c 15,000 (2/3 of 22,500)
To Q's Capital A/c 7,500 (1/3 of 22,500)
(Sacrifice ratio assumed 2:1, same as old ratio)

· Steps: · Building A/c Dr 20,000 — Revaluation A/c Cr 20,000
Revaluation A/c Dr 5,000 — Stock A/c Cr 5,000
Revaluation A/c Dr 3,000 — Outstanding Liability A/c Cr 3,000
Revaluation Profit = 20,000 - 5,000 - 3,000 = Rs 12,000
A's Capital Dr/Cr 7,200; B's Capital 4,800 (in 3:2 ratio)

· Steps: · General Reserve of Rs 50,000 is distributed among OLD partners A and B in their OLD ratio 3:2.
A = 3/5 x 50,000 = Rs 30,000; B = 2/5 x 50,000 = Rs 20,000
General Reserve A/c Dr 50,000
To A's Capital A/c 30,000
To B's Capital A/c 20,000

· Steps: · Total capital = 40,000 / (1/5) = Rs 2,00,000
Old partners' total = 2,00,000 - 40,000 = Rs 1,60,000
Actual capitals: A + B = 70,000 + 60,000 = Rs 1,30,000
Hidden Goodwill = 1,60,000 - 1,30,000 = Rs 30,000 (distributed to A and B in old ratio)

· Steps: · Old Partners' Capital A/cs Dr 60,000 (in old ratio)
To Goodwill A/c 60,000
This eliminates existing goodwill before fresh treatment on admission.