Partnership and LLP Accounts — Admission of a New Partner
Learning Outcomes
- Understand the reasons for which revaluation of assets and recomputation of liabilities is required in case of admission of a new partner.
- Understand the logic of revaluation of assets and recomputation of liabilities at the time of admission of a partner.
- Learn the accounting treatments under two circumstances:
- (a) When revalued assets and recomputed liabilities are shown in the Balance Sheet
- (b) When revalued assets and recomputed liabilities are not shown in the Balance Sheet
- Learn the technique of treating reserve balance on admission of a partner.
- See the technique of arriving at new profit-sharing ratio.
- Observe the technique of inferring goodwill although figure of goodwill is not mentioned clearly.
3.1 Introduction
- New partners are admitted for the benefit of the partnership firm.
- New partner is admitted either for increasing the partnership capital or for strengthening the management of the firm.
- When a new partner joins a firm, it is desirable to bring all appreciation or reduction in the value of assets into accounts as on the date of admission.
- All profits which have accrued but not yet brought into books and similarly, all losses which have occurred but not recorded, should now be brought into books so that the Capital Accounts of the old partners reflect the proper figure.
KNOWLEDGE NUGGET
- Purpose of Admission: Increase capital or strengthen management
- Revaluation Required: To bring assets and liabilities to their current values
- Goodwill Adjustment: Compensation to old partners for sacrifice
3.2 Revaluation Account or Profit and Loss Adjustment Account
- When a new partner is admitted into the partnership, assets are revalued and liabilities are reassessed.
- A Revaluation Account (or Profit and Loss Adjustment Account) is opened for the purpose.
JOURNAL ENTRIES — REVALUATION ACCOUNT
- 1. Revaluation Account Dr.
- To Assets Account (with reduction in value)
- To Liabilities Account (with increase in liability)
- 2. Assets Account Dr. (with increase in value)
- To Revaluation Account
- 3. Liabilities Account Dr. (with reduction in liability)
- To Revaluation Account
- 4. If Profit: Revaluation Account Dr.
- To Old Partners' Capital Accounts (in old profit sharing ratio)
- If Loss: Old Partners' Capital Accounts Dr.
- To Revaluation Account (in old profit sharing ratio)
When Revised Values are Not to be Recognised in the Books
- Sometimes all the partners including the new partner may agree to keep the assets and liabilities at the old values even when they agree to revalue them.
- To record these, a Memorandum Revaluation Account is opened.
MEMORANDUM REVALUATION ACCOUNT
- First Part: Entries for revaluation of assets and liabilities are made in the usual way. Result is transferred to old partners' capital accounts in old profit sharing ratio.
- Second Part: Reverse entries are made so that values of assets and liabilities remain unchanged. Result is transferred to all partners (including new partner) in new profit sharing ratio.
- If there is profit in first part, there will be loss of same amount in second part, and vice versa.
DIFFERENCE — REVALUATION ACCOUNT vs MEMORANDUM REVALUATION ACCOUNT
| Basis | Revaluation Account | Memorandum Revaluation Account |
|---|---|---|
| Purpose | To find profit/loss on revaluation; assets shown at revalued figures | To record effect of revaluation but assets shown at old figures |
| Parts | Not divided into parts | Divided into two parts |
| Transfer of result | To old partners in old ratio | First part to old partners; Second part to all partners in new ratio |
Illustration 1
The following is the Balance Sheet of Ram and Mohan, who share profits in the ratio of 3:2 as on 1st January, 2022:
SOLUTION
Balance Sheet as at January 1, 2022
| Liabilities | Amount (₹) | Assets | Amount (₹) |
|---|---|---|---|
| Trade payables | 15,000 | Buildings | 18,000 |
| Ram's Capital | 20,000 | Plant and Machinery | 15,000 |
| Mohan's Capital | 25,000 | Inventories | 12,000 |
| Trade receivables | 10,000 | ||
| Bank | 5,000 | ||
| Total | 60,000 | Total | 60,000 |
Balance Sheet after admission
| Liabilities | Amount (₹) | Assets | Amount (₹) |
|---|---|---|---|
| Trade payables | 16,500 | Buildings | 25,000 |
| Capital Accounts: | Plant and Machinery | 12,000 | |
| Ram | 26,200 | Inventories | 12,000 |
| Mohan | 30,800 | Trade receivables | 10,000 |
| Shyam | 25,000 | Less: Provision for Doubtful Debts | (500) |
| 82,000 | Bank | 40,000 | |
| Total | 98,500 | Total | 98,500 |
Illustration 2
A and B are partners sharing profits and losses in the ratio of 3:2. They admit C on certain terms. Partners agreed that the values of the assets and liabilities remain the same and, as such, there should not be any change in their book values as a result of the adjustments.
