RECONSTITUTION
OF A PARTNERSHIP FIRM - ADMISSION OF A PARTNER
Partnership is an agreement
between two or more persons for sharing the profits of a business carried on by
all or any of them acting for all. Any change in the existing agreement leads to reconstitution of the partnership firm. This
changes an end of the existing agreement
and a new agreement comes into being with a changed relationship among the
members of the partnership firm and/or their composition. However, the firm continues.
The partners often resort to reconstitution of the firm in various ways such as
admission of a new partner, change in profit sharing ratio, retirement of a partner,
death or insolvence of a partner.
Modes
of Reconstitution of a Partnership Firm
Reconstitution
of a partnership firm usually takes place in any of the following ways:
1. Admission of a new partner: A new partner may be admitted when the firm
needs additional capital or managerial help. According to the provisions of Partnership
Act 1932 unless it is otherwise provided in the partnership deed a new partner
can be admitted only when the existing partners unanimously agree for it.
2. Change in the profit sharing ratio among the
existing partners:
Sometimes the partners of a
firm may decide to change their existing profit sharing ratio. This may happen
an account of a change in the existing partners’ role in the firm.
3.Retirement of an existing partner: It means withdrawal by a partner from the business
of the firm which may be due to his bad health, old age or change in business
interests. In fact a partner can retire any time if the partnership is at will.
4.Death of a partner: Partnership may also stand reconstituted on
death of a partner, if the remaining partners decide to continue the business of
the firm as usual.
Admission of a New Partner
When firm requires
additional capital or managerial help or both for the expansion of its business
a new partner may be admitted to supplement its existing resources. According
to the Partnership Act 1932, a new partner can be admitted into the firm only
with the consent of all the existing partners unless otherwise agreed upon.
With the admission of a new partner, the partnership firm is reconstituted and
a new agreement is entered into to carry on the business of the firm. A newly
admitted partner acquires two main rights in the firm–
1. Right to share the assets of the partnership firm; and
2. Right to share the profits of the partnership firm.
For the right to acquire share in the assets and
profits of the partnership firm, the partner brings an agreed amount of capital
either in cash or in kind. Moreover, in the case of an established firm which
may be earning more profits than the normal rate of return on its capital the
new partner is required to contribute some additional amount known as premium
or goodwill. This is done primarily to compensate the existing partners for
loss of their share in super profits of the firm.
Following are the other important points which
require attention at the time of admission of a new partner:
1. New profit sharing ratio;
2. Sacrificing ratio;
3. Valuation and adjustment of goodwill;
4. Revaluation of assets and Reassessment of
liabilities;
5. Distribution of accumulated profits
(reserves); and
6. Adjustment of partners’ capitals.
New
Profit Sharing Ratio
At the time of admission of
a new partner, the old partners sacrifice a share of their profit in favour of
the new partner. After they admit the new partner sharing of profit will be as
per the calculated new profit sharing ratio.But, what will be the share of new
partner and how he will acquire it from the existing partners is decided mutually
among the old partners and the new partner. However, if nothing is specified as
to how the new partner acquires his share from the old partners; it may be
assumed that he gets it from them in their profit sharing ratio. In any case,
on admission of a new partner, the profit sharing ratio among the old partners
will change keeping in view their respective contribution to the profit sharing
ratio of the incoming partner. Hence, there is a need to ascertain the new profit
sharing ratio among all the partners. This depends upon how does the new
partner acquires his share from the old partners for which there are many possibilities.
Let us understand it with the help of the following illustrations.
Illustration
1
Anandu and Vishal are partners sharing profits in the
ratio of 3:2. They admitted Ravi as a new partner for 1/5 share in the future
profits of the firm. Calculate new profit sharing ratio of Anandu, Vishal and Ravi
.
Solution
Ravi’s share = 1/5
Remaining share = 1− 1/5 = 4/5
Anil’s new share = 3/5 of 4/5 = 12/25
Vishal’s new share = 2/5 of 4/5 = 8/25
New profit sharing ratio of Anandu, Vishal and Ravi will be
12:8:5.
Illustration 2
Ajith and Bharath are partners sharing profits in the ratio
of 3:2. They admit Daneesh as a new partner for 1/5th share in the future
profits of the firm which he gets equally from Ajith and Bharath. Calculate new
profit sharing ratio of Ajith, Bharath and Daneesh.
Solution
Daneesh’s share = 1/5 = 2/10
Ajith’s share = 3/5 – 1/10 = 5/10
Bharath’s share = 2/5 – 1/10 = 3 /10
New profit sharing ratio between, Ajith, Bharath and Daneesh
will be 5:3:2.
Illustration 3
Ram and Murukan are partners in a firm
sharing profits in the ratio of 3:2. They admit Ganesh as a new partner. Ram
surrenders 1/4 of his share and Murukan 1/3 of his share in favour of Ganesh.
