NCERT Class 12 Accountancy Reconstitution of a Partnership Firm Admission of a Partner

Reconstitution of a Partnership Firm – Admission of a Partner

Partnership is an agreement between two or more persons (called partners) for sharing the profits of a business carried on by all or any of them acting for all. Any change in the existing agreement amounts to reconstitution of the partnership firm. This results in 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. In this chapter we shall have a brief idea about all these and in detail about the accounting implications of admission of a new partner or an on change in the profit sharing ratio.

3.1 Modes of Reconstitution of a Partnership Firm

Reconstitution of a partnership firm usually takes place in any of the following ways: 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. For example, Hari and Haqque are partners sharing profits in the ratio of 3:2. On April 1, 2007 they admitted John as a new partner with 1/6 share in profits of the firm. With this change now there are three partners of the firm and it stand reconstituted.

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. For example, Ram, Mohan and Sohan are partners in a firm sharing profits in the ratio of 3:2:1. With effect from April 1,2007 they decided to share profits equally as Sohan brings in additional capital. This results in a change in the existing agreement leading to reconstitution of the firm.

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 a will. For example, Roy, Ravi and Rao are partners in the firm sharing profits in the ratio of 2:2:1. On account of illness, Ravi retired from the firm on March 31, 2007. This results in reconstitution of the firm now having only two partners. 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. For example, X,Y and Z are partners in a firm sharing profits in the ratio 3:2:1. X died on March 31, 2007. Y and Z decide to carry on the business sharing future profits equally. The continuity of business by Y and Z sharing future profits equally leads to reconstitution of the firm.

3.2 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 unlessotherwise agreed upon. With the admission of a new partner, the partnershipfirm 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.

Questions for Practice

Short Answer Questions

1. Identify various matters that need adjustments at the time of admission of a new partner.

2. Why it is necessary to ascertain new profit sharing ratio even for old partners when a new partner is admitted?

3. What is sacrificing ratio? Why is it calculated?

4. On what occasions sacrificing ratio is used?

5. If some goodwill already exists in the books and the new partner brings in his share of goodwill in cash, how will you deal with existing amount of goodwill?

6. Why there is need for the revaluation of assets and liabilities on the admission of a partner?

Long Answer Questions

1. Do you advise that assets and liabilities must be revalued at the time of admission of a partner? If so, why? Also describe how is this treated in the book of account?

2. What is goodwill? What factors affect goodwill?

3. Explain various methods of valuation of goodwill.

4. If it is agreed that the capital of all the partners should be proportionate to the new profit sharing ratio, how will you work out the new capital of each partner? Give examples and state how necessary adjustments will be made.

5. Explain how will you deal with goodwill when new partner is not in a position to bring his share of goodwill in cash.

6. Explain various methods for the treatment of goodwill on the admission of a new partner?

7. How will you deal with the accumulated profits and losses and reserves on the admission of a new partner?

8. At what figures the value of assets and liabilities appear in the books of the firm after revaluation has been due. Show with the help of an imaginary balance sheet.

Please refer to attached file for NCERT Class 12 Accountancy Reconstitution of a Partnership Firm Admission of a Partner