Admission
of a Partner
Introduction:
A new partner can be admitted only with the concent of
all the existing partners. A new partner is not liable for any profit or loss
occured before his admission. Such a partner is called a new partner or
incoming partner.
purpose of Admission of a partner:
1. For additional capital
2. for progress of the firm
3. For acquiring additional managerial skill
4. For reducing competition
Effect of Admission of a PartnerAdmission of a new
partner is a major event in a partnership business. A new admission can take
place only with the unanimous consent of all the existing partners. New
partners are admitted for several reasons. Additional capital contribution,
fresh ideas more contacts etc. are some of the advantages in admitting a new
partner.Following are the most important accounting aspects to be considered at
the time of admission of a new partner.1. Change in profit sharing ratio2.
Accounting treatment of Goodwill3. Revaluation of assets and liabilities4
Treatment of reserves and accumulated profits / losses5. Adjustment of Capital
Accounts
1. Change in Profit Sharing RatioWhen a new partner comes
into the business, old partner have to adjust his profit share from their
portion. Thus change in profit sharing ratio is the first accounting aspect to
be considered on admission of a new partner. In academic accounting, change in
profit sharing ratio can be presented in various ways:
2. The new partner's share is mentioned without
specifying the old partner's profit sharing arrangement.In this case it is to
be assumed that the profit available after paying the new partner?s share is to
be divided by the old partners in their old profit sharing ratio. In other
words the even though the overall profit sharing ratio changes, the old ratio
is still maintained between the old partners, within the new 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. The sacrifice by a partner is equal to :
Old Share of Profit – New Share of Profit
As stated earlier, the new partner is required to
compensate the old partner’s for their loss of share in the super profits of
the firm for which he brings in an additional amount known as premium or
goodwill. This amount is shared by the existing partners in the ratio in which
they forego their shares in favour of the new partner which is called
sacrificing ratio.
The ratio is normally clearly given as agreed among the
partners which could be the old ratio, equal sacrifice, or a specified ratio.
The difficulty arises where the ratio in which the new partner acquires his
share from the old partners is not specified. Instead, the new profit sharing
ratio is given. In such a situation, the sacrificing ratio is to be worked out
by deducting each partner’s new share from his old share.
3. Revaluation of Assets and LiabilitiesRevaluation of
assets and liabilities is another major step prior to admission or retirement.
Revaluation is important, as there are hidden profits or losses in the
difference between book value and actual market value of assets or liabilities.
Revaluation is necessary whenever there is a change in profit sharing ratio,
even without admission or retirement. The hidden profits or losses should be distributed
in the ratio prior to change (Old ratio).Revised values of assets and
liabilities are brought into books by opening a temporary account called
?revaluation account?. The purpose of revaluation account is to summarise
effect of revaluation of assets and liabilities.Revaluation account represents
the combined capital account of partners. Any gain on revaluation of asset or
liabilities, which are to be credited to partners, will be credited in
revaluation account. Similarly any loss on revaluation will be debited in
revaluation account instead of capital accounts. The revaluation account is
closed by transferring its net balance to partner?s capital accounts in the
profit sharing ratio.
4. Treatment of Reserves and Accumulated
ProfitsAccumulated profits such as general reserve, credit balance in profit
&loss account etc. will be transferred to the capital accounts of old
partners in the old profit sharing ratio. Similarly accumulated losses shall be
transferred to the debit side of old partner?s capital accounts. Therefore
these items will not appear in the new balance sheet.
5. Adjustment of Capital AccountsWhen the partners change
their profit sharing ratio at admission, retirement or any other reason, they
also rearrange their capital accounts. Capital contribution is not essentially
the basis of profit sharing. However the in most partnerships capital
contribution is considered as the major factor in determining profit sharing
ratio.At the time of admission, capital contribution will be raised as an
important condition. When a new partner is admitted for a certain share of
profit for a certain amount of capital contribution he would naturally expect
the other also maintain a capital balance matching with their profit share.
Admission of a partner is not the only situation when a capital rearrangement
is considered. Retirement, death or any other change in profit sharing ratio
would prompt rescheduling the capital balances. The basic purpose of following
?fixed capital method? is to maintain a steady capital ratio. When capital is
readjusted on the basis of new partner?s capital contribution, the first step
is to determine the revised capital balances of each partner. Readjustment in
capital account is usually done by bringing in or taking out cash. Sometimes,
in place of cash transactions, old partners may adjust their capital balances
by transferring the excess or deficit in the capital accounts to their current
accounts as a temporary measure. Once the capital balances are adjusted current
accounts can be settled in due course.
Goodwill:
Goodwill is also one of the special aspects of
partnership accounts which requires adjustment (also valuation if not
specified) at the time of reconstitution of a firm viz., a change in the profit
sharing ratio, the admission of a partner or the retirement or death of a
partner.
Meaning of
Goodwill
Over a period of time, a well-established business
develops an advantage of good name, reputation and wide business connections.
This helps the business to earn more profits as compared to a newly set up
business. In accounting, the monetary value of such advantage is known as
“goodwill”.