Calculate new profit sharing ratio of Ram, Murukan and Ganesh
Solution
Ram’s
old share = 3/5
Share
surrendered by Ram = 1/4 of 3/5 = 3/20
Ram’s
new share
=3/5 – 3/20 = 9/20
Murukan’s
old share = 2/5
Share
surrendered by Murukan = 1/3 of 2/5 = 2/15
Murukan’s
new share = 2/5 – 2/15 =
4/15
Ganesh’s
new share = Ram’s
sacrifice + Murukan’s Sacrifice
= 3/20 + 4 /
15 = 17/60
New profit sharing ratio among Ram, Murukan and Ganesh will
be 27:16:17
Sacrificing
Ratio
The ratio in which the old
partners agree to sacrifice their share of profit in favour of the incoming
partner is called sacrificing ratio. The sacrifice by a partner is equal to :
Sacrificing Ratio = Old
Share of Profit – New Share of Profit
As stated earlier, the new
partner is required to compensate the old partner’s for their loss of share in
the super profits of the firm for which he brings in an additional amount known
as premium or goodwill. This amount is shared by the existing partners in the
ratio in which they forego their shares in favour of the new partner which is
called sacrificing ratio.
The ratio is normally
clearly given as agreed among the partners which could be the old ratio, equal
sacrifice, or a specified ratio. The difficulty arises where the ratio in which
the new partner acquires his share from the old partners is not specified.
Instead, the new profit sharing ratio is given. In such a situation, the
sacrificing ratio is to be worked out by deducting each partner’s new share from
his old share.
Illustration 4
Roja and Manju are partners in a firm
sharing profits in the ratio of 5:3. They
admit Beena as a new partner for 1/7 share in the profit. The new profit
sharing ratio will be 4:2:1.
Calculate the sacrificing ratio of Roja and Manju
Solution
Roja’s old share = 5/8
Roja’s new share
= 4/7
Roja’s sacrifice = 5/8 – 4/7 = 3/56
Manju’s old share
= 3/8
Manju’s new share = 2/7
Manju’s sacrifice = 3/8 – 2/7 = 5/56
Sacrificing ratio among Roja and Manju will be 3:5.
Illustration 5
Amar and Bahadur are
partners in a firm sharing profits in the ratio of 3:2. They admitted Mary as a
new partner for 1/4 share. The new profit sharing ratio between Amar and
Bahadur will be 2:1. Calculate their sacrificing ratio.
Solution
Marry’s share = 1/4
Remaining share =
1-1/4 = 3/4
This 3/4 share is to be shared by Amar and
Bahadur in the ratio of 2:1.
Therefore,
Amar’s new share =
2/3 of 3/4 = 6/12
Bahadur’s new share = 1/3 of 3/4 = 3/12
New profit sharing ratio of Amar, Bahadur and
Mary will be 2:1:1.
Amar’s sacrifice = 3/5 – 2/4 = 2/20
Bahadur’s sacrifice = 2/5 – 1/4 = 3/20
Sacrificing ratio among Amar and Bahadur will be
2:3.
Treatment of Goodwill
The
incoming partner who acquires his share in the profits of the firm from the
existing partners brings in some additional amount to compensate them for loss
of their share in super profits. It is termed as his share of goodwill (also
called premium). Alternatively he may agree that goodwill account be raised in
the books of the firm by giving the necessary credit to the old partners. Thus,
when a new partner is admitted, goodwill can be treated in two ways: (1) By
Premium Method, and (2) By Revaluation Method.
1.Premium Method
This
method is followed when the new partner pays his share of goodwill in cash. The
amount of premium brought in by the new partner is shared by the existing
partners in their ratio of sacrifice. If this amount is paid to the old partners
directly (privately) by the new partner, no entry is made in the books of the
firm. But, when the amount is paid through the firm, the following journal
entries are passed:
Cash
A/c Dr.
To Goodwill A/c
(Amount
brought by new partner as premium)
Goodwill A/c Dr.
To Existing Partners Capital A/c
(Individually)
(Goodwill
distributed among the existing partners in their sacrificing ratio)
Alternatively, it is credited to the
new partner’s capital account and then adjusted in favour of the existing
partners in their sacrificing ratio. In that case the journal entries will be
as follows:
Cash A/c Dr.
To New Partner’s Capital A/c
(Amount
brought by new partner for his share of goodwill)
New Partner’s Capital A/c Dr.
To Existing Partner’s Capital A/cs (Individually)
(Goodwill
brought by new partners distributed among the existing partners in their sacrificing
ratio)
If the partners decide that the amount
of premium credited to their capital accounts should be retained in business,
there is no need to pass any additional entry. If, however, they decide to
withdraw their amounts, (in full or in part) the following additional entry
will be passed:
Existing Partner’s Capital A/c (Individually) Dr.