SOLUTION — Memorandum Revaluation Account
| Particulars | Amount (₹) | Particulars | Amount (₹) |
|---|---|---|---|
| To Provision for Bad Debts | 500 | By Freehold premises | 40,000 |
| To Inventory | 3,000 | By Furniture | 5,000 |
| To Plant | 5,000 | By Office equipment | 2,500 |
| To Profit transferred: | |||
| A's Capital (3/5) | 23,400 | ||
| B's Capital (2/5) | 15,600 | ||
| Total | 47,500 | Total | 47,500 |
Second Part (Reversal)
| Particulars | Amount (₹) | Particulars | Amount (₹) |
|---|---|---|---|
| To Freehold premises | 40,000 | By Provision for Bad Debts | 500 |
| To Furniture | 5,000 | By Inventory | 3,000 |
| To Office equipment | 2,500 | By Plant | 5,000 |
| Loss transferred: | |||
| A's Capital (12/25) | 18,720 | ||
| B's Capital (8/25) | 12,480 | ||
| C's Capital (5/25) | 7,800 | ||
| Total | 47,500 | Total | 47,500 |
3.3 Reserves in the Balance Sheet
- Whenever a new partner is admitted, any reserve etc. appearing in the Balance Sheet should be transferred to the Capital Accounts of the old partners in the old profit sharing ratio.
JOURNAL ENTRY
- Reserve Account / Profit and Loss Account Dr.
- To Old Partners' Capital Accounts (in old profit sharing ratio)
3.4 Computation of New Profit Sharing Ratio
- When a new partner is admitted and there is no agreement to the contrary, it is supposed that old partners will continue to have inter se at the old profit sharing ratio.
CASE I: When new partner's share is given (silent about sacrifice)
- It is assumed that old partners share remaining share in old ratio.
- Example: A and B (3:2) admit C for 1/3 share.
- Remaining share = 2/3
- A = 2/3 × 3/5 = 6/15, B = 2/3 × 2/5 = 4/15, C = 1/3 = 5/15
- New ratio = 6:4:5
CASE II: When new partner purchases his share from old partners
- New ratio = Old share — Sacrifice
- Example: A and B (3:2) admit C for 1/3 share (1/9 from A, 2/9 from B)
- A = 3/5 — 1/9 = 22/45, B = 2/5 — 2/9 = 8/45, C = 1/3 = 15/45
- New ratio = 22:8:15
CASE III: When old partners surrender a particular fraction
- A and B (3:2). A surrenders 1/3 of his share, B surrenders 2/3 of his share.
- A surrenders = 3/5 × 1/3 = 3/15, A's new = 3/5 — 3/15 = 6/15
- B surrenders = 2/5 × 2/3 = 4/15, B's new = 2/5 — 4/15 = 2/15
- C's share = 3/15 + 4/15 = 7/15
- New ratio = 6:2:7
SACRIFICING RATIO vs GAINING RATIO
- Sacrificing Ratio: Old Share — New Share (for partners whose share decreases)
- Gaining Ratio: New Share — Old Share (for partners whose share increases)
- At admission of new partner, old partners sacrifice in favour of new partner.
- At retirement/death, continuing partners gain.
3.5 Hidden Goodwill
- When the value of the goodwill of the firm is not specifically given, the value of goodwill has to be inferred.
