Chapter 3: Reconstitution of a Partnership Firm — Admission of a Partner NCERT SOLUTION CLASS 12TH ACCOUNTS | EDUGROWN NOTES

Short Answer Type Question:

Q.1Identify various matters that need adjustments at the time of admission of a new partner.

ANSWER: The following are the various items that need to be adjusted at the time of admission of a new partner.

1. Profit Sharing Ratio: Calculation of new profit sharing ratio.

2. Goodwill: Valuation and adjustment of goodwill among the sacrificing old partners.

3. Revaluation of Assets and Liabilities: Assets and liabilities are revalued to ascertain the current value of the assets and liabilities of the partnership firm. Moreover, the profit or loss due to the revaluation need to be distributed among the old partners.

4. Accumulated profits, losses and reserves are distributed among the old partners in their old ratio.

5. Adjustment of capital of the partners.

Q.2 Why i is it necessary to ascertain new profit sharing ratio even for old partners when a new partner is admitted?

ANSWER: When new partner/s is/are admitted, then the old partners in the partnership firm need to sacrifice their share of profit in favour of the new partner/s. This reduces the share of profit of the old partners ,hence, it is necessary to ascertain the new profit sharing ratio even for the old partners in the event of admission of new partner/s.

Q.3 What is sacrificing ratio? Why is it calculated?

ANSWER: Sacrificing ratio refers to the ratio in which the old partners of a partnership firm surrender their share of profit in favour of the new partner/s. It is calculated as a difference between the old ratio and the new ratio of the old partners.

Sacrificing Ratio = Old Ratio − New Ratio

It is very important to calculate this ratio, as the new partner need to compensate the old partners for sacrificing their share of profit. The new partner compensates the old partners by making payment to them in the form of goodwill that is transferred among the old partners in their sacrificing ratio

Q.4 On what occasions sacrificing ratio is used?

ANSWER: The following are the different situations when sacrificing ratio is used.

1. When the existing partners of a partnership firm agree to change the share of profit among themselves.

2. When a new partner is admitted in the partnership firm and the amount of the goodwill brought by him/her is transferred among the old partners in sacrificing ratio of the old partners.

Q.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 existing amount of goodwill?

ANSWER: If goodwill already appears in the books of old firm (before the admission of new partner), then this should be written off among the old partners in their old profit sharing ratio. The following Journal entry is passed.

Old Partner’s Capital A/c	Dr.
To Goodwill A/c
(Goodwill written off in old ratio among the old partners)

Q.6 Why is there need for the revaluation of assets and liabilities on the admission of a partner?

ANSWER: At the time of admission of a new partner, it becomes very necessary to revalue the assets and liabilities of a partnership firm for ascertaining its true and fair values. This is done because the value of assets and liabilities may have increased or decreased and consequently their corresponding figures in the old balance sheet may either be understated or overstated. Moreover, it may also be possible that some of the assets and liabilities are left unrecorded. Thus, in order to record the increase and decrease in the market value of the assets and liabilities, Revaluation Account is prepared and any profits or losses associated with this increase or decrease are distributed among the old partners of the firm.

Long Answer Type Question:

---

Q.1 Do you advise that Liabilities and Assets must be revalued at the time of admission of a partner? If so, why? Also describe how is this treated in the book of account?

ANSWER: It is logical to revalue Liabilities and Assets when a new partner gets admitted in the firm, as it is helpful in determining the true value of them on that day. Revaluation is helpful as the value of Liabilities and Assets may increase or decrease and as such their values in existing balance sheet may be not justified, also some assets or liabilities may not be recorded at all. Hence, for recording the changes in market value for the Liabilities and Assets, a revaluation account is needed to be prepared and the associated profits or losses needs to be distributed between the existing partners of firm.

Following journal entries are added to the account on the date a new partner is admitted in a firm.

i. When asset value increases:

Assets A/c Dr.

To Revaluation A/c

(For increase in asset value)

ii) When asset value decreases:

Revaluation A/c	Dr.
	To Asset A/c
(For Decrease in asset value)

iii) When Liabilities increase:

Revaluation A/c	Dr.
	To Liabilities A/c
(For increase in liabilities value)

iv) When liabilities decrease:

Liability A/c	Dr.
	To Revaluation A/c
(For decrease in liabilities value)

v) To record assets that are unrecorded:

Unrecorded Assets A/c	Dr.
	To Revaluation A/c
(Recording unrecorded assets)

vi) To record liabilities that are unrecorded :

Revaluation A/c	Dr.
	To Unrecorded Liabilities A/c
(To record unrecorded liabilities)

vii) Transferring credit balance of Revaluation account:

Revaluation	Dr.
	To Old Partner’s Capital A/c
(Transfer of profit earned from Revaluation to Old Partners as per existing profit sharing ratio)

vii) Transferring debit balance of Revaluation account:

Old Partner’s Capital A/c	Dr.
	To Revaluation A/c
(Transfer of loss on revaluation to Old Partners as per existing profit sharing ratio)

Q.2 What is goodwill? What are the factors that affect goodwill?

