Reconstitution of Firm – Admission Of Partner

ADMISSION OF A PARTNER

According to Section 31 of Indian Partnership Act, 1932, New Partner shall be admitted in the Firm only when all existing partners agree to admission of new partner or it is agreed otherwise by partners in Partnership Deed.

Change in Profit Sharing Ratio

Change in Profit Sharing Ratio takes place at the time of Reconstitution of Firm. In this chapter Admission of new Partner will lead to change in Profit Sharing Ratio of a Partner in existing firm. Since, New or Incoming Partner acquires his/her share from old Partners; therefore, we need to determine New Profit Sharing Ratio and also Sacrificing Ratio.

New Profit Sharing Ratio

New Profit Sharing Ratio is the ratio in which all Partners, including new Partner, share future profits and losses of the Firm. New Partner acquires share from Old Partners through different ways. There are different cases related to acquisition of Shares by New Partner from Old Partners

Case 1. When New or Incoming Partner acquires his share from Old or Existing Partners in their Old Profit Sharing Ratio:

Situation I. When Profit Share of New Partner is given, but sacrifice made by Old Partners are not given:

NPSR is calculated as follows:

Subtract New Partner’s Ratio from 1 and Divide remaining share among Old Partners in their OPSR.

Example:

A & B Profit Sharing Ratio is 2:3. New Partner C enters into Partnership for 1/5th Share.

In this case NPSR will be calculated as follows:

 1 – 1/5 = 4/5

New Ratio of A = 4/5 × 2/5 =8/25

New Ratio of B = 4/5 × 3/5 =12/25

Ratio of C = 1/5 = 1/5 ×5/5 = 5/25

So, NPSR of A: B: C = 8:12:5

Ratio of Old Partners remain same as is evident from example A:B = 8:12 = 2:3

Situation II. When Share of New Partner is given and also New Profit Sharing Ratio of Old Partner is given.

Subtract New Partner’s Ratio from 1 and Divide remaining share among Old Partners in their NPSR.

Example:                           

New Partner C enters into Partnership for 1/5th Share. Future Profit Sharing Ratio or NPSR  of A & B is 2:3.

In this case NPSR will be calculated as follows:

 1 – 1/5 = 4/5

New Ratio of A = 4/5 × 2/5 =8/25

New Ratio of B = 4/5 × 3/5 =12/25

Ratio of C = 1/5 = 1/5 ×5/5 = 5/25

So, NPSR of A: B: C = 8:12:5

Situation III. When New or Incoming Partner acquires his share from old or existing Partners equally.

Deduct sacrifice made by old Partner to get NPSR of each Old Partner.

Example:

New Partner C enters into Partnership for 1/5th Share, which he took equally from A & B. Old Profit Sharing Ratio of A & B is 2:3.

In this case NPSR will be calculated as follows:

Share Surrendered by A= 1/2 × 1/5 = 1/10

Share Surrendered by B= 1/2 × 1/5 = 1/10

New Ratio of A = 2/5 – 1/10 = 3/10

New Ratio of B = 3/5 – 1/10= 5/10

Ratio of C = 1/5 = 1/5 ×2/2 = 2/210

So, NPSR of A: B: C = 3:5:2

Case 2. When New or Incoming Partner acquires his shares from Old or Existing Partners in a particular ratio

Deduct sacrifice made by old Partner to get NPSR of each Old Partner.

Example:

New Partner C enters into Partnership for 1/5th Share, which he took from A & B in the ratio of 2:3. Old Profit Sharing Ratio of A & B is 2:1.

In this case NPSR will be calculated as follows:

Share Surrendered by A= 2/5 × 1/5 = 2/25

Share Surrendered by B= 3/5 × 1/5 = 3/25

New Ratio of A = 2/3 – 2/25 = 44/75

New Ratio of B = 1/3 – 3/25= 16/75

Ratio of C = 1/5 = 1/5 ×15/15 = 15/75

So, NPSR of A: B: C = 44:16:15

Case 3. When New or Incoming Partner acquires his shares in Particular Fraction from Old or Existing Partners

Shares surrendered by Old Partners are added to get Profit Sharing Ratio of New Partner.

Example:

Profit Sharing Ratio of A & B is 2:1. A surrenders 2/5th of his share and B surrenders 1/5th of his share in favour of C.

