Admission of a Partner in a partnership firm accountancy

admission of a partner in a partnership firm. 2nd puc chapter number 3

1. RECONSTITUTION OF A PARTNERSHIP FIRM ADMISSION OF A PARTNER

2. Modes of Reconstitution of a Partnership Firm Admission of a new partner Change in the profit sharing ratio among the existing partners Retirement of an existing partner Death of a partner

3. ADMISSION OF A PARTNER 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

4. 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.

5. 1. 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. Share Sacrificed= Old share – New Share

6. 2. NEW PROFIT SHARING RATIO When new partner is admitted he acquires his share in profits from the old partners. In other words, on the admission of a new partner, the old partners sacrifice a share of their profit in favour of the new partner. The new ratio in which all the partners (including the new partner admitted) share the profits/losses of the firm is called NPSR. New Profit Sharing Ratio = Old Share-Sacrificed Share OR New Profit Sharing Ratio = Old Ratio – Sacrifice Ratio

7. 3. GOODWILL Goodwill is the value of the reputation of a firm in respect of the profits expected in future over and above the normal profits. Goodwill can be defined as “the present value of a firm’s anticipated excess earnings” or as “the capitalised value attached to the differential profit capacity of a business”. Any firm that earns normal profit or incurs a loss has no goodwill. The capacity of a business to earn profits in future is basically what is meant by the term Goodwill

8. Factors Affecting the Value of Goodwill Nature of business Location Efficiency of management Market situation Special advantages

9. Need For Valuation Of Goodwill Need for valuation of goodwill arises at the time of sale of a business. But, in the context of a partnership firm it may also arise in the following circumstances: Change in the profit sharing ratio amongst the existing partners; Admission of new partner; Retirement of a partner; Death of a partner; and Dissolution of a firm involving sale of business as a going concern. Amalgamation of partnership firms.

10. Methods of Valuation Of Goodwill The important methods of valuation of goodwill are as follows: 1. Average Profits Method 2. Super Profits Method 3. Capitalisation Method

11. AVERAGE PROFITS METHOD The goodwill is valued at agreed number of ‘years’ purchase of the average profits of the past few years 1. Average Profits= Total profits for the given years/ No. of years 2. Goodwill = Average profits x no. of years of purchase

12. SUPER PROFITS METHOD Under this method, goodwill is calculated by multiplying super profits with the given number of years of purchase. Super profit – The excess of actual earnings of the business over the normal earnings. CAPITALISATION METHOD Under this method, average normal profit is Capitalised on the basis of the normal rate of returns and from such Capitalised value, the net asset (i.e. capital employed) is subtracted to ascertain goodwill.

13. 4. REVALUATION OF ASSETS AND LIABILITIES It Is an account prepared to record the increase/decrease in the value of Assets and Liabilities and to find out the profit or loss on revaluation, which is transferred to the old partners’ capital a/c in their old ratio. It is a nominal account. Increase in asset and decrease in liability is a profit- Credit side of revaluation a/c Decrease in asset and increase in liability is a loss- Debit side of revaluation a/c.

14. (i) For increase in the value of an asset Asset A/c Dr. To Revaluation A/c (Gain) (ii) For reduction in the value of an asset Revaluation A/c Dr. To Asset A/c (Loss) (iii) For appreciation in the amount of a liability Revaluation A/c Dr. To Liability A/c (Loss) (iv) For reduction in the amount of a liability Liability A/c Dr. To Revaluation A/c (Gain) The journal entries recorded for revaluation of assets and reassessment of liabilities are as follows:

15. (v) For an unrecorded asset Cash A/c Dr. To Revaluation A/c (Gain) (vi) For an unrecorded liability Revaluation A/c Dr. To Cash A/c (Loss) (vii) For transfer of gain on Revaluation if credit balance Revaluation A/c Dr. To Old Partners Capital A/c (Old ratio) (viii) For transferring loss on revaluation Old partner’s Capital A/c Dr. (Individually) (Old ratio) To Revaluation A/c

16. Format Dr. Revaluation a/c Cr. Particulars Amount (Rs) Particulars Amount (Rs) To decrease in Value of Assets XXX By Increase in value of Assets XXX To increase in value of liabilities XXX By Decrease in value of liabilities XXX To unrecorded liability brought in a/c XXX By unrecorded asset brought in a/c XXX To profit on revaluation transferred to partners’ capital a/c (O/R) By loss on revaluation transferred to partners’ capital a/c (O/R) A’s Capital a/c XXX A’s Capital a/c XXX B’s Capital a/c XXX B’s Capital a/c XXX XXX XXX

17. 5. ADJUSTMENT FOR ACCUMULATED PROFITS/LOSSES These are usually in the form 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 old partners only by transferring it to their capital accounts in old profit sharing ratio.

18. JOURNAL ENTRIES: For distribution of reserves : General reserve/reserve fund a/c Dr. To old partners’ Capital a/c For distribution of accumulated profits Profit/Loss a/c Dr. To old partners’ capital a/c For Distribution of accumulated losses: Old partners’ capital a/c Dr. To profit/loss a/c

19. 6. ADJUSTMENT OF CAPITALS At the time of admission, the partners agree that their capitals should also be adjusted so as to be proportionate to their profit sharing ratio. In such a situation, if the capital of the new partner is given, the same can be used as a base for calculating the new capitals of the old partners. The capitals ascertained should be compared with their old capitals after all adjustments and then: The partner whose capital falls short, will bring in the necessary amount to cover the shortage and The partner who has a surplus, will withdraw the excess amount of capital.

20. ACCOUNTS TO BE PREPARED 1. REVALUATION A/C 2. PARTNERS’ CAPITAL A/C- This contains : Capital balance of old partners Profit/loss on revaluation Undistributed reserves and Profit/loss a/c appearing in the balance sheet Capital brought in by new partner : If capital brought in cash : Cash/Bank a/c Dr. To new partners’ capital a/c If capital brought in the form of assets : Concerned asset a/c Dr. To new partners’ capital a/c

21. Distribution of Goodwill (based on the cases) Balancing of Capital a/c 3. NEW BALANCE SHEET This will contain all the assets and liabilities of the firm at their revalued values. (old balance sheet values + adjustments)

22. 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.