To Cash A/c
(The amount of goodwill withdrawn by
the existing partners)
Illustration 6
Anil and Dileep are partners in a firm sharing profits and losses
in the ratio of 5:3. Sajan is admitted in the firm for 1/5 share of profits. He
is to bring in Rs. 20,000 as capital and Rs. 4,000 as his share of goodwill.
Give the necessary journal entries,
(a) When the amount of
goodwill is retained in the business.
(b) When the amount of
goodwill is fully withdrawn.
(c) When 50% of the amount
of goodwill is fully withdrawn.
Solution
(a) When the amount of
goodwill credited to existing partners is retained in business
Books of Anil & Dileep
Journal Entry
|
Date
|
Particular
|
l/f
|
Debit (Rs)
|
Credit(Rs)
|
|
1
2
|
Cash A/c Dr.
To Sajan’s Capital A/c
To Goodwill A/c
(The amount brought in by Sajan as Capital and Goodwill)
|
|
24,000
4,000
|
20,000
4,000
2,500
1,500
|
|
Goodwill A/c Dr.
To
Anil’s Capital A/c
To
Dileep’s Capital A/c
(Goodwill transferred to Anil and
Dileep in the ratio of 5:3)
|
Alternatively,
if the goodwill account is not be the brought into the books of accounts the
following entries will be recorded:
(i) Cash A/C Dr. 24,000
To
Sajan’s Capital A/c 24,000
(ii) Sajan’s Capital A/c Dr 4,000
To Anil’s Capital A/c 2,500
To Dileep’s Capital A/c 1,500
Note: It assumed that the sacrificing ratio
is the same as old profit sharing ratio.
(b)
When the amount of goodwill credited to existing partners is fully withdrawn.
Journal
|
Date
|
Particular
|
l/f
|
Debit (Rs)
|
Credit(Rs)
|
|
1
2
3
|
Cash A/c Dr.
To Sajan’s Capital A/c
To Goodwill A/c
(The amount brought in by Sajan as Capital and Goodwill)
Goodwill A/c Dr.
To
Anil’s Capital A/c
To
Dileep’s Capital A/c
(Goodwill transferred to Anil and
Dileep in the ratio of 5:3)
Anil’s Capital A/c Dr.
Dileep’s Capital A/c Dr.
To Cash A/c
(Cash withdrawn by Anil and Dileep equal
to their share of goodwill)
|
|
24,000
4,000
2,500
1,500
|
20,000
4,000
2,500
1,500
4,000
|
(c) When 50% of the amount of goodwill credited to existing
partners is withdrawn.
Journal
|
Date
|
Particular
|
l/f
|
Debit (Rs)
|
Credit(Rs)
|
|
1
2
3
|
Cash A/c Dr.
To Sajan’s Capital A/c
To Goodwill A/c
(The amount brought in by Sajan as Capital and Goodwill)
Goodwill A/c Dr.
To
Anil’s Capital A/c
To
Dileep’s Capital A/c
(Goodwill transferred to Anil and
Dileep in the ratio of 5:3)
Anil’s Capital A/c Dr.
Dileep’s Capital A/c Dr.
To Cash A/c
(Cash withdrawn for 50% of their
share of goodwill)
|
|
24,000
4,000
1250
750
|
20,000
4,000
2,500
1,500
2,000
|
When goodwill already exists in books: The above treatment of goodwill was based
on the assumption that there was no goodwill account in the books of the firm.
However, It is quite possible that when a new partner brings in his share of goodwill
in cash, some amount of goodwill already exists in books. In that case, after
crediting the old partners by the amount of goodwill brought in by the new partner,
the existing goodwill must be written off by debiting the old partners in their
old profit sharing ratio. But, if it is decided that the goodwill may continue to
appear in the books at its old value, the amount to be brought in by new partner
will have to be proportionately reduced i.e., He will be required to bring cash
only for this share of the excess of the agreed value of goodwill over the amount
of goodwill already appearing in books.
Old Partner’s Capital A/Cs Dr.
To Goodwill A/c
(Goodwill written-off in old ratio)
2.Revaluation Method
This method is followed
when the new partner does not bring in his share of goodwill in cash. In such a
situation, the goodwill account is raised in the books of account by crediting
the old partners in the old profit sharing ratio. When goodwill account is to
be raised in the books of account there are two possibilities,
(a) No goodwill appears in books at the time of
admission, and
(b) Goodwill already exists in books at the time
of admission.