FORMULA — HIDDEN GOODWILL
- Step 1: Incoming partner's capital × Reciprocal of share of incoming partner
- Step 2: Less: Total capital of old partners + Net Accumulated Profits and Reserves + capital brought in by incoming partner
- = Value of Goodwill
ILLUSTRATION 8 — HIDDEN GOODWILL
A and B are partners with capitals of ₹7,000 each. They admit C as a partner with 1/4th share. C brings ₹8,000 as capital.
Hidden Goodwill = ₹8,000 × 4/1 — (₹7,000 + ₹7,000 + ₹8,000) = ₹10,000
C's share of goodwill = ₹10,000 × 1/4 = ₹2,500
Journal Entry:
- C's Capital A/c Dr. ₹2,500
- To A's Capital A/c ₹1,250
- To B's Capital A/c ₹1,250
Summary
- New partners are admitted for the benefit of the partnership firm — either for increasing capital or for strengthening management.
- When a new partner is admitted, assets are revalued and liabilities are reassessed.
- A Revaluation Account (or Profit and Loss Adjustment Account) is opened for the purpose.
- Debit side: Reduction in assets and increase in liabilities; Credit side: Increase in assets and decrease in liabilities.
- Profit/Loss on revaluation is transferred to old partners' Capital Accounts in old profit sharing ratio.
- When revalued figures are not to be shown in the Balance Sheet, a Memorandum Revaluation Account is prepared.
- Any reserve appearing in the Balance Sheet should be transferred to old partners in old profit sharing ratio.
- New profit sharing ratio computation depends on how the new partner acquires his share.
- Hidden goodwill is inferred when the value of goodwill is not specifically given.
Test Your Knowledge
True and False
- 1. A newly admitted partner does not have same rights as old partners. False
- 2. When a new partner is admitted, old partners have to forego certain share in profits of the firm, this is called as sacrifice ratio. True
- 3. Revaluation account is also called as Profit and Loss Adjustment Account. True
- 4. Any appreciation in the value of an asset is credited to Revaluation account. True
- 5. All the partners may decide not to change the values of assets and liabilities in the books of accounts. True
- 6. New partner is entitled to have share in reserves appearing in the balance sheet prior to his admission. False
- 7. If revaluation account shows credit balance then it represents profit and therefore it is credited to all partners equally. False
- 8. New partner brings necessary amount as his capital. True
- 9. New partner is entitled to share in revaluation profit. False
Multiple Choice Questions
| 1. A and B are partners sharing profits and losses in the ratio 5:3. They admitted C and agreed to give him 3/10th of the profit. What is the new ratio after C's admission? | (a) 35:42:17. (b) 35:21:24. (c) 49:22:29. |
| 2. A and B are partners sharing profits in the ratio 5:3, they admitted C giving him 3/10th share. If C acquires 1/5 from A and 1/10 from B, new profit sharing ratio will be: | (a) 5:6:3. (b) 2:4:6. (c) 17:11:12 |
| 3. C was admitted with 1/4th share. C contributes ₹15,000 as capital, A and B have ratio 3:2. Find required capital of A and B taking C's as base capital: | (a) ₹27,000 and ₹16,000. (b) ₹27,000 and ₹18,000. (c) ₹32,000 and ₹21,000. |
| 4. A, B and C are partners sharing in ratio 6:3:3, they agreed to take D for 1/8th share. Find new ratio. | (a) 12:27:36:42. (b) 42:21:21:12. (c) 34:27:20:15. |
| 5. A and B are partners sharing 3:2 (A's Capital ₹30,000, B's ₹15,000). They admitted C and gave 1/5th share. How much C should bring towards his capital? | (a) ₹9,000. (b) ₹12,000. (c) ₹11,250. |
| 6. A and B (3:2) take C who brings ₹25,000 capital and ₹10,000 goodwill. New ratio 1:1:1. In what ratio will goodwill be shared among old partners? | (a) ₹8,000:₹2,000. (b) ₹5,000:₹5,000. (c) Old partners will not get any share. |
| 7. A and B share 3:2. C brings capital and goodwill but compensates A and B outside the firm. How will this be treated in books? | (a) Cash brought by C will only be credited to his capital account. (b) Goodwill will be raised to full value in old ratio. (c) Goodwill will be raised to full value in new ratio. |
