Reconstitution of a Partnership Firm: Admission of a Partner | CBSE Class 12 Accountancy Notes

This note covers reconstitution of a partnership firm, admission of a partner, new profit sharing and sacrificing ratios, goodwill valuation and adjustment, accumulated profits and losses, revaluation of assets and liabilities, adjustment of capitals, and changes in profit sharing among existing partners.

What changes when a partnership firm is reconstituted?

Definition: Reconstitution of a partnership firm means a change in its existing agreement, creating a new relationship among the partners or a change in their composition while the firm continues.

A partnership rests on an agreement to share the profits of a business carried on by all partners or any of them acting for all. A change in that agreement ends the existing arrangement and brings a new agreement into operation.

What are the main modes of reconstitution?

• Admission: A new partner joins when the firm needs additional capital, managerial help or both.
• Change in profit sharing ratio: Existing partners change their shares, perhaps because their roles in the firm have changed.
• Retirement: A partner withdraws, possibly because of ill health, age or changed business interests.
• Death: The remaining partners may decide to continue the business with a changed arrangement.

Unless otherwise agreed, admission requires the consent of all existing partners. Admission gives the incoming partner rights to share the firm's assets and its profits. The agreed capital contribution may be in cash or in kind. In an established firm earning super profits, an additional premium compensates partners who surrender part of their profit share.

The admission adjustments concern the new profit sharing ratio, sacrificing ratio, valuation and treatment of goodwill, revaluation of assets and reassessment of liabilities, distribution of accumulated profits, and adjustment of partners' capitals.

Note: Admission changes the partnership agreement while the firm's business continues. Capital brought into the firm and premium for goodwill serve different accounting purposes and must be identified separately.

How is the new profit sharing ratio calculated?

The new profit sharing ratio determines the shares of all partners after admission. The incoming partner obtains a share from the existing partners according to their agreement. The method of acquiring that share determines how much each old partner retains.

If the agreement specifies only the incoming partner's share, assume that the old partners surrender it in their old profit sharing ratio. If the agreement specifies equal sacrifice, particular fractions or surrender by one partner alone, follow those terms instead.

What happens when sacrifice follows the old ratio?

Remaining share = 1 − New partner's share. Multiply this remaining share by each old partner's original fraction to find the new shares.

Worked example 1. Anil and Vishal share profits in the ratio 3:2. They admit Sumit for a 1/5 share, with no other terms about how he acquires it.

Answer: Remaining share = 1 − 1/5 = 4/5. Anil receives 3/5 × 4/5 = 12/25; Vishal receives 2/5 × 4/5 = 8/25; Sumit receives 1/5 = 5/25. Their new ratio is 12:8:5.

How do specific terms alter the calculation?

Distinguish a fraction of a partner's own share from a fraction of the firm's total profits. If Ram surrenders 1/4 of his 3/5 share, his sacrifice is 3/20. If Shyam surrenders 1/3 of his 2/5 share, his sacrifice is 2/15.

Ram retains 9/20 and Shyam retains 4/15. Ghanshyam receives 3/20 + 2/15 = 17/60. Expressing the retained shares with denominator 60 gives the new ratio 27:16:17.

How does the sacrificing ratio differ from the new ratio?

The sacrificing ratio shows the proportions in which old partners surrender profit shares to the incoming partner. It determines the distribution of compensation for goodwill. The new ratio instead determines the sharing of future profits among all partners.

Sacrifice = Old share − New share. Calculate the difference for each old partner using fractions with a common denominator. The ratio of the positive differences gives the sacrificing ratio when those partners are surrendering shares.

Worked example 2. Rohit and Mohit share profits in the ratio 5:3. Bijoy joins for 1/7, and the new ratio becomes 4:2:1. Find the sacrificing ratio.

Answer: Rohit's sacrifice = 5/8 − 4/7 = 3/56. Mohit's sacrifice = 3/8 − 2/7 = 5/56. Their sacrificing ratio is 3:5, although their old ratio was 5:3.

Can an existing partner gain on admission?

Yes. An existing partner may obtain a larger share under the new agreement. Gain = New share − Old share. That partner gains rather than sacrifices and should not be treated as a recipient of compensation merely because they were already in the firm.

