Reconstitution of a Partnership Firm – Admission of a Partner — Class 12 Accountancy

Any change in the existing agreement among partners results in the reconstitution of a partnership firm. One of the most common forms is the admission of a new partner, who is admitted to bring in additional capital, managerial skill or business connections. On admission, the new partner acquires two rights: a share in the future profits and a share in the assets of the firm. Because the new partner gains a share of profit, the existing partners sacrifice part of theirs, so a new profit-sharing ratio and the sacrificing ratio must be calculated. The incoming partner usually pays a premium for goodwill to compensate the sacrificing partners; goodwill is valued by the average profit, super profit or capitalisation methods and is treated according to whether it is paid privately, brought in cash or adjusted through capital accounts. At the time of admission the firm also revalues its assets and reassesses its liabilities through a Revaluation Account, so that profits or losses up to the date of admission belong to the old partners. Accumulated reserves and the balance of the Profit and Loss Account are distributed among the old partners in their old ratio, and the capital accounts may be adjusted to make them proportionate to the new profit-sharing ratio. Finally, a new balance sheet of the reconstituted firm is prepared.