ANSWER: Goodwill refers to the intangible asset that represents the firms value and reputation and the brand name that it carries in the market. Goodwill is earned by a firm from the work it does which helps earn people trust by meeting all customer demands both in quality and quantity. Having a positive goodwill is very much helpful for a firm to earn extraordinary profits in comparison to its competitors. It also ensures profits that keep coming in the future and helps in retaining old customers.

Factors affecting firms’ goodwill are:

1. Product Quality: A firm which is constantly delivering the best product for its customers will have a greater goodwill.

2. Location: A central location makes it easy to reach and attracts more footfalls which leads to higher sales and more goodwill.

3. Management: Cost efficiency and higher productivity can be achieved by having an efficient management in place, also it ensures quality products at less price which increases goodwill.

4. Market Structure: A firm will enjoy more benefits of goodwill if the market is monopolistic in nature and there are no substitutes, it will add more goodwill to the firm.

5. Other Advantages: A firm that is getting benefits such as continuous supply of fuel, power and raw materials and uses it to produce quality goods enjoys a higher goodwill.

Q.3 Explain various methods of valuation of goodwill.

ANSWER: There are four different methods of goodwill valuation:

1. Average Profit Method: In this method, the calculation of goodwill is done based on the average profits of the past years. It can be calculated as

Goodwill = Average Profit × No. of Years Purchase

Here, the number of years of purchase signifies the years till which the firm expects profits to generate in the same way as current period

Following steps are involved in this method

1. Determine total profit of past years

2. Add all losses which are abnormal in nature such as theft, fire etc.

3. Add all normal income, if not done previously

4. Deduct all incomes that are not obtained from business, and all such abnormal incomes for e.g winning a lottery

5. Deduct all normal expenses, if not deducted previously

6. Calculate the average profit, by dividing total profit determined in the previous step

7. Multiply the average profit hence obtained to the number of year’s purchases in order to determine goodwill.

Example:

Last 5 years profits are 3,00,000,  9,00,000,   (6,00,000),  15,00,000,  24,00,000.

Goodwill calculated as:

Goodwill = 9, 00,000 × 4 = 36, 00,000

2. Weight Average Method: In this method, weights are allocated to each year’s profit with the highest weight given to recent year’s profit and lower weights marked for past years profits. The product of the profits and weights are added and divided by the total weight to determine weighted average profits. It is a modified version of Average Profit Method. The following formulae is used.

The following steps are involved:

1. Assign highest weightage to recent year’s profit and lowest weightage to past years profits.

2. Multiply weights with the profits corresponding to each year

3. Determine product total

4. Divide the product total with total of weightage to find Weighted Average Profit

5. Multiply the weighted average profit with number of years purchase

For example:

Last 5 years profits are ₹ 3,00,000,   ₹ 9,00,000,   ₹ (6,00,000),   ₹ 15,00,000,   ₹ 24,00,000.

Goodwill calculated as:

Profit/Loss ₹	Weights	Product ₹
3,00,000	1	3,00,000 × 1 = 3,00,000
9,00,000	2	9,00,000 × 2 = 18,00,000
(6,00,000)	3	(6,00,000) × 3 = (18,00,000)
15,00,000	4	15,00,000 × 4  = 60,00,000
24,00,000	5	24,00,000× 5  = 1,20,00,000
Total	15	₹ 1,83,00,000

3. Super Profit Method:  In this method, goodwill is determined on excess profit earned by a firm as compared to profit earned by rivals in the same industry. The excess profit earned over normal profit is called as Super Normal Profit

Following steps are involved:

1. Calculate the average profit

2. Calculating average capital engaged

3. Calculating normal profit

4. Calculation of Super Normal Profit using the formulae: Super Normal Profit = Average Profit – Normal Profit

5. Multiply super normal profit with number of years purchase to determine goodwill.

4. Capitalisation Method: Goodwill is determined by two ways as follows:

a) By Average Profit capitalisation. b) By Super Profit capitalisation.

a) By Average Profit capitalisation

Following steps are involved:

1. Average profit is calculated

2. Calculating average profits capitalised value using the formulae

3. Determine Actual Capital Employed

4. Deduct Actual Capital Employed from Capitalised Average Profit to calculate goodwill.

Goodwill = Capitalised Average Profit – Actual Capital Employed

b) By Super Profit capitalisation.