Ramesh and Suresh originally share profits in the ratio 4:3. After Mohan joins, their new ratio is 2:3:1. Ramesh sacrifices 4/7 − 2/6 = 10/42, while Suresh gains 3/6 − 3/7 = 3/42.

Mohan's share is 1/6, or 7/42. Ramesh's sacrifice therefore equals Suresh's gain plus Mohan's share: 10/42 = 3/42 + 7/42. The whole sacrifice comes from Ramesh, so an automatic allocation to both old partners would be incorrect.

What is goodwill and what affects its value?

Definition: Goodwill is the monetary value of a firm's reputation and business advantages that enable it to earn anticipated profits above the normal level.

Goodwill is an intangible asset. A well-established business may benefit from a good name, reputation and wide business connections. These advantages can give it a greater profit-earning capacity than a newly established business.

The incoming partner receives access to that earning capacity. The premium for goodwill compensates sacrificing partners for the portion of super profits they give up. Valuing the whole firm's goodwill and calculating the incoming partner's share are separate steps.

Which factors affect goodwill?

When is valuation needed?

Valuation may be required on a change in profit sharing ratio, admission, retirement or death of a partner. It may also be needed when a business is sold, when dissolution involves sale as a going concern, or when partnership firms amalgamate.

The main methods are average profits, super profits and capitalisation. Different methods can produce different values. The partners therefore need to agree on the method to be used rather than treat every valuation method as interchangeable.

How do simple and weighted average profits value goodwill?

The average profits method values goodwill at an agreed number of years' purchase of past average profits. Its underlying assumption is that a new business may not earn profits during its initial years, whereas an established business provides an existing stream of earnings.

Average profit = Total profits ÷ Number of years.

Goodwill = Average profit × Years' purchase.

Worked example 3. A firm's profits were ₹4,00,000 in 2013, ₹3,98,000 in 2014, ₹4,50,000 in 2015, ₹4,45,000 in 2016 and ₹5,00,000 in 2017. Value goodwill at four years' purchase of five years' average profits.

Answer: Total profits = ₹21,93,000. Average profit = ₹21,93,000 ÷ 5 = ₹4,38,600. Goodwill = ₹4,38,600 × 4 = ₹17,54,400.

When should weighted average be used?

Where profits show an increasing or decreasing trend, recent years may receive greater weight. However, use the weighted average only when specified. Multiply each year's adjusted profit by its assigned weight, total the products and divide by the sum of weights.

Weighted average profit = Sum of weighted profits ÷ Sum of weights.

Worked example 4. Profits for 2012-13 to 2016-17 are ₹20,000, ₹24,000, ₹30,000, ₹25,000 and ₹18,000. Apply weights 1, 2, 3, 4 and 5 respectively and value goodwill at three years' purchase.

Answer: Weighted products are ₹20,000, ₹48,000, ₹90,000, ₹1,00,000 and ₹90,000. Their total is ₹3,48,000; total weights are 15. Weighted average profit = ₹23,200. Goodwill = ₹23,200 × 3 = ₹69,600.

Why must the given profits sometimes be adjusted?

The profit figures may require corrections before averaging. Capital expenditure charged to revenue is added back, with the appropriate depreciation then deducted. An overvalued closing stock overstates that year's profit and also affects the following year's opening stock.

Where an annual management charge is specified for goodwill valuation, deduct it in arriving at adjusted profits. Apply the weights to these adjusted profits, rather than to the uncorrected figures. This keeps the valuation based on the profit amounts required by the agreement.

A loss is deducted when totalling profits. The number of years used to calculate the average and the number of years' purchase are different quantities: the first determines the average; the second multiplies that average to obtain goodwill.

How do super profits and capitalisation value goodwill?

The super profits method focuses on earnings above a normal return on the firm's capital. It recognises that the buyer's advantage lies in excess profits, rather than in all the profits that any comparable investment might normally earn.

Normal profit = Capital employed × Normal rate of return ÷ 100.

Super profit = Average profit − Normal profit.

Goodwill = Super profit × Years' purchase.

