Admission of A Partner Class 12 Notes Accountancy

ADMISSION OF A PARTNER

Meaning

According to the Partnership Act 1932, a new partner can be admitted into the firm only with the consent of all the existing partners unless otherwise agreed upon. With the admission of a new partner, the partnership firm is reconstituted and a new agreement is entered into to carry on the business of the firm.

Need for a new partner in the business:

  1. When more capital is needed.
  2. When the new person possess expertise and knowledge which will prove fruitful to the business.
  3. When the new person is a renowned person and adds to the goodwill of the firm.

A new partnership comes into existence when a partner is admitted and the old partnership deed ceases to exist.

Following needs to be done at the time of admission of a new partner:

    1. Calculation of new profit sharing ratio
    2. Revaluation of assets and liabilities and their accounting effect to be passed thereon
    3. Treatment of Reserves and accumulated profits and losses.
    4. Treatment of Goodwill
    5. Adjustments of capital on the basis of new profit sharing ratio.

 Calculation of new profit sharing ratio

Case 1: When the ratio of only new partner is given:

Let the total profits of the firm is 1 (Reason: Common sense and basic mathematics)

Hence, the amount of profits left for the old partners to be shared in the old ratio= 1 - share of the new partner

For example, Amar and Akbar are partners in a firm sharing profits equally. They decide to admit a new partner Anthony and his share in profits is 1/3rd. Calculate the new profit sharing ratio.

Solution:

Let total profit of the firm be 1

Anthony's share= 1/3

=> Share of profits left for Amar and Akbar= 1-1/3 = 2/3

Now, the old partners will share this remaining profit in their old ratio

=> Amar's share = 2/3 X 1/2 = 2/6 = 1/3

=> Akbar's share = 2/3 X 1/2 = 2/6 = 1/3

Hence, the new psr = 1/3 : 1/3 : 1/3 = 1:1:1

 Case 2: When new partner 'Purchases' his share of profit from the old partners equally:

For example,

P, Q, and R were partners in a firm sharing profits in the ratio of 3:2:1. They admitted S as a new partner for 1/8th share in the profits which he acquired1/16th from P and 1/16th from Q. Calculate the new profit sharing ratio.

(C.B.S.E 2016)

Solution:

P’s share = 3/6 – 1/16 = 21/48

Q’s share = 2/6 – 1/ 16 = 13/48

R’s share = 1/6 x 8/8 = 8/48

S’s share = 1/8 x 6/6 = 6/48

Thus, the New Profit sharing ratio for P, Q, R and S will be 21:13:8:6

 Case 3: When new partner 'Purchases' his share of profit from the old partners in a particular ratio:

 For example, X and Y are partners in a firm sharing profit in the ratio 3:2. They admitted Z as a new partner for 1/5th share in the profits. Z acquired his share from X & Y in the ratio 2:1. Calculate the new profit sharing ratio.

Solution: Z's share = 1/5

Z takes his share in the ratio of 2:1 from X & Y.

=> He takes 2/3 of 1/5 from X= 2/15

=> He takes 1/3 of 1/5 from Y= 1/15

Hence, the NEW ratio of:

X = 3/5 - 2/15 = 7/15

Y= 2/5 - 1/15 = 5/15

Therefore, the new PSR= X:Y:Z = 7/15 : 5/15 : 1/5 = 7:5:3

Case 4: When new partner's share of profit is not given and the old partners sacrifice some part of their share in favour of the new partner:

The new partner's share is calculated by adding up the sacrifices made by the old partner.

For example, A and B are partners in a firm sharing profits in the ratio of 1:2. They decide to admit C as a partner. A decides to sacrifice 1/5th of his share and B decides to sacrifice 1/6th of his share in favour of C. Calculate the new profit sharing ratio.

Solution:

Calculation of surrendered share of:

A= 1/3 X 1/5 = 1/15

B= 2/3 X 1/6 = 2/18= 1/9

Calculation of new ratios:

A= 1/3-1/15 = 4/15

B= 2/3-1/9 = 5/9

C= 1/15 + 1/9 = 8/45

=> New PSR= A:B:C = 4/15: 5/9: 8/45 = 12:25:8

Goodwill

The new partner after his admission is entitled to part of the future profits of the firm. In other words, the existing partners have to sacrifice their share in the future profits for the new partner. Hence, the new partner compensates by bringing something extra apart from his capital. This extra portion that he brings is the Premium for Goodwill.

 Treatment of goodwill on the admission if a new partner:

There may be 3 situations related to treatment of goodwill (premium) at the time of admission of a new partner-

    1. When the amount of goodwill (premium) is paid privately,
    2. When the new partner brings in share of his goodwill (premium) in cash,
    3. When the new partner does not bring his share of goodwill (premium) in cash.

 When the amount of goodwill (premium) is paid privately:

This means that the amount of goodwill is paid outside the firm to the partners as a compensation. Hence, no entries are passed in the books of the firm.

 When the new partner brings in share of his goodwill (premium) in cash:

There arise two sub-cases under this case:

    1. When the amount of goodwill brought is retained in the business:

Cash/Bank A/c    Dr.

            To Premium for Goodwill A/c

(The amount of goodwill/premium brought in cash by the new partner)

 Premium for goodwill A/c     Dr.

           To Old Partner's Capital A/c

(The amount of goodwill/premium transferred to old partner's capital accounts in Sacrificing Ratio)

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

Cash/Bank A/c    Dr.