It is regarded as an intangible asset. In other words,
goodwill is the value of the reputation of a firm in respect of the profits
expected in future over and above the normal profits. It is generally observed
that when a person pays for goodwill, he/she pays for something, which places
him in the position of being able to earn super profits as compared to the
profit earned by other firms in the same industry.
In simple words, goodwill can be defined as “the present
value of a firm’s anticipated excess earnings” or as “the capitalised value
attached to the differential profit capacity of a business”. Thus, goodwill
exists only when the firm earns super profits. Any firm that earns normal
profits or is incurring losses has no goodwill.
Factors Affecting the Value of Goodwill
The main factors affecting the value of goodwill are as
follows
Nature of business: A firm that produces high value added
products or having a stable demand is able to earn more profits and therefore
has more goodwill.
Location: If the business is centrally located or is at a
place having heavy customer traffic, the goodwill tends to be high.
Efficiency of management: A well-managed concern usually
enjoys the advantage of high productivity and cost efficiency. This leads to
higher profits and so the value of goodwill will also be high.
Market situation: The monopoly condition or limited
competition enables the concern to earn high profits which leads to higher
value of goodwill.
Special advantages: The firm that enjoys special
advantages like import licences, low rate and assured supply of electricity,
long-term contracts for supply of materials, well-known collaborators, patents,
trademarks.
Methods of Valuation of Goodwill:
1. Average Profits Method
2. Supper Profits Method
3. Capitalisation Method.
QUESTIONS
Q1. Amar and
Akbar are the partners in a business sharing profit and losses in the ratio 3 :
2 respectively.
Their
Balance Sheet as on 31st December, 2007 stood as under.
Balance Sheet
|
Liabilities
|
Rs.
|
Assets
|
Rs.
|
|
Sundry Creditors
|
12,600
|
Land and Building
|
25,000
|
|
Amar's Capital A/c
|
27,000
|
Furniture
|
3,700
|
|
Akbar's Capital A/c
|
18,000
|
Stock
|
14,500
|
|
Sundry Debtors
|
13,400
|
||
|
Cash at Bank
|
1,000
|
||
|
57,600
|
57,600
|
They
admitted Amit on the above date as a partner on the following terms.
(1)
Depreciate Furniture by Rs. 800 and Stock by 10%
(2) Reserve
of 5% on debtors be created for bad and doubtful debts.
(3) Amit
should bring in Rs. 7,000 as capital and Rs. 4,000 as Goodwill.
(4) Amit
will recieve 1/8th share in future profits.
(5) The
value of Land & Building be raised upto Rs. 32,000.
(6) The
capital Accounts of all the partners be adjusted in proportion to their profit
sharing ratio and
excess amount be refunded to the partners.
Prepare
Profit and loss Adjustment Account, Capital Accounts of the Partners and the
Balance Sheet
of the new
firm.
Q2. Given
below is the Balance Sheet of Sunita, Surekha and
Nilima who
were sharing profits and losses in the ratio of 3 : 3 : 2.
Balance Sheet as on 31st December, 2000
|
Liabilities
|
Rs.
|
Assets
|
Rs.
|
|
|
Creditors
|
17,400
|
Cash
|
10,800
|
|
|
Bills Payable
|
4,400
|
Debtors
|
25,000
|
|
|
Reserve Fund
|
8,000
|
Stock
|
12,600
|
|
|
Capital A/cs. :
|
|
Machinery
|
17,400
|
|
|
Sunita
|
24,000
|
Furniture
|
8,000
|
|
|
Surekha
|
26,000
|
Buildings
|
24,000
|
|
|
Nilima
|
18,000
|
|
|
|
|
|
97,800
|
|
97,800
|
|
|
|
|
|
|
|
On 1st
January 2001, Nilima retired from the firm on the following terms :
(1) Assets
be revalued as under - Stock Rs. 12,000, Machinery Rs. 16,000, Furniture Rs.
8,400.
(2) R.D.D
be maintained at 4% on Debtors.
(3) An Item
of Rs. 200 from Creditors is no longer a liability and hence should be properly
adjusted.
(4)
Goodwill of the firm be valued at Rs. 8,000.
(5) The
Amount due to Nilima be transferred to her Loan A/c.
Prepare
Profit & Loss Adjustment A/c, Partner's Capital A/c, and Balance Sheet of
new firm.
[Ans.: Loss Rs. 2,400; BS Total Rs. 1,03,200]
Q.3 A, B, C share profits and losses in the
proportion of 3 : 2 : 1. Their Balance sheet is as follows :
|
Liabilities
|
Rs.
|
Assets
|
Rs.
|
|
Capital
Accounts :
|
Sundry
Assets
|
80,000
|
|
|
A
|
30,000
|
|
|
|
B
|
30,000
|
|
|
|
C
|
20,000
|
|
|
|
|
80,000
|
|
80,000
|
The
Parnership is dissolved and the assets are realised as follows :
First
Realisation Rs.
17,000
Second
Realisation Rs. 21,000
Third and
Final Realisation Rs. 36,000
Show
Distribution of cash at each stage : (a) in profit sharing ratio (b) in ratio
of capital balances.