1. Calculate the average profit from the specified years.
2. Calculate normal profit using the firm's capital and normal rate of return.
3. Deduct normal profit from average profit to obtain super profit.
4. Multiply super profit by the agreed number of years' purchase.

Worked example 5. Capital employed is ₹5,00,000 and the normal return is 10%. Profits for 2011 to 2015 are ₹40,000, ₹50,000, ₹55,000, ₹70,000 and ₹85,000. Goodwill is valued at three years' purchase of super profits.

Answer: Total profits = ₹3,00,000; average profit = ₹60,000. Normal profit = ₹5,00,000 × 10/100 = ₹50,000. Super profit = ₹10,000. Goodwill = ₹10,000 × 3 = ₹30,000.

How does capitalisation of average profits work?

Capitalisation finds the capital that would earn the average profit at the normal rate. Deduct the actual capital employed, or net assets, from this capitalised value to determine goodwill.

Capitalised value = Average profit × 100 ÷ Normal rate of return.

Goodwill = Capitalised value − Net assets. Net assets are total assets, excluding goodwill and fictitious assets, less outside liabilities. Outside liabilities include both long-term and short-term liabilities.

Worked example 6. Average profit is ₹1,00,000, normal return is 10%, and net assets are ₹8,20,000. Calculate goodwill by capitalising average profits and super profits.

Answer: Capitalised value = ₹1,00,000 × 100/10 = ₹10,00,000. Goodwill = ₹10,00,000 − ₹8,20,000 = ₹1,80,000. Alternatively, normal profit is ₹82,000 and super profit is ₹18,000. Capitalised super profit = ₹18,000 × 100/10 = ₹1,80,000.

Why do the two capitalisation methods agree?

Goodwill = Super profit × 100 ÷ Normal rate of return. Capitalising super profits directly removes the need to calculate the capitalised value of average profits separately. With the same underlying figures, both capitalisation methods give the same goodwill.

How is goodwill brought in cash recorded?

When the incoming partner pays a premium through the firm, debit Bank Account and credit Premium for Goodwill Account. Transfer the premium by debiting that account and crediting the sacrificing partners' capital accounts in their sacrificing ratio.

If the incoming partner pays the old partners privately, no entry is made in the firm's books. The payment does not pass through the firm. Where premium is retained in the business after being credited to the old partners, no further entry is required.

Worked example 7. Sunil and Dalip share profits in the ratio 5:3. Sachin joins for 1/5, bringing ₹20,000 as capital and ₹4,000 as goodwill by cheque. The sacrificing ratio is assumed to be 5:3.

Answer: Bank receives ₹24,000. Sunil's goodwill credit is ₹4,000 × 5/8 = ₹2,500; Dalip's is ₹4,000 × 3/8 = ₹1,500. Sachin's capital credit remains ₹20,000.

What are the journal entries?

In the journal tables, each numbered row is one complete entry. Amounts are in rupees; the debit and credit accounts are shown separately to keep compound entries clear.

Withdrawal of premium reduces the old partners' capital balances and the firm's bank balance. It does not reverse the incoming partner's admission or capital contribution. The withdrawal entry is additional to the receipt and distribution entries.

What if goodwill already appears in the books?

Write off existing goodwill by debiting old partners' capital accounts in their old profit sharing ratio and crediting Goodwill Account. This is separate from distributing the incoming partner's premium in the sacrificing ratio.

For Vijay and Sanjay, sharing 3:2, existing goodwill of ₹10,000 is written off by debiting Vijay's Capital Account ₹6,000 and Sanjay's Capital Account ₹4,000, and crediting Goodwill Account ₹10,000.

How are unpaid goodwill and hidden goodwill treated?

If the incoming partner cannot bring the required goodwill wholly or partly in cash, debit the unpaid amount to that partner's Current Account. Credit the sacrificing partners' capital accounts with their respective shares of compensation.

If existing goodwill appears in the books, first write it off against the old partners in their old ratio. The compensation for the incoming partner's share is then adjusted separately. A valuation of goodwill does not, by itself, require retaining self-generated goodwill as an asset.

What happens when only part of the premium is paid?

