Plus Two Accountancy Notes Chapter 3 Reconstitution of a Partnership Firm-Admission of Partner

Kerala Plus Two Accountancy Notes Chapter 3 Reconstitution of a Partnership Firm-Admission of Partner

Summary
Reconstitution of a partnership firm
Reconstitution of a partnership firm means a change in the nature of relationship amongst members, effected through a fresh agreement under which the existing business continues.

Mode of reconstitution
Reconstitution of a partnership firm usually takes place in any of the following ways:

1. Change in the profit sharing ratio of the existing partners
2. Admission of a partner
3. Retirement of a partner
4. Death of a partner

Admission of a partner
Inclusion of a person as partner to an existing partnership firm is called admission of a partner. Acquisition of rights by a new partner:

1. right to share the assets of the firm
2. right to share profits/losses of the firm

Accounting problems at the time of admission

1. Capital of new partner
2. Calculation of new profit sharing ratio
3. Calculation of sacrificing ratio
4. Treatment of goodwill
5. Revaluation of assets and liabilities
6. Adjustment of reserves and accumulated profits/ losses
7. Adjustment of capital accounts of partners

New profit sharing ratio
The ratio in which the old partners and new partner share the future profit after the admission is new ratio.
New ratio = old ratio – sacrificing ratio

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.
Sacrificing ratio = old ratio – New ratio

Goodwill
Goodwill is the value of the reputation of a firm in respect of profits in future over and above the normal profits. It is an invisible intangible asset. Thus goodwill really arises only if a firm is able to earn super profit.
Treatment of goodwill (Different situations):

1. Premium paid directly
2. Premium brought in cash and retained in business
3. Premium brought in cash and half the amount withdrawn by partners
4. Premium brought in kind
5. New partner brings in only a portion of the goodwill in cash
6. New partner is not in a position to bring premium in cash
7. Goodwill existing in the books at the time of admission

Methods of valuation of goodwill:
1. Average profit method:
Goodwill = \(\frac{\text { Total profit }}{\text { No. of years }}\) × No. of years purchase

2. Super profit method:
Normal Profit = Cap employed × \(\frac{N R R}{100}\)
Average Profit = \(\frac{\text { Total profit }}{\text { No. of years }}\)
Super profit = Average profit – Normal profit
Goodwill = Super Profit × No. of years purchase

3. Capitalisation method:
(a) Capitalising the average profit:
Goodwill = Capitalised value of average profit – capital employed – Total assets (excluding goodwill) – outside liabilities
Capital employed = Total Asset – Outside liabilities.

(b) Capitalisation of superprofit
Goodwill = Super profit × \(\frac{100}{\mathrm{NRR}}\)

Treatment of goodwill:
Premium method – When the new partner brings cash for his share of goodwill.
(i) When this amount is paid directly/ privately to the old partner by new partner.
No entry is needed.

(ii) When the amount is paid through firm

To Old partner’s capital A/c (Sacrificing Ratio)

(iii) When the old partners decide to withdraw their amounts (full or part)

When goodwill already exists in books, the existing goodwill must be written off by debiting the old partners in their old ratio.

If they decide to retain goodwill as such, the amount to be brought in by the new partner will have to be proportionately reduced.

Revaluation of Assets and Reassessment of liabilities
Assets and liabilities are revalued at the time of admission. The account opened for this purpose is called revaluation account. The Journal entries recorded for revaluation of assets and reassessment of liabilities are as follows:
1. For increase in the value of an asset

2. For reduction in the value of an asset

3. For appreciation in the amount of a liability

4. For reduction in the amount of a liability

5. For an unrecorded asset

6. For an unrecorded liability

7. For transfer of gain on Revaluation in credit balance

8. For transferring loss on revaluation

Adjustment for reserves and accumulated Profits/Losses
Items like reserve and accumulated profits/losses appearing in the balance sheet should be distributed to old partners at the time of admission of a partner.
1. Reserve and Profit & Loss A/c if any on the liability side of balance sheet Reserve A/c Dr.

2. Profit & Loss A/c on the asset side of balance sheet

Adjustment of capital accounts of partners
It may sometimes be agreed that the capitals of all partners should be in proportion to their respective share in profits. This can be effected in two ways:

1. Adjustment of old partners’ capital accounts on the basis of incoming partner’s capital
2. Bringing in proportionate capital by the incoming partner based on the capitals of existing partners.

Change in profit sharing ratio
Sometimes, the existing partners may decide to change their profit sharing ratio. In such a case, those who gain must compensate the others who have made the sacrifice on account of change in profit sharing ratio.

Plus Two Accountancy Notes