            To Premium for Goodwill A/c

(The amount of goodwill/premium brought in cash by the new partner)

 Premium for goodwill A/c         Dr.

           To Old Partner's Capital A/c

(The amount of goodwill/premium transferred to old partner's capital accounts in Sacrificing Ratio)

 Old partner's capital A/c  Dr. (Portion of the Amount of goodwill withdrawn)

             To cash/Bank A/c

(The amount of goodwill/premium withdrawn by the old partners)

 When the new partner does not bring his share of goodwill (premium) in cash:

 AS-26 specifies that Goodwill account cannot be raised if the goodwill is self-generated goodwill and no consideration in money or money's worth is paid for it.

Now, since the new partner is not bringing any cash on account of goodwill, new partner's current account is opened and debited from his share of goodwill and the old partner's capital accounts are credited in their sacrificing ratio. The current account is opened so that the capital of the new partner doesn't get reduced.

 Following journal entries will be passed:

New Partner's Current A/c     Dr.

              To Old Partner's Capital A/c

(In Sacrificing ratio)

 Goodwill already appearing in the books will be written off first among the old partners in the old profit sharing ratio:

Old partner's capital A/c     Dr.

                To Goodwill A/c

If a partner brings in only a part of his share of goodwill/premium, the part that he brings in will be treated as premium for goodwill A/c and the part that he doesn't bring in cash will be treated as Current A/c. And the treatment of both has already been discussed.

The concepts of Revaluation of Assets and Liabilities and Distribution of Reserves and accumulated profits/losses have already been discussed in the previous chapter's notes.

Entries for transferring the Reserves and Accumulated Profits or Losses must be passed even if the question is silent on this point.

Employee's Provident Fund or Employee's Saving Account appearing on the Liabilities side of the Balance Sheet are not distributed among the old partners as they are not reserves but are outside liabilities payable by the firm.

General reserve is also known as Reserve Fund.

The Profit or Loss of the Revaluation A/c is distributed among the old partners in the old ratio.

 Hidden Goodwill:

Sometimes, the value of goodwill is not given in the question of admission. It is referred to as Hidden Goodwill. In this case, the value of goodwill needs to be calculated on the basis of total capital of the firm and the profit sharing ratio of the partners.

Steps for Calculation:

Step 1: Find the total capital of the new firm on the basis of the new partner's share.

Step 2: Subtract the Net worth (Combined capital of old partners) and new partner's capital from the total capital calculated in Step 1.

Step 3: The resulting figure is the goodwill of the firm. Now to find the new partner's share of goodwill, multiply the goodwill with the share of new partner's profit.

 For example, Abhay and Beena are partners in a firm. They admit Chetan as a partner with 1/4th share in the profits of the firm. Chetan brings  ₹ 2,00,000 as his share of capital. The value of the total assets of the firm is ₹5,40,000 and outside liabilities are valued at ₹1,00,000 on that date. Give the necessary entry to record goodwill at the time of Chetan's admission. Also show your working notes. (C.B.S.E. 2013)

Solution:

Date

Particulars

L.F.

Debit(₹)

Credit(₹)

Bank A/c                                           Dr.

         To Chetan's Capital A/c

(Cash brought in by Chetan as his capital)

2,00,000

2,00,000

Chetan's Current A/c                     Dr.

         To Abhay's Capital A/c

         To Beena's Capital A/c

(Being adjustment of goodwill made on Chetan's admission)

40,000

20,000

20,000

 Working Notes:

Step 1: Calculation of total capital of the new firm:

=> Based on Chetan's share, total capital of the new firm=

₹2,00,000 X 4/1 = ₹8,00,000

Step 2: Subtract the Net worth (Combined capital of old partners) and new partner's capital from the total capital calculated in Step 1:

=> Net worth= Combined Capital of Abhay and Beena= Sundry Assets- Outside Liabilities

=> Net Worth = ₹5,40,000 - ₹1,00,000 = ₹4,40,000

And, Capital of Chetan= ₹2,00,000

=> TOTAL= ₹4,40,000 + ₹2,00,000= ₹6,40,000

 Value of firm's goodwill= ₹8,00,000 - ₹6,40,000= ₹1,60,000

Step 3: The new partner's share of goodwill:

Chetan's share of goodwill = ₹1,60,000X1/4 = ₹40,000

When the new partner brings in Proportionate Capital

Sometimes, the capital of the new partner is not given. He brings in proportionate capital in such a case. The new partner's capital is calculated on the basis of total capital of the old partners after all adjustments of revaluation and reserves, profits/losses, goodwill appearing in the balance sheet and also goodwill (premium).

Adjustment of Old Partner's Capital Accounts on the basis of new partner's capital

 This is, when the capital of old partners are adjusted on the basis of the newly admitted partner. In such questions, following steps are followed:

 Step 1: Entire Capital of the firm is determined on the basis of new partner's capital

Step 2: Then amount of capital of each partner is determined on the basis of division of capital in Step 1 in the profit sharing ratio.

Step 3: The difference between the old capitals and the capitals in Step 2 is found out and necessary Journal entries are passed.

 Journal Entries:

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                   Dr.

              To Bank or Partner's Current A/c

If the existing capital of any partner is in less than of his newly calculated capital, the partner brings in additional capital:

Bank A/c or Partner's Current A/c   Dr.

              To Old Partner's Capital A/c

 Note: If an old customer who has been written off as a bad debt acknowledges to pay some amount in full settlement of his debt, will be added in Debtors balance.