For a goodwill share of ₹50,000 with only ₹20,000 brought in, debit Bank Account ₹20,000 and credit Premium for Goodwill Account ₹20,000. Then debit Premium for Goodwill Account ₹20,000 and the incoming partner's Current Account ₹30,000.

Credit the sacrificing partners' capital accounts with the total ₹50,000 in their sacrificing ratio. The two debits together provide the full compensation, while only the cash portion increases the firm's bank balance.

How is hidden goodwill inferred?

Hidden goodwill is inferred from the capital contribution and profit share when goodwill is not stated. Compare the implied total capital with the actual combined capitals, including the incoming partner's capital.

Worked example 8. Hem and Nem share profits 3:2, with capitals of ₹80,000 and ₹50,000. Sam brings ₹60,000 for a 1/5 share. Find hidden goodwill and Sam's share.

Answer: Implied total capital = ₹60,000 ÷ 1/5 = ₹3,00,000. Actual combined capitals = ₹80,000 + ₹50,000 + ₹60,000 = ₹1,90,000. Goodwill = ₹1,10,000. Sam's share = ₹1,10,000 × 1/5 = ₹22,000.

The distribution is ₹22,000 × 3/5 = ₹13,200 to Hem and ₹22,000 × 2/5 = ₹8,800 to Nem. Use either the cash-paid pair of entries or the unpaid pair, according to the facts.

How are accumulated profits and losses adjusted?

Accumulated profits belong to the partners who earned them before admission. They may appear as general reserve, another reserve or a credit balance of Profit and Loss Account. The incoming partner is not entitled to a share of these past profits.

Transfer such balances to the old partners' capital or current accounts in their old profit sharing ratio. Debit the reserve or profit balance being transferred and credit the old partners' accounts. This removes the accumulated balance from its previous account.

How does the treatment of losses differ?

Accumulated losses, including a debit balance of Profit and Loss Account, are also borne by old partners in their old ratio. Debit their capital accounts and credit the loss account. Deferred revenue expenditure appearing in the balance sheet is similarly transferred.

Rajinder and Surinder share profits 4:1. When Narender joins, General Reserve is ₹20,000 and Profit and Loss Account has a debit balance of ₹10,000. The reserve allocations are ₹16,000 and ₹4,000; loss allocations are ₹8,000 and ₹2,000.

The old ratio governs both adjustments because both relate to the period before the new arrangement. Do not distribute the reserve among all partners in the new ratio merely because it is being transferred on the date of admission.

How are revaluation entries and ledger accounts prepared?

At admission, assets and liabilities may need revision to their correct values. Revaluation Account collects these gains and losses, including unrecorded assets and liabilities. Its final profit or loss belongs to the old partners in their old profit sharing ratio.

Which changes are gains and which are losses?

Note: Record the amount of the increase or decrease in an existing asset or liability, not its entire revised value. A provision newly created against debtors is a revaluation loss.

Worked example 9. A and B share profits 3:2, with capitals of ₹30,000 and ₹20,000. C joins for 1/6, bringing ₹15,000 capital and ₹5,000 goodwill. Stock of ₹15,000 falls by 10%; plant of ₹30,000 rises by 10%.

Furniture falls from ₹10,000 to ₹9,000. Create a 5% provision on debtors of ₹12,000 and provide ₹200 for electricity. Record an unrecorded investment of ₹1,000 and write off a creditor of ₹100 who is not likely to claim payment.

Answer: Stock loss = ₹1,500; plant gain = ₹3,000; furniture loss = ₹1,000; doubtful debts provision = ₹600. Total gains = ₹4,100; total losses = ₹3,300. Revaluation profit = ₹800, allocated ₹480 to A and ₹320 to B.

How are the adjustments journalised?

The Goodwill Account in this example receives and distributes C's premium in equal amounts. It therefore closes after the transfer. This use as a temporary account does not leave goodwill as an asset in the reconstituted firm's balance sheet.

What does the revaluation ledger show?

Revaluation Account has losses on the debit side and gains on the credit side. The profit transferred to capital accounts balances the debit side. A zero in an otherwise unused ledger cell below denotes no posting.

How do the partners' capital accounts close?

The capital accounts receive the old balances, the premium allocations and the revaluation profit. C's account receives the capital contribution. The balance carried down closes each account on its debit side; there are no capital withdrawals in this example.

How are capitals adjusted to the new profit sharing ratio?

Partners may agree that their capitals should be proportionate to their new profit shares. Compare required capitals with the existing balances after adjustments for goodwill, reserves and revaluation. A partner contributes a deficiency or withdraws an excess, according to the agreement.

How can the incoming partner's capital provide the base?

Total agreed capital = New partner's capital ÷ New partner's profit share. Multiply that total by each partner's new share to calculate the required individual capital.

Worked example 10. A and B share profits 2:1. C brings ₹20,000 for a 1/4 share. A's and B's adjusted capitals are ₹45,000 and ₹15,000. Capitals must match the new ratio.

Answer: The new ratio is 2:1:1. Total capital = ₹20,000 ÷ 1/4 = ₹80,000. A requires ₹40,000 and withdraws ₹5,000. B requires ₹20,000 and contributes ₹5,000. C's capital is ₹20,000.

Record A's withdrawal by debiting A's Capital Account ₹5,000 and crediting Cash Account ₹5,000. Record B's contribution by debiting Cash Account ₹5,000 and crediting B's Capital Account ₹5,000.

What if the total capital is given?

Allocate the stated total among all partners using the new ratio. For A, B and C originally sharing 3:2:1, D takes 1/8 each from A and B. The new shares are 3/8, 5/24, 1/6 and 1/4, giving 9:5:4:6.

With total capital of ₹1,20,000, required capitals are ₹45,000, ₹25,000, ₹20,000 and ₹30,000 respectively. Against adjusted capitals of ₹40,000, ₹35,000 and ₹30,000, A contributes ₹5,000, B and C each withdraw ₹10,000, and D brings ₹30,000.

Can current accounts replace cash adjustments?

Subject to agreement, transfer an old partner's surplus or deficiency to their current account. Debit capital and credit current account for a surplus. Debit current account and credit capital for a deficiency. This adjusts capital without requiring the corresponding cash movement.

In the preceding case, debit A's Current Account ₹5,000 and credit A's Capital Account ₹5,000. Debit B's and C's Capital Accounts ₹10,000 each and credit their respective Current Accounts by the same amounts.

What happens when existing partners change their profit shares?

A partnership can be reconstituted without admitting or retiring anyone. When existing partners change their profit sharing ratio, some may sacrifice future profits while others gain. Compensation for goodwill is adjusted between those partners according to their actual gain or sacrifice.

For A, B and C changing from 8:5:3 to 5:6:5, A sacrifices 8/16 − 5/16 = 3/16. B gains 6/16 − 5/16 = 1/16, and C gains 5/16 − 3/16 = 2/16.

Which adjustments remain necessary?

1. Compare each partner's old and new share to identify sacrifice or gain.
2. Adjust goodwill by debiting gaining partners and crediting sacrificing partners with the appropriate amounts.
3. Transfer revaluation gains or losses and accumulated profits or losses in the old profit sharing ratio.
4. Adjust capitals to the new profit sharing ratio if the agreement requires it.

The old ratio remains relevant to values and balances arising before the change. The new ratio governs future profit sharing and any agreed proportionate capital arrangement. Keeping these purposes distinct prevents a correct calculation from being allocated using the wrong ratio.

This follows the same accounting logic as admission: protect the partners' rights under the old arrangement, compensate changes in future profit entitlement, and then establish the balances required under the new agreement.

Glossary

• Reconstitution — A change in the partnership agreement that alters partners' relationships or composition while the firm continues.
• Admission — Entry of a new partner into an existing firm under a new partnership agreement.
• New profit sharing ratio — The agreed proportion in which all partners share profits after the firm's reconstitution.
• Sacrificing ratio — The ratio in which partners surrender part of their existing shares of future profits.
• Gaining share — The excess of a partner's new profit share over that partner's old profit share.
• Goodwill — The monetary value of reputation and business advantages associated with anticipated earnings above normal profits.
• Premium for goodwill — Compensation contributed by the incoming partner for the profit shares surrendered by sacrificing partners.
• Years' purchase — The agreed number of years used to multiply average profits or super profits when valuing goodwill.
• Normal profit — The return expected on the firm's capital at the normal rate for a similar business.
• Super profit — The amount by which the firm's average profit exceeds its normal profit on capital employed.
• Capitalisation — Conversion of an expected profit into capital value using the normal rate of return.
• Hidden goodwill — Goodwill inferred from the incoming partner's capital contribution, profit share and the firm's actual combined capitals.
• Revaluation Account — An account collecting gains and losses from revised asset values and reassessed or unrecorded liabilities.
• Accumulated profits — Undistributed past profits retained as reserves or as a credit balance of Profit and Loss Account.

Common errors and misconceptions

• Misconception: The old ratio is automatically the sacrificing ratio. Correct: Calculate old share minus new share when the agreement specifies a different pattern of sacrifice or a new ratio.
• Misconception: Surrendering 1/4 of one's share means surrendering 1/4 of total profits. Correct: Multiply that fraction by the partner's existing share before deducting it.
• Misconception: The incoming partner brings the whole firm's goodwill as premium. Correct: Calculate the incoming partner's share of the total goodwill.
• Misconception: Years' purchase is the number used to divide total profits. Correct: Divide by the number of profit years to obtain the average, then multiply by years' purchase.
• Misconception: Existing goodwill is written off in the sacrificing ratio. Correct: Write it off against old partners in their old profit sharing ratio.
• Misconception: Revaluation Account records the full revised value of every existing asset. Correct: Record only the increase or decrease; recognise an unrecorded item at the amount given.
• Misconception: The incoming partner shares old reserves and revaluation profit. Correct: These belong to the old partners and are transferred in the old ratio.
• Misconception: Capital deficiencies are calculated before goodwill and reserve adjustments. Correct: Compare required capitals with balances after the admission adjustments have been made.

Exam-style questions with model answers

Q1. What is the sacrificing ratio, and why is it needed? [2 marks]

1. The sacrificing ratio is the ratio in which old partners give up shares of profit in favour of the incoming partner.
2. It determines how the premium for goodwill is distributed among sacrificing partners. Individual sacrifice equals old share minus new share.

Q2. Anil and Vishal share profits 3:2 and admit Sumit for 1/5. Calculate the new ratio when no acquisition terms are specified. [3 marks]

1. Since no separate acquisition terms are given, assume Sumit obtains his share from Anil and Vishal in their old ratio of 3:2.
2. The remaining share is 1 − 1/5 = 4/5. Anil's new share is 3/5 × 4/5 = 12/25.
3. Vishal's new share is 2/5 × 4/5 = 8/25, while Sumit's share is 1/5 = 5/25. Therefore, the new profit sharing ratio is 12:8:5.

Q3. Explain five factors affecting the value of goodwill. [5 marks]

1. Nature of business: Businesses producing high value added products or facing stable demand can earn higher profits and therefore command more goodwill.
2. Location: A central location or a place with heavy customer traffic tends to support a higher value of goodwill.
3. Efficiency of management: Effective management can improve productivity and cost efficiency. The resulting higher profits support greater goodwill.
4. Market situation: Monopoly conditions or limited competition can enable a firm to earn high profits and increase its goodwill.
5. Special advantages: Import licences, assured electricity at low rates, long-term supply contracts, well-known collaborators, patents and trademarks can give the business advantages that enhance its earning capacity and goodwill.

Q4. Distinguish average profits, super profits and capitalisation methods of valuing goodwill. [4 marks]

1. The average profits method multiplies past average profit by an agreed number of years' purchase. Use weighted average only when specified.
2. The super profits method first deducts normal profit from average profit, then multiplies the excess by the agreed years' purchase.
3. Capitalisation of average profits converts average profit into capital value at the normal return and deducts actual net assets.
4. Capitalisation of super profits directly multiplies super profit by 100 and divides by the normal rate of return. The two capitalisation approaches give the same result using the same data.

Q5. Sunil and Dalip share 5:3. Sachin brings ₹20,000 capital and ₹4,000 premium by cheque. Give entries for receipt, distribution and full withdrawal of premium. [5 marks]

1. The ₹24,000 received includes two distinct amounts: ₹20,000 capital and ₹4,000 premium. Debit Bank Account ₹24,000; credit Sachin's Capital Account ₹20,000 and Premium for Goodwill Account ₹4,000.
2. Assume the sacrificing ratio equals the old ratio, 5:3. Sunil receives ₹4,000 × 5/8 = ₹2,500, and Dalip receives ₹4,000 × 3/8 = ₹1,500.
3. Debit Premium for Goodwill Account ₹4,000; credit Sunil's Capital Account ₹2,500 and Dalip's Capital Account ₹1,500. This distributes the premium.
4. For full withdrawal, debit Sunil's Capital Account ₹2,500 and Dalip's Capital Account ₹1,500; credit Bank Account ₹4,000. If the premium is retained instead, this final withdrawal entry is unnecessary.

Q6. How are revaluation gains and losses recorded and distributed on admission? [4 marks]

1. Debit an asset and credit Revaluation Account for an increase in its value or an unrecorded asset. Reverse the treatment for a decrease in an asset.
2. Debit Revaluation Account and credit the liability for an increased or unrecorded liability. A reduction in a liability credits Revaluation Account.
3. Transfer net revaluation profit by debiting Revaluation Account and crediting old partners' capital accounts in the old ratio.
4. For a net loss, debit the old partners' capital accounts in the old ratio and credit Revaluation Account. Existing asset and liability adjustments use only the amount of change.

Q7. C brings ₹20,000 as capital for a 1/4 share. A and B previously share profits 2:1, and their adjusted capitals are ₹45,000 and ₹15,000. The partners agree to make capitals proportionate to the new profit sharing ratio, using C's capital as the base, and to settle excesses or deficiencies in cash. Explain the capital adjustments. [4 marks]

1. A and B share the remaining 3/4 in their old ratio. The new ratio is therefore 2:1:1.
2. C's capital implies total capital of ₹20,000 ÷ 1/4 = ₹80,000. A requires ₹40,000 and B requires ₹20,000.
3. A's excess is ₹5,000. Debit A's Capital Account ₹5,000 and credit Cash Account ₹5,000 for withdrawal.
4. B's deficiency is ₹5,000. Debit Cash Account ₹5,000 and credit B's Capital Account ₹5,000 for the additional contribution.

Key takeaways

• Reconstitution changes the partnership agreement while the firm continues; admission gives the new partner rights in assets and profits.
• Calculate new shares from the actual admission terms, using the old ratio for sacrifice only when the terms justify it.
• Distribute goodwill compensation in the sacrificing ratio, but write off existing goodwill in the old profit sharing ratio.
• Average profits, super profits and capitalisation are distinct valuation methods; apply the agreed method and its required adjustments.
• Unpaid goodwill is debited to the incoming partner's current account and credited to the sacrificing partners' capital accounts.
• Accumulated profits, accumulated losses and revaluation results belong to the old partners in their old profit sharing ratio.
• Record changes in existing asset and liability values through Revaluation Account, including recognition of unrecorded assets and liabilities.
• Adjust capitals after goodwill, reserves and revaluation; settle differences through cash or agreed transfers to current accounts.

Test yourself

What two main rights does a newly admitted partner acquire?

The right to share the firm's assets and the right to share its profits.

How do you calculate an old partner's sacrifice?

Subtract the partner's new profit share from the old profit share, expressing both as fractions.

When is no goodwill entry passed in the firm's books?

When the incoming partner pays the old partners privately rather than paying premium through the firm.

How is weighted average profit calculated?

Multiply each year's adjusted profit by its assigned weight, total the products and divide by total weights.

What distinguishes super profit from average profit?

Super profit is the excess remaining after normal profit is deducted from the firm's average profit.

Who receives the general reserve on admission?

The old partners receive it in their old profit sharing ratio, excluding the incoming partner.

Which side of Revaluation Account receives an unrecorded liability?

Debit Revaluation Account and credit the liability account because recognising the obligation creates a revaluation loss.

How can an old partner's excess capital be adjusted without withdrawal?

Subject to agreement, debit the partner's capital account and credit that partner's current account with the surplus.