In this case NPSR will be calculated as follows:

Share Surrendered by A= 2/3 × 2/5 = 4/15

Share Surrendered by B= 2/3 × 1/5 = 2/15

New Ratio of A = 2/3 – 4/15 = 6/15

New Ratio of B = 1/3 – 2/15= 3/15

Ratio of C = 4/15 + 2/15 = 6/15

So, NPSR of A: B: C = 6:3:6 = 2:1:1

Case 4. When one of the existing Partner retains his original share of Profit on the admission of a new Partner

In this situation, share of New Partner and share of existing partner is deducted from 1 and remaining balance of share is divided among remaining Old Partners in their OPSR to Get their New Profit Sharing Ratio.

Example

A, B & C Profit Sharing Ratio is 4:5:6. D is admitted for 1/15th share. C will retain his share

In this case NPSR will be calculated as follows:

1 – 1/15 – 6/15 = 8/15

New Ratio of A = 4/9 × 8/15 =32/135

New Ratio of B = 5/9 × 8/15 =40/135

Ratio of C = 6/15 = 6/15 ×9/9 =54/135

Ratio of D = 1/15 = 1/15 ×9/9 = 9/135

So, NPSR of A: B: C: D = 32:40:54:9

Sacrificing Ratio

It is the ratio in which Old Partners sacrifice to give share to new Partner.

Sacrifice = Old Ratio of Partner – New Ratio of Partner

Determination of Sacrificing Ratio under Different cases:

Case 1. When Share of New or Incoming Partner is given without giving details of Sacrifice made by Old or Existing Partners

It is assumed that Old Partners sacrifice in OPSR, due to which there no change in Profit Sharing Ratio of Old Partners.

Example:

A & B Profit Sharing Ratio is 2:3. New Partner C enters into Partnership for 1/5th Share.

In this case sacrificing ratio of A&B will be calculated as follows:

A’s Sacrifice = 1/5 × 2/5 =2/25

B’s Sacrifice = 1/5 × 3/5 =3/25

Sacrificing Ratio of A & B = 2:3

In this case NPSR will be calculated as follows:

1 – 1/5 = 4/5

New Ratio of A = 4/5 × 2/5 =8/25

New Ratio of B = 4/5 × 3/5 =12/25

Ratio of C = 1/5 = 1/5 ×5/5 = 5/25

So, NPSR of A: B: C = 8:12:5

Ratio of Old Partners remain same as is evident from example A: B = 8:12 = 2:3

Case 2. When Old Ratio of Old or Existing Partners and New Ratio of Old Partner is given.

In this case subtract new ratio from old Ratio to get sacrifice ratio.

Example: A & B shares profit in ratio of 2:3. On Admission of New Partner C, NPSR of A, B & C is 2:3:1.

In this case sacrificing Ratio will be calculated as follows:

Sacrifice made by A = 2/5 – 2/6 =2/30

Sacrifice made by B = 3/5 – 3/6 = 3/30

Sacrificing Ratio of A & B = 2:3

Case 3: When New or Incoming Partner acquires share by surrender of a Particular fraction of Shares by Old Partners:

In this case, surrendered Shares of Old Partners are deducted from his old Share to determine his share in reconstituted Firm.

Example:

Profit Sharing Ratio of A & B is 2:1. A surrenders 2/5th of his share and B surrenders 1/5th of his share in favour of C.

In this case NPSR will be calculated as follows:

Share Surrendered by A= 2/3 × 2/5 = 4/15

Share Surrendered by B= 2/3 × 1/5 = 2/15

New Ratio of A = 2/3 – 4/15 = 6/15

New Ratio of B = 1/3 – 2/15= 3/15

Ratio of C = 4/15 + 2/15 = 6/15

So, NPSR of A: B: C = 6:3:6 = 2:1:1

Sacrificing Ratio of A & B = 4:2 = 2:1

Note: At the time of Admission, Old Partner can also gain. In that case Sacrifice made by Old Partners is the total of Shares acquired by new Partner +Share gained by Existing Partner. 

Accounting Treatment of Goodwill at the time of Admission of a Partner

Five situations can exist with regard to Goodwill / Premium for Goodwill:

Situation 1: Premium for Goodwill is paid Privately

No Journal Entry passed.

Situation 2: Premium for Goodwill is brought in Cash by New or Incoming Partner and that amount is retained in Business.

