Class 12 Accountancy I Notes

Chapter 2: Reconstitution of a Partnership Firm – Admission of a Partner

Chapter Overview

A partnership firm is reconstituted whenever there is a change in the existing agreement among partners. Although the agreement changes, the business continues.

Modes of Reconstitution

Admission of a new partner
Change in profit-sharing ratio
Retirement of a partner
Death of a partner

1. Admission of a Partner

A new partner is admitted when the firm requires:

Additional capital
Better management
Business expansion
Technical expertise

According to the Indian Partnership Act, 1932, a new partner can be admitted only with the consent of all existing partners unless otherwise agreed in the partnership deed.

Rights of the New Partner

Right to share assets
Right to share future profits

The incoming partner generally brings:

Capital
Goodwill (Premium for Goodwill)

2. Adjustments Required on Admission

Whenever a partner is admitted, the following accounting adjustments are required:

New Profit Sharing Ratio
Sacrificing Ratio
Goodwill
Revaluation of Assets
Reassessment of Liabilities
Distribution of Reserves and Accumulated Profits
Adjustment of Capitals

3. New Profit Sharing Ratio

The incoming partner acquires his share from the old partners.

Formula

New Share = Old Share − Share Sacrificed

Different situations:

Case 1

New partner acquires share in old ratio.

Case 2

Share acquired equally.

Case 3

Share acquired in a specified ratio.

Case 4

Old partners sacrifice a fraction of their own share.

Example

A and B share profits 3:2.

C admitted for 1/5 share.

Remaining profit = 4/5

New Ratio

A = 3/5 × 4/5 = 12/25

B = 2/5 × 4/5 = 8/25

C = 5/25

New Ratio

12 : 8 : 5

4. Sacrificing Ratio

Sacrificing Ratio is the ratio in which old partners surrender their profit to the new partner.

Formula

Sacrifice = Old Share − New Share

Importance

Goodwill is distributed among old partners in the sacrificing ratio.

5. Goodwill

Meaning

Goodwill is an intangible asset representing the reputation of a business that enables it to earn higher-than-normal profits.

Factors Affecting Goodwill

Nature of business
Location
Efficient management
Market conditions
Patents and trademarks
Government licences
Customer loyalty

Need for Valuation

Goodwill is valued during:

Admission
Retirement
Death
Change in Profit Sharing Ratio
Sale of Business
Amalgamation

6. Methods of Valuation of Goodwill

(A) Average Profit Method

Formula

Goodwill

= Average Profit × Number of Years Purchase

Steps

Calculate total profits.

Find average profit.

Multiply by years’ purchase.

(B) Weighted Average Profit Method

Recent years receive higher weights.

Formula

Weighted Average Profit

= Total Weighted Profit ÷ Total Weights

Goodwill

= Weighted Average Profit × Years Purchase

(C) Super Profit Method

Step 1

Normal Profit

= Capital × Normal Rate of Return

Step 2

Super Profit

= Average Profit − Normal Profit

Step 3

Goodwill

= Super Profit × Years Purchase

(D) Capitalisation Method

Method 1

Capitalisation of Average Profit

Goodwill

= Capitalised Value − Net Assets

Method 2

Capitalisation of Super Profit

Goodwill

= Super Profit × 100 ÷ Normal Rate of Return

7. Treatment of Goodwill

When Goodwill is brought in cash

Entry

Bank A/c Dr.

To Premium for Goodwill A/c

Premium for Goodwill A/c Dr.

To Sacrificing Partners’ Capital A/c

When Goodwill is not brought

New Partner’s Current A/c Dr.

To Sacrificing Partners’ Capital A/c

When Goodwill already exists

Old Partners’ Capital A/c Dr.

To Goodwill A/c

8. Hidden Goodwill

Sometimes goodwill is not given directly.

It is calculated from the capital brought by the new partner.

Formula

Hidden Goodwill

= Implied Capital − Actual Capital

Implied Capital

= Capital Brought × Reciprocal of Share

9. Accumulated Profits and Losses

These belong only to old partners.

Examples

General Reserve
Profit & Loss Account
Workmen Compensation Reserve
Investment Fluctuation Reserve

Journal Entries

General Reserve

General Reserve A/c Dr.

To Old Partners’ Capital A/c

Debit Balance of P&L

Old Partners’ Capital A/c Dr.

To Profit & Loss A/c

10. Revaluation of Assets and Liabilities

Purpose

To bring assets and liabilities to their current values before admitting a new partner.

Revaluation Entries

Increase in Asset

Asset A/c Dr.

To Revaluation A/c

Decrease in Asset

Revaluation A/c Dr.

To Asset A/c

Increase in Liability

Revaluation A/c Dr.

To Liability A/c

Decrease in Liability

Liability A/c Dr.

To Revaluation A/c

Unrecorded Asset

Asset A/c Dr.

To Revaluation A/c

Unrecorded Liability

Revaluation A/c Dr.

To Liability A/c

Profit on Revaluation

Revaluation A/c Dr.

To Old Partners’ Capital A/c

Loss on Revaluation

Old Partners’ Capital A/c Dr.

To Revaluation A/c

Important Formulas

New Ratio

Old Share − Sacrifice

Sacrifice

Old Share − New Share

Average Profit

Total Profit ÷ Number of Years

Weighted Average Profit

Weighted Profit ÷ Total Weights

Normal Profit

Capital × Normal Rate ÷ 100

Super Profit

Average Profit − Normal Profit

Goodwill (Average Profit)

Average Profit × Years Purchase

Goodwill (Super Profit)

Super Profit × Years Purchase

Goodwill (Capitalisation)

Super Profit × 100 ÷ Normal Rate

Hidden Goodwill

Implied Capital − Actual Capital

Important Journal Entries for Exams

Admission of partner
Premium for goodwill
Goodwill adjustment
Goodwill written off
Hidden goodwill
Revaluation
Distribution of reserves
Adjustment of accumulated losses
Capital adjustment

CBSE Exam Tips

Learn all goodwill formulas thoroughly.
Practice new ratio and sacrificing ratio calculations.
Memorize journal entries for goodwill and revaluation.
Solve numerical questions on hidden goodwill.
Draw Revaluation and Partners’ Capital Accounts neatly with proper narration.
Most board exam questions combine goodwill, revaluation, reserves, and capital adjustment in a single comprehensive problem.