Admission of New partner

Sometimes a new partner is needed into the business due to the following reasons:

a. When more capital is needed for the expansion of the businessb. When competent and experienced person is needed for efficient running of

the businessc. To increase the goodwill of the business by taking a reputed and renowned

person into the partnershipd. To encourage a capable employee by taking him into the partnership

According to section 31 (1) of the Indian Partnership Act, a new partner can be admitted only with the consent of all the existing partners

Following adjustments are needed at the time admission of a new partner

1. Calculation of new PSR2. Accounting treatment of goodwill3. Accounting treatment for revaluation of assets and liabilities4. Accounting treatment of reserves and accumulated profits5. Adjustment of capitals on the basis of new PSR

Calculation of New PSR

a. When only the ratio of the new partner is given, then in the absence of any agreement, it is presumed that the old partners will continue to share the remaining profits in the same ratio in which they were sharing before the admission of a new partner

b. Sometimes the new partner purchases his share of profit from the old partners equally. In such case the new PSR of the old partners will be ascertained by deducting the sacrifice made by them from their existing share of profit.

c. Sometimes the new partner purchases his share from the old partners in a particular ratio. In such case the new PSR of old partners will be calculated after deducting the sacrifice made by a partner from his existing share of profit.

d. Sometimes the old partners surrender a particular fraction of their share in favor of new partner. In such cases the new partner’s share is calculated by adding the surrendered portion of the share by the old partners. Old partner’s shares are calculated by deducting the surrendered share from their old shares.

1. Sacrificing ratio

When there is an admission of a new partner, old partners have to surrender some of their old shares in the favor of new partner. The ratio in which they surrender their profits is called sacrificing ratio. Goodwill is paid to the old partners in their sacrificing ratio because the goodwill is the amount of compensation to be paid by the new partner to the old partners for acquiring the share of profits which they have surrendered in the favor of the new partner.

Sacrificing ratio = old ratio – new ratio

2. Accounting treatment of goodwill in the admission of a new partner

There may be three situations related to treatment of goodwill

a. When the amount of goodwill is paid privately in cash to the old partners outside the business then no entries are required to be passed.

b. When new partners bring his share of goodwill in cash, then there are two alternatives

When amount of good will brought in by new partner is retained in the business then the amount is credited to the capital accounts of old partners in their sacrificing ratio.

Cash a/c…….drTo premium for goodwill a/c(Amount of goodwill brought in cash by new partners)

Premium of goodwill a/cTo old partner’s capital a/c(The amount of goodwill transferred to old partner’s capital account in sacrificing ratio)

When goodwill brought in by new partner is withdrawn by the old partners

Old partner’s capital a/c……………drTo cash a/c

When goodwill already appears in the books and new partner bring his share of goodwill in cash, first of all the existing goodwill account will have to be written off. For this purpose the old partner’s capital accounts are debited in their old PSR and good will account is credited.

Old partner’s capital account………..dr

To goodwill a/c(goodwill is written off in old ratio)

c. When the new partner does not bring his share of goodwill in cashAS (26) Intangible assets specifies that goodwill can be recorded in books when some consideration in money has been paid for it. It means that only purchased goodwill can be recorded in the books and goodwill account cannot be raised.When the goodwill of the firm is evaluated and the new partner does not bring his share of goodwill in cash, goodwill should be adjusted through partner’s capital accounts. For this purpose new partner’s current account is debited from his share of goodwill and the old partner’s capital accounts are credited in their sacrificing ratio.New partner’s current account…………………dr(from his share of good will)To old partner’s capital account (in sacrificing ratio)(current account of new partner debited from his share of Goodwill on his admission and capital account of old partner’s credited in their sacrificing ratio)

New partner’s current account has been debited instead of his capital account so that his capital account is not reduced.

When goodwill already appears and a new partner does not bring in his share of goodwill in cash, the amount of goodwill already existing is written off by debiting the capital accounts of old partners in old ratio.

When new partner brings in only a part of his share of goodwill.