| 8. X and Y (3:1) admit Z who pays ₹4,000 as goodwill. New ratio 2:1:1. Goodwill will be credited to: | (a) X and Y as ₹3,000 and ₹1,000 respectively. (b) X only (c) Y only. |
| 9. P and Q (2:1) admit R for 1/4th share with ₹20,000 capital and ₹9,000 goodwill, half withdrawn. Revaluation profit ₹6,000. Opening capitals P:₹40,000, Q:₹30,000. Find closing balances. | (a) ₹47,000:₹33,500:₹20,000 (b) ₹50,000:₹35,000:₹20,000 (c) ₹40,000:₹30,000:₹20,000 |
| 10. Adam, Brain and Chris equal partners with goodwill ₹1,20,000 shown in balance sheet. They take Daniel as equal partner who brings ₹1,60,000. His share of goodwill is ₹60,000. Goodwill account to be written off before admission. What is treatment? | (a) Write off goodwill of ₹1,20,000 in old ratio. (b) Cash brought by Daniel for goodwill will be distributed among old partners in sacrificing ratio. (c) Both (a) & (b) |
High-Yield Interactive Quiz — Admission of a New Partner
Q1. A Revaluation Account is prepared at the time of admission of a new partner to:
Correct Answer: B. When a new partner is admitted, assets are revalued and liabilities are reassessed. A Revaluation Account is opened for this purpose.
Q2. Profit on revaluation at the time of admission of a new partner is credited to:
Correct Answer: B. Profit on revaluation is transferred to the Capital Accounts of old partners in the old profit sharing ratio. New partner is not entitled to share in revaluation profit.
Q3. In a Memorandum Revaluation Account, the first part shows profit and the second part shows:
Correct Answer: B. If the first part of Memorandum Revaluation Account shows a profit, the second part must show a loss of the same amount (reversal entries), and vice versa.
Q4. Reserves appearing in the Balance Sheet at the time of admission of a new partner are transferred to:
Correct Answer: B. Any reserve appearing in the Balance Sheet should be transferred to the Capital Accounts of the old partners in the old profit sharing ratio. New partner is not entitled to reserves prior to admission.
Q5. If a new partner acquires his share entirely from one old partner, the sacrificing ratio will be:
Correct Answer: C. If the new partner acquires his share entirely from one old partner, only that partner sacrifices. The sacrificing ratio would be that partner's sacrifice.
Q6. When the revalued figures are NOT to be shown in the Balance Sheet, which account is prepared?
Correct Answer: B. When partners agree to keep assets and liabilities at old values even after revaluation, a Memorandum Revaluation Account is prepared.
Q7. Sacrificing ratio is calculated as:
Correct Answer: B. Sacrificing Ratio = Old Share — New Share. A positive difference indicates sacrifice.
Q8. A and B are partners sharing in ratio 3:2. They admit C for 1/4th share. What is the new ratio (assuming silent on sacrifice)?
Correct Answer: C. Remaining share = 3/4. A = 3/4 × 3/5 = 9/20, B = 3/4 × 2/5 = 6/20, C = 1/4 = 5/20. New ratio = 9:6:5.
Q9. Hidden goodwill is calculated when:
Correct Answer: B. Hidden goodwill is inferred when the value of goodwill is not specifically given but can be derived from the capital contribution of the incoming partner.
Q10. On admission of a new partner, the balance of Revaluation Account (profit) is transferred to:
Correct Answer: B. Profit on revaluation is transferred to the Capital Accounts of old partners in the old profit sharing ratio.
Q11. A and B (3:2) admit C for 1/5th share. C acquires his share from A and B in the ratio of 2:1. What is A's new share?
Correct Answer: B. A's sacrifice = 1/5 × 2/3 = 2/15. A's new share = 3/5 — 2/15 = 9/15 — 2/15 = 7/15.
Q12. In Memorandum Revaluation Account, the result of the second part is shared by:
Correct Answer: B. The result of the second part of Memorandum Revaluation Account is shared by all partners (including the new partner) in the new profit sharing ratio.