Following steps are involved:

1. Capital Employed for calculation

2. Calculation of Normal profit

3. Calculation of average profit

4. Calculating Super Normal Profit:

Super Normal Profit = Average Profit – Normal Profit

Step 5: Goodwill calculation by the following formula:

4. If it is agreed that the capital of all the partners be proportionate to the new profit sharing ratio, how will you work out the new capital of each partner? Give examples and state how necessary adjustments will be made.

When a new partner is admitted to the firm, the capital of all partners must be determined using new profit sharing ratio. In such cases new capital of each partner is determined and is dependent on the following instances:

1. New partner’s capital is given

2. Firm’s total capital is given

1) New partner’s capital is given

It involves the following steps

1. Calculation of total capital of firm based on the new partners’ capital

2. Divide total capital of the firm by individual share of partner’s profits to determine each partner’s new capital

3. After posting adjustments determine each partner’s capital balance

4. The capital determined previously is written in Partners Capital account on the credit side

5. Calculation of surplus or deficit. If new capital is more than the old share, then it needs to be contributed by old partners and is termed deficit and if new capital is less than old capital, it is called surplus and the difference is paid to old partners.

Let us understand the above steps with the help of an example.

A & B are partners in business who share profits and losses equally. They agree to admit C for
share in profit. C brings ₹ 1, 00,000 as capital. A and B have old capital of ₹ 80,000 and ₹ 60,000 respectively, at the time admission of C.

Step 3:

	A	B
New Capital	100,000	100,000
Less: Existing Capital	(80,000)	(60,000)
Withdrawal (deposit)	(20,000)	(40,000)

So both A and B need to pay 20,000 and 40,000 more as share for their new capital.

2) When new firms’ total capital is known:

When new partner’s capital is not mentioned, then new capital is determined based on the total capital of the firm on a proportionate basis. The amount that is determined has to be brought in by the new partner as capital. Following steps are taken to determine the new partners’ capital:

1. Finding the total old capital of the existing partners after performing all adjustments.

2. Finding total capital of the new firm by multiplying old capital of existing partners with the reciprocal of old partners total share.

Q.4 The new capital of each partner is determined on the basis of total capital calculated which is multiplying new profit ratio with the total capital, individually for all partners. Here is an example to help understand the concept.

ANSWER: Ram and Shyam are partners in a firm sharing profit and loss equally. They agree to admit Anil for 1/3^rd share in profit and decided to share future profit and loss equally. X’s capital is ₹ 1, 00,000 and Y’s capital is ₹ 50,000. Z brings sufficient capital for his share in profit.

1. Old Capital= ₹ 1, 00,000 + 50,000 = 1, 50,000

2. Calculation of total capital

3. New Partners Capital

Q.5 Explain how will you deal with goodwill when new partner is not in a position to bring his share of goodwill in cash?

ANSWER: The situation in which a new partner is unable to bring his share of goodwill in cash, the goodwill account gets adjusted through Old Partners account. New partners’ capital account is debited with the share of goodwill and the same gets credited to Old Partner’s account.

New Partner’s Capital A/c	Dr.
	To Old Partners’ Capital A/c
(New Partner account debited)

Note: According to Para 16 of Accounting Standard 10, Goodwill is recorded only when it is any transaction equivalent to money or money’s worth. It is a mandatory practice that is followed.

Q.6 Explain various methods for the treatment of goodwill on the admission of a new partner?

ANSWER: Goodwill is treated in the following ways on introduction of a new partner:

1. Premium Method

2. Revaluation Method

When a new partner pays the share of goodwill in the form of cash, it is called as premium method. There can be two scenarios:

1. New partners pays directly to old partners

2. Partner brings goodwill in form of cash and it is retained in the business.

The corresponding entries are:

(i) When goodwill brought in cash by new partner

Cash/Bank A/c Dr.

