Reconstitution of a Partnership Firm — Admission of a Partner
1. Introduction
Reconstitution of a partnership firm occurs when there is a change in the existing agreement among the partners. Admission of a new partner is one of the ways in which a partnership firm can be reconstituted. The new partner brings in new capital, skills, and experience to the firm, but also necessitates several adjustments to the existing financial statements and capital accounts of the old partners.
2. Reasons for Admission of a Partner
- To raise additional capital.
- To avail the benefits of new partner’s expertise.
- To share the increasing workload.
- To expand the business.
3. New Profit Sharing Ratio
When a new partner is admitted, the profit-sharing ratio among the partners changes. The new ratio is agreed upon by all partners, including the new one.
4. Sacrificing Ratio
The old partners have to sacrifice a part of their profit share in favor of the new partner. This sacrifice is measured by the sacrificing ratio, which is the difference between the old ratio and the new ratio.
[ \text{Sacrificing Ratio} = \text{Old Ratio} – \text{New Ratio} ]
5. Calculation of Goodwill
Goodwill is the value of a firm’s reputation and its potential to earn future profits. When a new partner is admitted, they compensate the existing partners for their share of goodwill. Goodwill can be calculated using various methods:
- Average Profit Method
- Super Profit Method
- Capitalization Method
The new partner’s share of goodwill is shared among the existing partners in their sacrificing ratio.
6. Adjustment for Goodwill
Goodwill brought in by the new partner can be treated in the following ways:
- Premium Method: The new partner brings in the goodwill amount in cash.
- Revaluation Method: Goodwill is adjusted through the revaluation account.
- Hidden Goodwill Method: When the amount of goodwill is not specifically mentioned but can be inferred from the capital introduced by the new partner.
7. Revaluation of Assets and Liabilities
On the admission of a new partner, assets and liabilities are revalued to reflect their current market values. This is done through a revaluation account. The revaluation profit or loss is shared among the old partners in their old profit-sharing ratio.
7.1. Revaluation Account Format
Revaluation Account
Particulars Amount Particulars Amount
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Decrease in Value of Assets XXX Increase in Value of Assets XXX
Increase in Liabilities XXX Decrease in Liabilities XXX
Profit transferred to:
Old Partner A’s Capital A/c XXX
Old Partner B’s Capital A/c XXX
(Loss transferred to respective Capital Accounts)8. Adjustment of Capitals
The capitals of the partners may need to be adjusted to reflect the new profit-sharing ratio. This can be done by:
- Adjusting the capitals to the new profit-sharing ratio.
- Bringing in additional capital by the new partner.
9. Treatment of Reserves and Accumulated Profits
Any reserves or accumulated profits in the books are distributed among the old partners in their old profit-sharing ratio before the admission of the new partner.
10. Preparation of Balance Sheet
After all adjustments are made, a new balance sheet is prepared to reflect the reconstituted partnership firm.
10.1. Example of a Balance Sheet Format
Balance Sheet of M/s ABC and Co. as on 31st March, 20XX
Liabilities Amount Assets Amount
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Creditors XXX Cash/Bank XXX
Bills Payable XXX Debtors XXX
Outstanding Expenses XXX Less: Provision for Doubtful Debts XXX
Partners’ Capital: Closing Stock XXX
Partner A XXX Fixed Assets XXX
Partner B XXX Furniture XXX
Partner C (New Partner) XXX Goodwill XXXConclusion
The admission of a new partner in a partnership firm involves several important financial adjustments, including recalculating profit-sharing ratios, valuing and compensating for goodwill, revaluing assets and liabilities, and adjusting capital accounts. Understanding these adjustments is crucial for maintaining accurate and fair financial records in a reconstituted partnership.
