OMTEX CLASSES: Accounts and Financial Management - II

Accounts and Financial Management - II

Admission of a Partner
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 competition

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.


Goodwill is also one of the special aspects of partnership accounts which requires adjustment (also valuation if not specified) at the time of reconstitution of a firm viz., a change in the profit sharing ratio, the admission of a partner or the retirement or death of a partner.
 Meaning of Goodwill

Over a period of time, a well-established business develops an advantage of good name, reputation and wide business connections. This helps the business to earn more profits as compared to a newly set up business. In accounting, the monetary value of such advantage is known as “goodwill”.

It is regarded as an intangible asset. In other words, goodwill is the value of the reputation of a firm in respect of the profits expected in future over and above the normal profits. It is generally observed that when a person pays for goodwill, he/she pays for something, which places him in the position of being able to earn super profits as compared to the profit earned by other firms in the same industry.

In simple words, goodwill can be defined as “the present value of a firm’s anticipated excess earnings” or as “the capitalised value attached to the differential profit capacity of a business”. Thus, goodwill exists only when the firm earns super profits. Any firm that earns normal profits or is incurring losses has no goodwill.
Factors Affecting the Value of Goodwill
The main factors affecting the value of goodwill are as follows
Nature of business: A firm that produces high value added products or having a stable demand is able to earn more profits and therefore has more goodwill.
Location: If the business is centrally located or is at a place having heavy customer traffic, the goodwill tends to be high.
Efficiency of management: A well-managed concern usually enjoys the advantage of high productivity and cost efficiency. This leads to higher profits and so the value of goodwill will also be high.
Market situation: The monopoly condition or limited competition enables the concern to earn high profits which leads to higher value of goodwill.
Special advantages: The firm that enjoys special advantages like import licences, low rate and assured supply of electricity, long-term contracts for supply of materials, well-known collaborators, patents, trademarks.
Methods of Valuation of Goodwill:
1. Average Profits Method
2. Supper Profits Method
3. Capitalisation Method.

Q1.     Amar and Akbar are the partners in a business sharing profit and losses in the ratio 3 : 2 respectively.
Their Balance Sheet as on 31st December, 2007 stood as under.

Balance Sheet
Sundry Creditors
Land and Building
Amar's Capital A/c
Akbar's Capital A/c
Sundry Debtors
Cash at Bank

They admitted Amit on the above date as a partner on the following terms.
(1) Depreciate Furniture by Rs. 800 and Stock by 10%
(2) Reserve of 5% on debtors be created for bad and doubtful debts.
(3) Amit should bring in Rs. 7,000 as capital and Rs. 4,000 as Goodwill.
(4) Amit will recieve 1/8th share in future profits.
(5) The value of Land & Building be raised upto Rs. 32,000.
(6) The capital Accounts of all the partners be adjusted in proportion to their profit sharing ratio and
     excess amount be refunded to the partners.
Prepare Profit and loss Adjustment Account, Capital Accounts of the Partners and the Balance Sheet
of the new firm.

Q2.     Given below is the Balance Sheet of Sunita, Surekha and
Nilima who were sharing profits and losses in the ratio of 3 : 3 : 2.

Balance Sheet as on 31st December, 2000


Bills Payable

Reserve Fund

Capital A/cs. :







On 1st January 2001, Nilima retired from the firm on the following terms :
(1) Assets be revalued as under - Stock Rs. 12,000, Machinery Rs. 16,000, Furniture Rs. 8,400.
(2) R.D.D be maintained at 4% on Debtors.
(3) An Item of Rs. 200 from Creditors is no longer a liability and hence should be properly adjusted.
(4) Goodwill of the firm be valued at Rs. 8,000.
(5) The Amount due to Nilima be transferred to her Loan A/c.
Prepare Profit & Loss Adjustment A/c, Partner's Capital A/c, and Balance Sheet of new firm.
[Ans.: Loss Rs. 2,400; BS Total Rs. 1,03,200]

Q.3     A, B, C share profits and losses in the proportion of 3 : 2 : 1. Their Balance sheet is as follows :

Capital Accounts :
Sundry Assets





The Parnership is dissolved and the assets are realised as follows :
First Realisation                     Rs. 17,000
Second Realisation                Rs. 21,000
Third and Final Realisation      Rs. 36,000
Show Distribution of cash at each stage : (a) in profit sharing ratio (b) in ratio of capital balances.