(a) When no goodwill exists in the books:
When no goodwill exists in
the books at the time of the admission of a new partner, the goodwill account
must be raised at its full value. This can be done by debiting goodwill account
with its full value and crediting the old partners’ capital accounts in their
profit sharing ratio. The journal entry will be:
Goodwill A/c Dr.
To Old Partners’ Capitals A/c (individually)
(Goodwill raised at full value in the old ratio)
The goodwill thus raised shall appear in the balance
sheet of the firm at its full value.
(b) When goodwill already
exists in the books : If the books already show some balance in the Goodwill
Account, the adjustment for goodwill in the old partner’s capital accounts
shall be made only for the difference between the agreed value of goodwill and
the amount of goodwill appearing in books. The amount of goodwill appearing in
the books may be less than its agreed value or it may be more than the agreed
value. If it is less than the agreed value, the difference between the agreed
value of goodwill and the amount of goodwill appearing in the books will be
debited to goodwill account and credited to old partner’s capital accounts in
their old profit sharing ratio. If, however, it is more than the agreed value,
the difference will be debited to the old partners’ capital accounts in their
old profits sharing ratio and credited to the goodwill account.
Thus, the journal entries
will be as under:
(a) When the value of goodwill appearing in the books is
less than the agreed value.
Goodwill A/c Dr.
To Old Partners’ Capital
A/c (individually)
(Goodwill raised to its
agreed value)
(b) When the value of goodwill appearing in the books is
more than the agreed value.
Old Partners’ Capital A/c
(individually) Dr.
To Goodwill A/c
(Goodwill brought down to its agreed value)
Hidden Goodwill
Sometimes
the value of goodwill is not given at the time of admission of a new partner.
In such a situation it has to be inferred from the arrangement of the capital
and profit sharing ratio.
Illustration
Hemand and Nibu are partners in a firm
sharing profits in the ratio of 3:2. Their capitals were Rs. 50,000 and Rs. 30,000
respectively. They admitted Sameer on Jan. 1, 2011 as a new partner for 1/5
share in the future profits. Sameer brought Rs. 40,000 as his capital.
Calculate the value of goodwill of the firm and record necessary journal
entries on Sam’s admission.
Solution
Value
of Firm’s Goodwill
Sameer’s
capital = Rs. 40,000
Sameer’s
share = 1/5
Total
capital of new firm =
5 ×Rs.40,000 = Rs. 2,00,000
Hemand’s+Nibu’s+Sameer’s = Rs.50,000 + Rs. 30,000 + Rs.40,000
=
Rs.1,20,000
Goodwill
of the firm = Rs.80,000
(Rs. 2,00,000 – Rs.1,20,000)
Sameer’s
share =
1/5× Rs.80,000 = Rs. 16,000
|
Date
|
Particular
|
l/f
|
Debit (Rs)
|
Credit(Rs)
|
|
1
2
3
|
Cash A/c Dr.
To Sameer’s Capital A/c
(The amount brought in by Sameer as Capital)
Goodwill A/c Dr.
To
Hemand’s Capital A/c
To
Nibu’s Capital A/c
(Goodwill transferred to Hemand and Nibu
in the ratio of 3:2)
If goodwill
account is not to be raised
Sameer’s Capital A/C Dr
To Hemand’s Capital A/c
To Nibu’s Capital A/c
(Amount of goodwill of new partner
adjusted )
|
|
40,000
80,000
16000
|
40,000
48000
32000
9600
6400
|
Adjustment
for Accumulated Profits and Losses
Sometimes a firm may have
accumulated profits not yet transferred to capital accounts of the partners.
These are usually in the firm of general reserve, reserve fund and/or Profit
and Loss Account balance. The new partner is not entitled to have any share in
such accumulated profits. These are distributed among the partners by
transferring it to their capital accounts in old profit sharing ratio. Similarly,
if there are some accumulated losses in the form of a debit balance of profit
and loss account appearing in the balance sheet of the firm.
Illustration
Raji
and Suresh are partners in a firm sharing profits in the ratio of 4:1. On April
15, 2014 they admit Narayan as a new partner. On that date there was a balance
of Rs. 20,000 in general reserve and a debit balance of Rs. 10,000 in the
profit and loss account of the firm. Pass necessary journal entries regarding adjustment
of a accumulate a profit or loss.
|
Date
|
Particular
|
l/f
|
Debit (Rs)
|
Credit(Rs)
|
|
1
2
|
General Reserve A/c Dr.
To Raji’s capital A/c
To Suresh’s capital A/c
(General Reserve balance transferred to
the capital account of Raji and Suresh on Narayan’s admission)
Raji’s Capital A/c Dr.
Suresh’s Capital A/c Dr.
To Profit and Loss A/c
(Debit balance of Profit and Loss A/c transferred
to old partners’ capital accounts)
|
|
20,000
8000
2000
|
16,000
4000
10000
|
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