Accounts XII Chapter 3 Reconstitution of Partnership
Admission of a New Partner

Effect of Admission of a Partner

Admission of a new partner is a major event in a partnership business. A new admission can take place only with the unanimous consent of all the existing partners. New partners are admitted for several reasons. Additional capital contribution, fresh ideas more contacts etc. are some of the advantages in admitting a new partner.

Following are the most important accounting aspects to be considered at the time of admission of a new partner.

1. Change in profit sharing ratio

2. Accounting treatment of Goodwill

3. Revaluation of assets and liabilities

4 Treatment of reserves and accumulated profits / losses

5. Adjustment of Capital Accounts

1. Change in Profit Sharing Ratio

When a new partner comes into the business, old partner have to adjust his profit share from their portion. Thus change in profit sharing ratio is the first accounting aspect to be considered on admission of a new partner. In academic accounting, change in profit sharing ratio can be presented in various ways:

2. The new partner's share is mentioned without specifying the old partner's profit sharing arrangement.

In this case it is to be assumed that the profit available after paying the new partner?s share is to be divided by the old partners in their old profit sharing ratio. In other words the even though the overall profit sharing ratio changes, the old ratio is still maintained between the old partners, within the new ratio.

3. Revaluation of Assets and Liabilities

Revaluation of assets and liabilities is another major step prior to admission or retirement. Revaluation is important, as there are hidden profits or losses in the difference between book value and actual market value of assets or liabilities. Revaluation is necessary whenever there is a change in profit sharing ratio, even without admission or retirement. The hidden profits or losses should be distributed in the ratio prior to change (Old ratio).

Revised values of assets and liabilities are brought into books by opening a temporary account called ?revaluation account?. The purpose of revaluation account is to summarise effect of revaluation of assets and liabilities.

Revaluation account represents the combined capital account of partners. Any gain on revaluation of asset or liabilities, which are to be credited to partners, will be credited in revaluation account. Similarly any loss on revaluation will be debited in revaluation account instead of capital accounts. The revaluation account is closed by transferring its net balance to partner?s capital accounts in the profit sharing ratio.

4. Treatment of Reserves and Accumulated Profits

Accumulated profits such as general reserve, credit balance in profit &loss account etc. will be transferred to the capital accounts of old partners in the old profit sharing ratio. Similarly accumulated losses shall be transferred to the debit side of old partner?s capital accounts. Therefore these items will not appear in the new balance sheet.

5. Adjustment of Capital Accounts

When the partners change their profit sharing ratio at admission, retirement or any other reason, they also rearrange their capital accounts. Capital contribution is not essentially the basis of profit sharing. However the in most partnerships capital contribution is considered as the major factor in determining profit sharing ratio.

At the time of admission, capital contribution will be raised as an important condition. When a new partner is admitted for a certain share of profit for a certain amount of capital contribution he would naturally expect the other also maintain a capital balance matching with their profit share. Admission of a partner is not the only situation when a capital rearrangement is considered. Retirement, death or any other change in profit sharing ratio would prompt rescheduling the capital balances. The basic purpose of following ?fixed capital method? is to maintain a steady capital ratio. When capital is readjusted on the basis of new partner?s capital contribution, the first step is to determine the revised capital balances of each partner. Readjustment in capital account is usually done by bringing in or taking out cash. Sometimes, in place of cash transactions, old partners may adjust their capital balances by transferring the excess or deficit in the capital accounts to their current accounts as a temporary measure. Once the capital balances are adjusted current accounts can be settled in due course.

Theory Questions

1. Explain the premium method of treatment of goodwill on admission a new partner.

2. What is sacrificing ratio on admission of a partner?

3. Give two circumstances in which sacrificing ratio must be applied.

4. Why is there a need for revaluation of assets and liabilities of a firm, if there is an admission of a new partner?

5. Explain the treatment of goodwill on admission of a partner.

6. Explain various accounting steps involved in the admission of a new partner.

7. What is meant by super profit in the valuation of goodwill?

8. Explain with reason the treatment of reserves and surplus existing in the books of the firm on admission of a partner.