Admission of a Partner
Introduction:
A new partner can be admitted only with the
concent of all the existing partners. A new partner is not liable for
any profit or loss occured before his admission. Such a partner is
called a new partner or incoming partner.
purpose of Admission of a partner:
1. For additional capital
2. for progress of the firm
3. For acquiring additional managerial skill
4. For reducing compitition
Effect of Admission of a PartnerAdmission of a new
partner is a major event in a partnership business. A new admission can
take place only with the unanimous consent of all the existing
partners. New partners are admitted for several reasons. Additional
capital contribution, fresh ideas more contacts etc. are some of the
advantages in admitting a new partner.Following are the most important
accounting aspects to be considered at the time of admission of a new
partner.1. Change in profit sharing ratio2. Accounting treatment of
Goodwill3. Revaluation of assets and liabilities4 Treatment of reserves
and accumulated profits / losses5. Adjustment of Capital Accounts
1. Change in Profit Sharing RatioWhen a new
partner comes into the business, old partner have to adjust his profit
share from their portion. Thus change in profit sharing ratio is the
first accounting aspect to be considered on admission of a new partner.
In academic accounting, change in profit sharing ratio can be presented
in various ways:
2. The new partner's share is mentioned without specifying the old partner's profit sharing arrangement.In
this case it is to be assumed that the profit available after paying
the new partner?s share is to be divided by the old partners in their
old profit sharing ratio. In other words the even though the overall
profit sharing ratio changes, the old ratio is still maintained between
the old partners, within the new ratio.
Sacrificing Ratio
The ratio in which the old partners agree to sacrifice
their share of profit in favour of the incoming partner is called
sacrificing ratio. The sacrifice by a partner is equal to :
Old Share of Profit – New Share of Profit
As stated earlier, the new partner is required to
compensate the old partner’s for their loss of share in the super
profits of the firm for which he brings in an additional amount known as
premium or goodwill. This amount is shared by the existing partners in
the ratio in which they forego their shares in favour of the new partner
which is called sacrificing ratio.
The ratio is normally clearly given as agreed among the
partners which could be the old ratio, equal sacrifice, or a specified
ratio. The difficulty arises where the ratio in which the new partner
acquires his share from the old partners is not specified. Instead, the
new profit sharing ratio is given. In such a situation, the sacrificing
ratio is to be worked out by deducting each partner’s new share from his
old share.
3. Revaluation of Assets and LiabilitiesRevaluation
of assets and liabilities is another major step prior to admission or
retirement. Revaluation is important, as there are hidden profits or
losses in the difference between book value and actual market value of
assets or liabilities. Revaluation is necessary whenever there is a
change in profit sharing ratio, even without admission or retirement.
The hidden profits or losses should be distributed in the ratio prior to
change (Old ratio).Revised values of assets and liabilities are brought
into books by opening a temporary account called ?revaluation account?.
The purpose of revaluation account is to summarise effect of
revaluation of assets and liabilities.Revaluation account represents the
combined capital account of partners. Any gain on revaluation of asset
or liabilities, which are to be credited to partners, will be credited
in revaluation account. Similarly any loss on revaluation will be
debited in revaluation account instead of capital accounts. The
revaluation account is closed by transferring its net balance to
partner?s capital accounts in the profit sharing ratio.
4. Treatment of Reserves and Accumulated ProfitsAccumulated
profits such as general reserve, credit balance in profit &loss
account etc. will be transferred to the capital accounts of old partners
in the old profit sharing ratio. Similarly accumulated losses shall be
transferred to the debit side of old partner?s capital accounts.
Therefore these items will not appear in the new balance sheet.
5. Adjustment of Capital AccountsWhen the partners
change their profit sharing ratio at admission, retirement or any other
reason, they also rearrange their capital accounts. Capital
contribution is not essentially the basis of profit sharing. However the
in most partnerships capital contribution is considered as the major
factor in determining profit sharing ratio.At the time of admission,
capital contribution will be raised as an important condition. When a
new partner is admitted for a certain share of profit for a certain
amount of capital contribution he would naturally expect the other also
maintain a capital balance matching with their profit share. Admission
of a partner is not the only situation when a capital rearrangement is
considered. Retirement, death or any other change in profit sharing
ratio would prompt rescheduling the capital balances. The basic purpose
of following ?fixed capital method? is to maintain a steady capital
ratio. When capital is readjusted on the basis of new partner?s capital
contribution, the first step is to determine the revised capital
balances of each partner. Readjustment in capital account is usually
done by bringing in or taking out cash. Sometimes, in place of cash
transactions, old partners may adjust their capital balances by
transferring the excess or deficit in the capital accounts to their
current accounts as a temporary measure. Once the capital balances are
adjusted current accounts can be settled in due course.