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Chapter 3: Reconstitution of a Partnership Firm Admission of a Partner
A partnership is an agreement between two or more persons (called partners) for sharing the profits of a business carried on by all or any of them acting for all.
Any change in the existing agreement amounts to the reconstitution of the partnership firm.
This results at an end of the existing agreement and a new agreement comes into being with a changed relationship among the members of the partnership firm and/or their composition.
However, the firm continues. The partners often resort to the reconstitution of the firm in various ways such as the admission of a new partner, change in profit sharing ratio, the retirement of a partner, death, or insolvency of a partner.
In this chapter, we shall have a brief idea about all these and in detail about the accounting implications of admission of a new partner or an on change in the profit-sharing ratio.
3.1 Modes of Reconstitution of a Partnership Firm
Reconstitution of a partnership firm usually takes place in any of the following ways:
Admission of a new partner: A new partner may be admitted when the firm needs additional capital or managerial help.
According to the provisions of the Partnership Act 1932 unless it is otherwise provided in the partnership deed a new partner can be admitted only when the existing partners unanimously agree to it.
For example, Hari and Haqque are partners sharing profits in the ratio of 3:2. On April 1, 2017, they admitted John as a new partner with 1/6 share in profits of the firm.
With this change now there are three partners in the firm and it stands reconstituted.
Change in the profit sharing ratio among the existing partners: Sometimes the partners of a firm may decide to change their existing profit sharing ratio.
This may happen on account of a change in the existing partners’ role in the firm.
For example, Ram, Mohan, and Sohan are partners in firm sharing profits in the ratio of 3:2:1. With effect from April 1, 2017, they decided to share profits equally as Sohan brings in additional capital.
This results in a change in the existing agreement leading to the reconstitution of the firm.
Retirement of an existing partner: It means withdrawal by a partner from the business of the firm which may be due to his bad health, old age, or change in business interests.
In fact, a partner can retire at any time if the partnership is at will.
For example, Roy, Ravi, and Rao are partners in the firm sharing profits in the ratio of 2:2:1.
On account of illness, Ravi retired from the firm on March 31, 2017 This resulted in the reconstitution of the firm now having only two partners.
Death of a partner: A partnership may also stand reconstituted on the death of a partner if the remaining partners decide to continue the business of the firm as usual.
For example, X, Y, and Z are partners in a firm sharing profits in the ratio of 3:2:1. X died on March 31, 2017. Y and Z decide to carry on the business sharing future profits equally.
The continuity of business by Y and Z sharing future profits equally leads to the reconstitution of the firm.
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NCERT Solutions Class 12 Accountancy Chapter 3 Reconstitution of a Partnership Firm Admission of a Partner
1. Identify various matters that need adjustments at the time of admission of a new partner.
Following matters need adjustment when adding a new partner
1. Capital Adjustment among partners
2. Revised calculation of profit sharing ratio
3. Evaluating and adjusting the goodwill of partners who are sacrificing their share
4. Accumulated profits, reserves, and losses should be distributed to old partners as per the old ratio that was agreed upon.
5. Revaluation of the Liabilities and Assets to determine the current value and distribution of profit or loss as per the old ratio
2. Why is it necessary to ascertain a new profit sharing ratio even for old partners when a new partner is admitted?
At the time of admission of a new partner, the existing partners sacrifice their present profit sharing ratio to make way for a share in profit sharing to the new partner which results in reducing their profit.
Therefore it is essential to determine the new profit sharing ratio for old partners on the occasion of adding a new partner as it creates a more justified share of profit.
3. What is sacrificing ratio? Why is it calculated?
The portion of profit sharing ratio that is sacrificed by current partners when a new partner joins the firm is called as sacrificing ratio. It is calculated as the difference between the old profit sharing ratio and the new profit sharing ratio.
Sacrificing ratio = Old profit sharing ratio – New profit sharing ratio
It is compulsory to determine this ratio as the new partner has to reimburse the existing partner for making the sacrifice of profit. It is paid to them as goodwill.
4. On what occasions sacrificing ratio is used?
Sacrificing ratio needs to be used on these occasions:
1. When it is mutually decided by partners of the firm to change the profit sharing ratio among the partners.
2. A new partner is introduced to the firm and accordingly the sum contributed by the new partner is distributed as goodwill based on the sacrificing ratio of existing partners.
5. If some goodwill already exists in the books and the new partner brings in his share of goodwill in cash, how will you deal with the existing amount of goodwill?
The goodwill that exists in the firms before the arrival of a new partner must be written off between the existing partners in the ratio of their profit-sharing as previously decided. The following journal entry needs to be passed.
Old Partner’s Capital A/c
To Goodwill A/c
(Being goodwill written off in the old ratio between existing partners)
Reconstitution of a Partnership Firm Admission of a Partner NCERT Textbook With Solutions PDF Free Download