Reconstitution of a Partnership Firm – Admission of a Partner
Class 12 Accountancy · Accountancy Part I · Chapter 2
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Summary
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.
Meaning of reconstitution and admissionNew ratio and sacrificing ratioValuation and treatment of goodwillRevaluation of assets and liabilitiesAdjustment of reserves and capitals; new balance sheet
Key terms
Reconstitution
A change in the existing agreement of partnership that ends the old partnership while the firm may continue.
Sacrificing Ratio
The ratio in which existing partners give up a part of their share of profit in favour of the new partner.
Goodwill
The value of a firm's reputation that enables it to earn higher than normal profits, valued by average profit, super profit or capitalisation methods.
New Profit-sharing Ratio
The ratio in which all partners, including the new one, share future profits after admission.
Revaluation Account
An account prepared to record the changes in the value of assets and liabilities at the time of reconstitution; its profit or loss belongs to the old partners.
Premium for Goodwill
The amount brought in by the incoming partner to compensate sacrificing partners for the share of profit they give up.
Extra questions & answers
Try one from this chapter
Reconstitution of a partnership firm occurs on: