Introduction of New Partner
Revaluation Accounts on Admission of New Partner in Partnership Firm
When a new partner is admitted in the firm, the new coming partner contributes capital to the firm and acquires the right to share in the assets and profit and loss of the firm.
Consequently, all or some of the existing partners have to sacrifice a part of their share of profit or assets in favour of the incoming partner. The existing partners are compensated by the incoming partner in the form of goodwill, which is credited to their capital account in accordance with their sacrificing ratio.
Consequently, theprofit sharing ratio of the partners is changed. All subsequent profits or losses will be automatically shared by the incoming partner along with old partners, as per the new profit sharing ratio.
So, it is desirable to revalue the assets and liability to make an updated Balance Sheet on the date of admission.
Revaluation or Profit and Loss Adjustment Accounts
When a new partner is admitted into the partnership, assets are valued and liabilities are reassessed and a Revaluation Account or Profit and Loss Account is opened for the purpose.
- Revaluation account is debited with all reduction in the value of assets and increase in liabilities, and credited with increase in the value of assets and decrease in the value of liabilities.
- The difference in two sides of the account will show Profit or Loss on revaluation, which is transferred to the Capital Accounts of old partners in the old profit sharing ratio.
Journal entries on Revaluation
|Increase in the value of Assets. Assets A/c Dr. To Revaluation A/c.||Reduction in the value of Assets. Revaluation A/c Dr. To Assets A/c.|
|Increase the value of Liabilities. Revaluation A/c Dr. To Liabilities A/c.||Reduction the value of Liabilities. Liabilities A/c Dr. To Revaluation A/c.|
|For recording unrecorded Assets. Assets A/c Dr. To Revaluation A/c.||For recording unrecorded Liabilities. Revaluation A/c Dr. To Liabilities A/c.|
|For Revaluation Expenses. Revaluation A/c Dr. To Cash A/c.||Profit Sharing Ratio|
|For Profit on Revaluation Revaluation A/c. Dr. To Partners Capital A/c. (as per old sharing ratio)||For Loss on Revaluation Partners Capital A/c. Dr. To Revaluation A/c. (as per old sharing ratio)|
Profit Sharing Ratio
On admission of a new partner, profit sharing ratio of partners will change. New ratio will depend upon the share given to new partner and also on the ratio in which old partners are sacrificing or contributing towards the share of new partner.
Share of New Partner: Share is given to new partner according to agreement .He may acquire his share of future profit either from one partner or from all the partners.
Profit Sharing Ratio of Old Partners:
Remaining shares = 1 – New Partner’s Share
Old Partner’s New Share = Remaining Shares x Old profit sharing ratio
Or Old Sharing Ratio – Sacrificing Ratio
Sacrificing Ratio : Sacrificing Ratio means forgoing a fraction of share in favour of a new partner by the old ones.
Sacrificing Ratio = Old Profit Sharing Ratio – New Profit sharing ratio
Profit sharing Ratio – Problems
Ex 1: Old Partners: A, B and C; Old profit sharing Ratio 5:3:2; New partner D is admitted for ¼ share. He gets his share from old partners in old profits sharing ratio.
Computation of New Profit Sharing Ratio
- New Partner D : The new Partner gets ¼ th share in total profit.
- Old Partners : Combined share of A, B & C after D’s admission will be (1-1/4) = ¾.
This ¾ share will be allocated among A, B and C in the ratio of 5:3:2.
New Profit Sharing Ratio
A = ¾ X 5/10 = 15/40; B = ¾ X 3/10 = 9/40; C = ¾ X 2/10 = 6/40;
D = ¼ (=10/40). So, New Profit Sharing Ratio becomesi.e A: B:C:D = 15:9:6:10
A = 5/10 – 15/40 = 5/40, B = 3/10 – 9/40 =3/40, C = 2/10 – 6/40 = 2/40
Sacrificing Ratio is 5:3:2, i.e. the old ratio.
Ex 2: Old Partners A, B and C; Old profit sharing ratio 5:3:2; New Partner D is admitted for ¼ share, which he gets equally from all the old partners.
Computation of New Profit Sharing Ratio
D gets ¼ share in profits in equal proportion from all partners. Therefore, contribution by each partner will be ¼ x 1/3 = 1/12. The new ratio will be calculated by deducting 1/12 from old share of each partner.
New Ratio : A = 5/10 – 1/12 = 25/60; B = 3/10 – 1/12 = 13/60; C = 2/10 – 1/12 = 7/60;D = ¼
Therefore new ratio of A, B, C and D = (25/60):(13/60):(7/60):(1/4) = (25/60):(13/60):(7/60):(15/60) = 25:13:7:15
Sacrificing Ratio : A = 5/10 – 25/60 = 5/60, B = 3/10 – 13/60 = 5/60, C = 2/10 – 7/60 = 5/60, i.e. 5:5:5 or 1:1:1
Ex 3: Old Partners A, B and C; Old profit sharing ratio 5:3:2; New Partner D is admitted for ¼ share, Only A and B contribute towards the share of D.
As C is not contributing anything towards the share given to D, C’s share will not be altered.
[If ratio in which old partners are contributing towards the share of new partner is not mentioned it will be assumed that they are contributing in old ratio]
Contributions by A and B : A = ¼ x 5/8 = 5/32; B = ¼ X 3/8 = 3/32
New sharing Ratio: A = 5/10 – 5/32 = 55/160; B = 3/10 – 3/32 = 33/160; C = 2/10 or 32/160;
D = ¼ or 40/160, i.e. 55:33:32:40
Sacrificing Ratio : A = 5/10 – 55/160 = 25/160, B = 3/10 – 33/160 = 15/160. So sacrificing Ratio :i.e. 25:15 or 5:3
Profit sharing Ratio – Problems
Ex. 1: X and Y are in partnership sharing profits and losses at the ratio of 5:3. They admitted Z as 1/4th partner. Show computation of new profit sharing ratio
Step1 : Deduct the share offered to new partner from 1, i.e. 1 – ¼ = 3/4
Step 2: Divide the balance of share between X and Y at the ratio of 5:3 : X = ¾ x 5/8 = 15/32, Y = ¾ x 3/8 = 9/32.
Step 3: New profit sharing ratio is X:Y:Z=15/32: 9/32:1/4, or, 15/32: 9/32:8/32, or , 15:9:8
Ex.2: A and B are equal partners. They admit C and D as partners with 1/5 and 1/6 share respectively. The new profit sharing ratio of all the partners is computed below:
Step 1 : Let total profit or losses of the firm be 1, then Shares of new partners : C =1/5, D =1/6.
Step 2: So, remaining balance, i.e 1 – (1/5 + 1/6) = 1 – 11/30 = 19/30 to be shared equally by A and B
Step 3: New profit sharing ratio of A & B :A= (19/30) /2 = 19/60, B=(19/30) /2= 19/60
Step 4 : New profit sharing ratio A: B: C: D = 19/60:19/60:1/5:1/6 = 19/60:19/60:12/60:10/60 i.e.19: 19: 12: 10.
Ex. 3 : X and Y are in partnership sharing profits in the ratio of 3:5. They admit Z. New profit sharing ratio is X :Y:Z = 2:3:5. Calculate the Sacrificing Ratio.
Sacrificing Ratio = Old Profit Sharing Ratio (X:Y=3:5) – New Profit sharing ratio (X:Y:Z=2:3:5)
Sacrifice by : X = 3/8 – 2/10 = 7/40, Y = 5/8 – 3/10 = 13/40. So, Sacrifice Ratio X:Y = 7:13.
Goodwill is the established reputation of a business regarded as a quantifiable asset and calculated as part of its value when it is sold.
The goodwill should be recorded in the books only when some consideration in money has been paid for it. As per AS-10, any self generated goodwill can not be raised in the books. Only purchased goodwill should be shown in the books of accounts.
Goodwill Accounting on Admission of new Partner
- The premium paid by new partner, above his capital contribution, at the time of his admission, should be distributed to other existing partners.
- The old partners generally sacrifice in favour of the new partner in terms of lower profit sharing ratio in the future.
- Goodwill premium brought in by the new partner shall be given to the existing partners on the basis of profit sacrificing ratio.
The new partner paying premium for goodwill
|a. Goodwill Premium is retained in the business i) Bank A/c Dr. To Premium for Goodwill A/c ii) Premium for Goodwill A/c To Old Partners Capital A/c (as per Sacrificing Ratio)|
|b. Goodwill premium is withdrawn by old partner Old Partners Capital A/c Dr To Bank A/c|
No Goodwill premium is brought by incoming partner
|Goodwill raised Goodwill A/c Dr. To Old Partners’ Capital A/c (Old Profit Sharing Ratio) [Note: Above Entry is passed after considering the amount of goodwill already appears in the firms Balance Sheet]|
|Goodwill written off: If no goodwill is to appear in the books All Partners Capital A/c To Goodwill A/c Note: In this case all the partners’ capital account (including the new partner) will be debited in the new profit sharing ratio.)|
Goodwill is paid privately: No adjustment is required.
Goodwill – Problems
A, B & C are equal partners. They decided to take D who brought in Rs.48,000 as goodwill. The new profit sharing ratio is 3:3:2:2.
Step 1: Sacrificing Ratio : Old Ratio – New Ratio = Sacrificing Ratio.
A = 1/3 – 3/10 = 1/30, B = 1/3 – 3/10 = 1/30, C = 1/3 – 2/10 = 4/30. So, sacrificing ratio A:B:C= 1/30:1/30:4/30=1:1:4
Step 2: Sharing of Goodwill : Rs.48,000 brought by D, would be distributed to A:B:C as per sacrificing ratio – 1:1:4.
A:48000´ 1/6=8,000, B:48000´ 1/6=8,000, C:48000´ 4/6=32,000,
Step 3 : Accounting Entry
Cash A/ c Dr 48,000
To A’s Capital A/c 8,000
To B’s Capital A/c 8,000
To C’s Capital A/c 32,000
Goodwill – Problems
X and Y are partners in a firm X& Y , sharing profits / losses @ 5:3. Balance Sheet of X &Y as on 01.01.2010 :
LIABILITIES: Sundry Creditors 12000, Bills Payable 8000, Bank Overdraft 10000, Capital (X: 40,000, Y: 30,000)
ASSETS : Building 26000, Furniture 2000, Debtors – 39700 (Debtors 40,000, Less Prov 300), Investment 4500, Cash 7800
Z was admitted to the firm on the above date for 1/5th share in the future profits and to introduce a capital of Rs.30,000. The new profit sharing ratio of X, Y and Z will be 5:3:1 respectively. ‘Z’ being unable to bring in cash for his share of goodwill, partners decided to raise goodwill account in the books of the firm, on the basis of Z’s share in the profits and the capital contribution made by him to the firm.
Furniture is to be written down by Rs.800 and stock to be depreciated by 10%. A provision for bad debt is required @ 5%. Outstanding wages Rs.1,500. Building revalued to Rs.30,000. Value of investments is increased by Rs.500. Creditors included a sum of Rs.1,500, which is not to be paid off. Prepare i) Revaluation Account. Ii) Partners’ Capital Account.
Step 1 : Computation of Capital : Z’s contribution 30,000 for 1/5th of capital. So, Capital of firm = 30,000 x 5 = 1,50,000.
Combined capital of X, Y & Z = 40,000 + 30,000 + 30,000 = 1,00,000.
Step 2 : Hidden goodwill =1,50,000 – Rs.1,00,000 = 50,000
Step 3 : Goodwill Disribution : The new partner is not bringing goodwill in cash. So the goodwill Rs 50,000 will be credited in the old partners in old profit sharing ratio (5:3), i.e X: 50000×5/8= 31,250, Y: 50000×3/8= 18,750,
Step 4 : Accounting entry for Goodwill :
Goodwill A/c Dr 50000
To X Capital A/c 31250
To Y Capital A/c 18750
|To Furniture||800||By Building (30,000 – 26,000)||4,000|
|To Stock (10% on 20,000)||2,000||By Sundry Creditors||1,500|
|To Provision for doubtful debts||By Investment||500|
|(2,000 – 300)||1,700|
|To Outstanding Wages||1,500|
Partners’ Capital Accounts
|To Balance c/d||71,250||48,750||30,000||By Balance b/d||40,000||30,000||–|
|By Cash A/c||–||–||30,000|
|By Goodwill A/c||31,250||18,750||–|
‘Proportionate Capital’ means Capital Account balances of partners in accordance with the Profit Sharing Ratio, Proportionate Capital is maintained generally under ‘Fixed Capital Method’
In case of admission of a partner, partners may decide to make their capitals proportionate to the profit sharing ratio. In this case, if base capital is given, other partners either introduce or withdraw capital to make their capitals proportionate to the base capital.
Step 1 : Calculate total capital of the firm on the basis of capital brought by new partner.
Step 2 : Divide total capital in new profit sharing ratio.
Ex 1. X and Y are in partnership, sharing profit or loss in the ratio of 3:2, having capital balances 95,000 & 40,000 respectively. They admitted Z for 1/6th share, who pays Rs.30,000 as Capital. Find the capital of the partners if Z’s capital is taken as base capital.
New profit sharing ratio : The remaining 5/6th (1-1/6=5/6) will be allocated in the ratio to X:(3/5 x 5/6) =15/30,Y:(2/5 x 5/6)= 10/30, Z : 1/6( or 5/30) . New ratio of X, Y and Z = 15/30:10/30:5/30 =3:2:1
Total Capital taking Z’s capital as base = (30,000 x 6) = 1,80,000. Now partners decide to make their capital as per their profit sharing ratio. So,Capital of X will be = (1,80,000 x 3/6) = 90,000, Capital of Y will be = (1,80,000 x 2/6) = 60,000
Capital : So, X should withdraw the excess capital of (95,000 -90,000) = Rs.5,000, Y should introduce the deficit balance = (60,000 – 40,000) = Rs.20,000
Ex 2. X and Y are in partnership who contributed proportionate capital of Rs.50,000 and Rs.70,000. Now they want to admit Z giving him 1/4th share for which Z agrees to bring Rs.40, 000. Compute value of Goodwill
[If the newly admitted partner brings capital more than what is required as per profit sharing ratio, then it is to be presumed that he has contributed the excess for goodwill]
Total capital of the firm before induction of Z=1,20,000, So Z should contribute (1,20,000 x ¼) = 30,000. But Z agrees to pay Rs.40,000. So he pays 10,000 (extra over normal capital) for goodwill for 1/4th share. Thus total value of goodwill =10,000 x 4 =40,000.
Goodwill – Problems
Ex. Valuation of Goodwill when the new partner contribute excess amount
X and Y are in partnership X& Y, sharing profits and losses equally. Balance Sheet of X an Y as on 31.12.2009 :
LIABILITIES: Capital (X: 50,000, Y: 40,000), Sundry Creditors 10000, Total – 1,00,000
ASSETS : Fixed Assets 50000, Stock 40,000, Bank 10000 Total – 1,00,000
On 01.01.2010 they agreed to take Z as 1/5th partner to increase the capital base to Rs.1,20,000. Z agrees to pay Rs.45,000. Show the necessary journal entries and partners’ capital accounts.
Step1: Allocation of remaining share to old partners: Remaining share 4/5th (1-1/5) share will be allocated between X and Y.
X = 1/2 x 4/5 = 4/10, Y = 1/2 x 4/5 = 4/10, Z = 1/5 or 2/10.
Step 2 : New profit sharing ratio of X : Y : Z = 4:4:2 or 2:2:1.
Step3 : Z’s share of capital =1,20,000 x 1/5 = 24,000
Step 4 : Goodwill = Rs.(45,000 – 24,000) = 21,000 for 1/5th share. So, Total value of Goodwill = 21,000 x 5 = 1,05,000.
Step 5: Capital of partners : Total base capital of the firm =1,20,000, Capital of the partners will be shared in the new profit sharing ratio : X = 1,20,000 x 2/5) = 48,000, Y= (1,20,000 x 2/5) =48,000,
Step 6: X should withdraw the excess capital of (50,000 -48,000) = 2,000, Y should introduce the deficit balance of 48,000 – 40,000) = Rs.8,000
|1. Cash introduced by Z for 1/5th Share Bank A/c Dr 45,000 To Z’s Capital A/c 45,000||4. Goodwill due to X and y withdrawn X’s Capital A/c Dr 10,500 Y’s Capital A/c Dr 10,500 To Bank A/c. 21,000 (A: 52500-42000-10,500, B: 52500-42000-10,500),|
|2. Goodwill raised in old profit sharing ratio. Goodwill A/c 1,05,000 To X’s Capital A/c. 52,500 To Y’s Capital A/c. 52,500||5. Excess capital withdrawn by X. X’s Capital A/c Dr 2000 To Bank 2000|
|3. Goodwill written off in new profit sharing ratio. X’s Capital A/c. 42,000 Dr Y’s Capital A/c. 42,000 Dr Z’s Capital A/c. 21,000 Dr To Goodwill A/c 1,05,000||6. Deficit Capital introduced by Y. Bank A/c Dr 8000 To Y’s Capital A/c 8000|
Partners’ Capital Accounts
|To Goodwill A/c||42,000||42,000||21,000||By Balance b/d||50,000||40,000||–|
|To Bank A/c||10,500||10,500||–||By Bank A/c||–||–||45,000|
|To Bank A/c||2,000||–||–||By Goodwill A/c||52,500||52,500|
|By Bank A/c||–||8,000||–|
|To Balance c/d||48,000||48,000||24,000|
Goodwill – Problems
A and B are partners sharing profit and losses in the ratio of 2:3. They admit C as a new partner and the new profit sharing ratio is 1:2:2. C brings 75% of his due for goodwill. Goodwill is valued at 3 years’ purchase of last 5 years’ average profits.
Net profit for last 5 years : 2004- 43,000, 2005-32,000, 2006-28,000, 2007-35,000, 2008-45,000
Calculate value of goodwill and transaction for goodwill be recorded in the books of the firm without opening a Goodwill Account.
Step 1. Calculation of Goodwill : Average profit for last 5 years = (43,000 + 32,000 + 28,000 + 35,000 + 45,000) /5 =36,600
Value of Goodwill on the basis of 3 years’ purchase of the average profit = 36,600 x 3=1,09,800.
Based on the new profit sharing ratio 1:2:2, C is required to bring in 2/5th of 1,09,800 = 43,920.
Out of this C actually brings 75%, i.e 75% of 43,920=32940 in cash. Balance of 10,980 ( i.e 43,920 – 32940) is to be debited to C’s Capital account.
Step 2. Calculation of sacrificing ratio : Old Profit Sharing Ratio = 2:3, New profit Sharing Ratio = 1:2:2
Sacrificing ratio= Old Profit Sharing Ratio – New Profit sharing ratio A:2/5 – 1/5 = 1/5, B: 3/5 – 2/5 = 1/5, So ratio A:B =1:1
Journal Entries in the Books of the firm
|Premium for goodwill brought in by C for 2/5th share Bank A/c 32,940 To Premium for Goodwill A/c 32,940|
|Adjustment to Capital A/c Premium for Goodwill A/c Dr 32,940 C’s Capital A/c Dr 10,980 To X’s Capital A/c 21,960 To Y’s Capital A/c 21,960|
Treatment of Reserves
When a new partner is admitted, any reserve etc. lying in the Balance Sheet should be transferred to the Capital Accounts of the partners in the old profit sharing ratio.
The journal entry will be:
Reserve A/c Dr
To Old Partners’ Capital A/c
Ex: A, B & C are partners in a firm sharing profit & losses in the ratio of 3:2:1. There is a General Reserve of Rs 30,000 in the firm’s accounts. They have decided to admit a new partner D.
Transfer of Reserve to Capital A/c : At the time of admission of new partner D, the general reserve will be transferred to the Capital Account of the old partners A, B & C in their old profit sharing ratio : A: 30000×3/6=15,000, B: 30000×2/6=10,000, C: 30000×1/6=5,000
General Reserve A/c Dr 30,000
To A’s Capital A/c 15,000
To B’s Capital A/c 10,000
To C’s Capital A/c 5,000
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