3. Accounting treatment of reserves and accumulated profits/Losses when there is change in PSRa. If there is change in the PSR, then the reserves and accumulated profits

existing in the books of the firm should be transferred to partner’s capital account in their old profit sharing ratio. The reason for such transfer is that these reserves and accumulated profits/losses have come into existence before the change in PSR and hence belong to the partners in their old PSR

For transfer of reserves and accumulated profitsReserve a/c………………………………………………………..drP&L a/c………………………………………………………………dr

Workmen’s compensation reserve a/c………………..dr (excess of reserve over actual liability)Investment fluctuation reserve a/c…………………………dr (excess of reserve over difference between book value and market value)

To old partner’s capital account (in old ratio)

For transfer of accumulated lossesOld partner’s capital account ………………drTo Profit & Loss a/cTo deferred revenue expenditure a/c

b. When reserves and accumulated profit/losses are not to be transferred to capital accountsIn case of change in PSR, the reserves and accumulated profits appearing in the balance sheet and partners decide to leave the reserves and accumulated profits undistributed, it will be necessary to pass an adjusting entry for the same. This is because at present the partners are entitled to share such reserves and profits in the old PSR whereas in future they will be entitled to share such profits and reserves in the new profit sharing ratio. Hence the gaining partner must compensate the sacrificing partner that share of reserves and profits which is proportionate to the share gained by him.

4. Accounting for revaluation of asset and liabilities when there is change in the PSR of existing partnersAssets and liabilities of a firm must be revalued at the time of change in the PSR. The reason is that the actual value of the asset and liabilities may be different from those shown in the balance sheet. Revaluation of assets and liabilities belongs to the period prior to the change in the PSR and hence must be shared by the partners in the old PSR.

Revaluation of assets and liabilities may be given effect in two different waysa. When revised values are to be recorded in the books: in this case revaluation

of asset and liabilities is done with help of new account called revaluation account. Sometimes it is also called as P&L adjustment a/c

Revaluation Account

Particulars Amount Particulars Amount

To decrease in the value of assetsTo increase in the value of liabilitiesTo unrecorded liabilitiesTo Profit on revaluation transferred to partner’s capital account (in old ratio)

…………….………………………….…………….

By increase in value of assetBy decrease in value of liabilitiesBy unrecorded assetsBy loss on revaluation transferred to partner’s capital account (in old ratio)

…………….………………………….…………….

If the credit side of the account exceeds, it reveals profit and if the debit side is in excess, it will reveal a loss. Such a profit or loss will be divided between all partners in their old PSR.

1. When revaluation account shows profitRevaluation a/c……………..drTo partner’s capital a/c(profit on revaluation credited to partner’s a/c)

2. When revaluation a/c shows lossPartner’s capital a/c…………..drTo revaluation a/c(loss on revaluation debited to partner’s capital a/c)

b. When revised values are not to be recorded in the books. In that case the memorandum revaluation account is prepared. It is divided into two parts. First part is prepared to record the increase or decrease in the value of assets and liabilities in usual way. The profit or loss on revaluation in the first part of this account is transferred to old partner’s capital account in old PSR.

In order to complete the double entry, entries made in the first part of the Memorandum Revaluation account are reversed in the second part again without passing any entries in the accounts of asset and liabilities in ledger. The balance of the second part of memorandum revaluation account is transferred to capital account of all partners including the new partner in the new PSR.

Note:

1. Hidden goodwill: if the value of goodwill is not given in the question, in such case the amount of goodwill is calculated on the basis of the total capital of the firm and profit sharing ratio of partners.

2. Sometimes the capital of new partner is not given in the question. He may be required to bring in proportionate capital. In such cases the new partner’s capital will be calculated on the basis of the capitals of the old partners remaining after all adjustment and revaluation.

3. Adjustment of old partner’s capital accounts on the basis of new partner’s capitalSometimes on the admission of a new partner it is decided that the capitals of old partners will be adjusted on the basis of new partner’s capital to make them proportionate to their share of profits.In such questions, first of all the entire capital of the new firm is determined on the basis of new partner’s capital. Then the capital of each partner is determined by dividing the total capital according to his PSR.If the existing capital of any partner is in excess of his newly calculated capital, the excess amount is either paid off immediately or credited to his current account

Old partner’s capital a/c……………….drTo bank a/c or partner’s current a/c

If the existing capital of any partner is less than his newly calculated capitalBank a/c or partner’s current a/c……………..drTo partner’s capital a/c