Meaning: Change in partnership agreement while firm continues (old agreement ends, new begins). Not dissolution.
Modes: Admission of new partner, Retirement of partner, Death of partner, Change in profit sharing ratio among existing partners.
ADMISSION OF A NEW PARTNER
Rights acquired: Right to share future profits, Right to share firm's assets.
Required adjustments: New profit sharing ratio & sacrificing ratio, Goodwill valuation & treatment, Revaluation of assets & liabilities, Distribution of accumulated profits/losses (reserves), Adjustment of partners' capitals (if agreed).
NEW PROFIT SHARING RATIO – CALCULATION METHODS (6 TYPES)
Method 1: New partner's share given – acquired from old partners in their old ratio (implied).
Example: Anil & Vishal (3:2) admit Sumit for 1/5. Remaining 4/5. Anil new = 3/5 of 4/5 = 12/25; Vishal new = 2/5 of 4/5 = 8/25; Sumit = 1/5 = 5/25. New ratio = 12:8:5.
Method 2: New partner's share given – acquired from old partners in a specified ratio.
Example: Akshay & Bharati (3:2) admit Dinesh for 1/5, acquired equally (1/10 each). Akshay new = 3/5 – 1/10 = 5/10; Bharati new = 2/5 – 1/10 = 3/10; Dinesh = 2/10. New ratio = 5:3:2.
Method 3: New partner's share given – acquired in parts (specific fractions).
Example: Anshu & Nitu (3:2) admit Jyoti for 3/10, 2/10 from Anshu, 1/10 from Nitu. Anshu new = 3/5 – 2/10 = 4/10; Nitu new = 2/5 – 1/10 = 3/10; Jyoti = 3/10. New ratio = 4:3:3.
Method 4: Old partners sacrifice a fraction of their own share.
Example: Ram & Shyam (3:2). Ram sacrifices 1/4 of his share (3/5 × 1/4 = 3/20), new = 3/5 – 3/20 = 9/20. Shyam sacrifices 1/3 of his share (2/5 × 1/3 = 2/15), new = 2/5 – 2/15 = 4/15. Ghanshyam's share = 3/20 + 2/15 = 17/60. New ratio (LCM 60) = 27:16:17.
Method 5: New partner's share wholly taken from one partner.
Example: Das & Sinha (4:1) admit Pal for 1/4 wholly from Das. Das new = 4/5 – 1/4 = 11/20; Sinha = 1/5 = 4/20; Pal = 1/4 = 5/20. New ratio = 11:4:5.
Method 6: New profit sharing ratio is given; find sacrificing ratio.
Example: Rohit & Mohit (5:3) admit Bijoy for 1/7, new ratio = 4:2:1. Rohit sacrifice = 5/8 – 4/7 = 3/56; Mohit sacrifice = 3/8 – 2/7 = 5/56. Sacrificing ratio = 3:5.
SACRIFICING RATIO
Meaning: Ratio in which old partners sacrifice their share in favour of new partner. Used to distribute goodwill brought by new partner.
Formula: Sacrificing Ratio = Old Share – New Share (for each old partner who sacrifices).
Exam Q (1 mark – 2019 Say): Premium for goodwill brought by incoming partner is shared by old partners in? (d) sacrificing ratio.
GOODWILL
Meaning: Value of firm's reputation; intangible asset enabling super profits.
Factors affecting value: Nature of business, Location, Efficiency of management, Market situation (monopoly), Special advantages (patents, licences).
Need for valuation (6 circumstances): Change in profit sharing ratio, Admission, Retirement, Death, Dissolution (sale), Amalgamation.
Valuation methods:
- Average Profits Method: Goodwill = Average Profit × Years' Purchase.
- Super Profits Method: Normal Profit = (Capital Employed × Normal Rate)/100; Super Profit = Average Profit – Normal Profit; Goodwill = Super Profit × Years' Purchase.
- Capitalisation Method: Capitalised Value = (Average Profit × 100)/Normal Rate; Goodwill = Capitalised Value – Net Assets (Capital Employed). OR Goodwill = (Super Profit × 100)/Normal Rate.
TREATMENT OF GOODWILL ON ADMISSION
Case 1: New partner brings goodwill in cash (Premium for Goodwill)
Entry 1: Bank A/c Dr.; To New Partner's Capital A/c, To Premium for Goodwill A/c.
Entry 2: Premium for Goodwill A/c Dr.; To Sacrificing Partners' Capital A/cs.
Case 2: Goodwill brought but not in cash (entry recorded, no cash received)
Entry: New Partner's Capital A/c Dr.; To Sacrificing Partners' Capital A/cs.
Case 3: Goodwill not brought (hidden goodwill) – partners' capitals adjusted.
Case 4: Existing goodwill already in books – written off to old partners' capital accounts.
Entry: Old Partners' Capital A/cs Dr.; To Goodwill A/c.
OTHER ADJUSTMENTS ON ADMISSION
Accumulated Profits/Losses (Reserves, P&L balance): Transferred to old partners' capital accounts in old ratio.
Revaluation of Assets & Liabilities: Revaluation Account prepared. Profit/loss transferred to old partners in old ratio.
Adjustment of Partners' Capitals (if agreed): Capitals made proportionate to new profit sharing ratio based on new partner's capital or total firm capital.
IMPORTANT EXAM QUESTIONS
1. Reconstitution of a partnership happens at the time of? (All of these – admission, retirement, death, change in ratio – 1 mark 2021 Mar).
2. Enumerate any two rights acquired by a newly admitted partner (2 marks – 2020 Mar, 2021 Say).
3. Kareem and Raheem (2:1) admit Jacob. Kareem surrenders 1/4 of his share, Raheem 1/2. Calculate new ratio (2 marks – 2022 Say).
4. Briefly explain any two circumstances which need valuation of goodwill (2 marks – 2020 Mar, 2022 Mar).
5. Calculate goodwill by super profit method given profits, capital, normal rate (3 marks – 2020 Mar).
6. Pass journal entries for treatment of goodwill when new partner brings premium in cash.
7. Distinguish between sacrificing ratio and new profit sharing ratio.