To Premium for Goodwill A/c

(Amount of goodwill brought in by new partner)

(ii)When goodwill is retained by business:

Premium for Goodwill A/c Dr

To Sacrificing Partners’ Capital A/c

(Goodwill brought by new partner distributed among old partners as per the sharing ratio)

Revaluation Method: Situations when new partner is unable to bring goodwill in form of cash

New Partner’s Capital A/c Dr. (Goodwill amount not brought by new partner)

To Old Partners’ Capital A/c

(Goodwill of new partner distributed to old partners as per their sharing ratio)

Note: According to Para 16 of Accounting Standard 10, Goodwill is recorded only when it is any transaction equivalent to money or money’s worth. It is a mandatory practice that is followed.

Q.7 How will you deal with the accumulated profit and losses and reserves on the admission of a new partner?

ANSWER: A new partner is not entitled to bear the losses or enjoy the profits of a previous business. Hence, when a new partner is added to the firm, the accumulated profits or losses, reserves needs to be distributed to current partners (partners of old firm) in their profit sharing ratio.

Treatment of accumulated losses, profits and reserve

Profit and Loss A/C Dr.

General Reserve A/C Dr.

Contingency Reserve A/C Dr.

When losses accumulate over a period.

For Profits and losses

Deferred Advertising expense Dr.

(Losses accumulated shared to old partners as per sharing ratio)

Q.8 At what figures the value of Liabilities and Assets appear in the books of the firm after revaluation has been done? Show with the help of an imaginary balance sheet.

ANSWER: After revaluation has been done, the Liabilities and Assets appear at their current market values in the Balance Sheet of the reconstituted firm. This can be better explained with the help of the below explained example.

Anil & Bijay shares profit and loss equally.

Balance Sheet of A and B as on April 01, 2019
Liabilities	Amount ₹	Assets	Amount ₹
Sundry Creditors	1,00,000	Cash in Hand	8,000
Capital Accounts		Cash at Bank	1,78,000
Anil 1,50,000		Debtors	40,000
Bijay 1,50,000	3,00,000	Stock	36,000
				Furniture	38,000
			Plant and Machinery	1,00,000
	4,00,000		4,00,000

1) On that date Chetan is admitted as new partner for 1/3^rd share and offers 2, 00,000 as capital.

2) Value of stocks increased by ₹ 7,000.

3) A ₹ 2,000 provision has been created against Debtors.

4) ₹ 35,000 value obtained after revaluating furniture.

5) A machinery costing ₹ 100,000 purchased is not recorded in books.

6) Outstanding rent ₹ 2,000.

Prepare Revaluation Account, Partners’ Capital Account, Cash Account and Balance Sheet.

Revaluation Account
Dr.			Cr.
Particular	Amount ₹	Particular	Amount ₹
Rent Outstanding A/c	2,000	Stock	7,000
Provision for Debtors	2,000	Machinery	100,000
Furniture	35,000
Profit transferred:
	Anil’s Capital A/c	50,000
	Bijay’s Capital A/c	50,000	100,000
	107,000		107,000

Anil’s Capital Account
Dr.						Cr.
Date	Particular	J.F.	Amount ₹	Date	Particular	J.F.	Amount ₹
	Balance c/d		2,00,000		Balance b/d		150,000
					Revaluation A/c		50,000
			2,00,000				2,00,000

Bijay’s Capital Account
Dr.							Cr.
Date	Particular	J.F.	Amount ₹	Date	Particular	J.F.	Amount ₹
	Balance c/d		2,00,000		Balance b/d		150,000
					Revaluation A/c		50,000
			2,00,000				2,00,000

Chetan’s Capital Account
Dr.							Cr.
Date	Particular	J.F.	Amount ₹	Date	Particular	J.F.	Amount ₹
	Balance c/d		2,00,000		Cash A/c		2,00,000
			2,00,000				2,00,000

Cash Account
Dr.							Cr.
Date	Particular	J.F.	Amount ₹	Date	Particular	J.F.	Amount ₹
	Balance b/d		8,000		Balance c/d		2,08,000
	Chetan’s Capital A/c		2,00,000
			2,08,000				2,08,000

Balance Sheet of Anil, Bijay & Chetan as at April
Liabilities	Amount ₹	Assets	Amount ₹
Sundry Creditors	1,00,000	Cash in hand	2,08,000
Rent Outstanding	2,000	Cash at Bank	178,000
		Debtors	40,000
		Less: Provision	2,000	38,000
Capital Account
Anil	2,00,000		Stock	43,000
Bijay	2,00,000		Furniture	35,000
Chetan	2,00,000	6,00,000	Plant and Machinery	2,00,000
	7,02,000		7,02,000