When New Partner brings Cash for his Share of Premium for Goodwill, that amount is transferred to Sacrificing Partners’ Capital A/C in sacrificing Ratio.

Journal Entries Passed in this case

1. For Premium of Goodwill & Capital brought in Cash by New Partner:

Cash/ Bank A/C………………….Dr

To Premium for Goodwill A/C

To New Partner’s Capital A/C

2. For Sharing of Premium for Goodwill by Sacrificing Partners:

Premium for Goodwill A/C………………Dr

To Sacrificing Partners’ Capital/Current A/C

Situation 3: Premium for Goodwill is brought in Cash by New or Incoming Partner and that amount is withdrawn by Sacrificing Partners’ fully or partly.

When New Partner brings Cash for his Share of Premium for Goodwill, that amount is transferred to Sacrificing Partners’ Capital A/C in sacrificing Ratio first; after that Sacrificing Partners can withdraw that money partly or fully.

Journal Entries Passed in this case

1. For Premium of Goodwill & Capital brought in Cash by New Partner:

Cash/ Bank A/C………………….Dr

To Premium for Goodwill A/C

To New Partner’s Capital A/C

2. For Sharing of Premium for Goodwill by Sacrificing Partners:

Premium for Goodwill A/C………………Dr

To Sacrificing Partners’ Capital/Current A/C

3. For withdrawal of Premium money fully/partly:

Sacrificing Partners’ Capital A/C…………….Dr                                                

To Cash/Bank A/C (with the amount withdrawn either fully or partly)

Situation  4. Premium for Goodwill is brought in kind

When New Partner brings his Share of Premium for Goodwill in the form of assets, these assets are debited for Premium for Goodwill A/C and New Partner’s Capital A/C(If question states for Capital) and then Premium for Goodwill is transferred to Sacrificing Partners’ Capital A/C in sacrificing Ratio

Journal Entries Passed in this case

1. For Assets brought in by New Partner  for Premium of Goodwill & Capital:

Assets A/C………………….Dr

To Premium for Goodwill A/C

To New Partner’s Capital A/C

2. For Sharing of Premium for Goodwill by Sacrificing Partners:

Premium for Goodwill A/C………………Dr

To Sacrificing Partners’ Capital/Current A/C

Situation 5: Premium for Goodwill is not brought in full or part in Cash by New Partner

In this case, Amount brought for Goodwill is credited to Premium for Goodwill A/C.

Remaining balance towards Premium for Goodwill not brought in by Incoming Partner is debited with his Capital / Current A/C.

Journal Entries Passed in this case

1. For Premium of Goodwill & Capital brought in Cash by New Partner:

Cash/ Bank A/C………………….Dr

To Premium for Goodwill A/C

To New Partner’s Capital A/C

2. For Sharing of Premium for Goodwill by Sacrificing Partners:

Premium for Goodwill A/C………………Dr

New Partner’s Capital / A/C ……………Dr (with Shortfall in Value of Goodwill)

To Sacrificing Partners’ Capital/Current A/C

Note:

In case, Capitals of Existing Partners are to be adjusted on the basis of New Partner’s Capital or New Partner will bring proportionate Capital of the Firm, then amount of Goodwill not brought in is adjusted by debiting New Partner’s Current A/C/. Never ever take New Partner’s Capital A/C.

Accounting Treatment of Existing Goodwill

Existing Goodwill means Goodwill appearing in Balance Sheet. It is a loss to the Firm and is written off by debiting Partners’ Capital / Current A/C in their Old Profit Sharing Ratio.

Journal Entry passed for the same is

Partners’ Capital / Current A/C………………..Dr

To Existing Goodwill A/C

Hidden or Inferred Goodwill

Sometimes, Goodwill is hidden in the question, means question will not mention Premium for Goodwill. In that Scenario,

A. First we Calculate Net Worth of the Firm by multiplying New Partner’s Capital × Reciprocal of Share of New Partner

B. Then we calculate Net Worth (Excluding Goodwill) of Reconstituted Firm (that is after taking into consideration New Partner’s Capital).

Hidden Goodwill = A – B = Net worth on the basis of New Partner’s Capital – Net worth of Reconstituted Firm

Net Worth of Reconstituted Firm = Sundry Assets – Outsiders’ Liabilities

OR Net Worth of Reconstituted Firm = Capitals of All Partners + Net Accumulated Profits & Reserves – Fictitious Assets – Non Trade Investments


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