In the world of partnership firms, the admission of a new partner is a significant event. It brings changes in the existing partnership agreement, profit-sharing ratio, and other financial aspects. This study note will guide you through the various concepts and accounting treatments involved when a new partner is admitted to a firm, as per the CBSE syllabus.
Tip
Always ensure that the new terms of partnership are clearly documented in the partnership deed.
When a new partner is admitted, several changes occur:
The existing partners may have to sacrifice a part of their profit share for the new partner. The ratio in which they sacrifice is called the sacrificing ratio.
$$ \text{Sacrificing Ratio} = \text{Old Ratio} - \text{New Ratio} $$
Example
If A and B are partners sharing profits in the ratio of 3:2. They admit C for 1/5th share. The new profit-sharing ratio will be calculated as follows:
When a new partner is admitted, the assets and liabilities of the firm may need to be revalued. The revaluation account is prepared for this purpose.
Note
All profits and losses from the revaluation account are transferred to the old partners' capital accounts in their old profit-sharing ratio.
The new partner brings in capital, which may lead to the adjustment of the existing partners' capital accounts. The capital can be brought in cash or kind.
Example
Suppose A and B are partners sharing profits in the ratio of 3:2. They admit C with a capital of $50,000. The capitals of A and B before admission are $60,000 and $40,000 respectively. The new profit-sharing ratio is 3:2:1.
Common Mistake
Not adjusting the capitals according to the new profit-sharing ratio can lead to incorrect financial statements.
Goodwill is the value of the firm's reputation and can be brought in by the new partner or adjusted among the old partners.
Example
Suppose the goodwill of the firm is valued at $30,000. The new partner, C, is to bring in his share of goodwill in cash. If C is admitted for 1/5th share:
Tip
Ensure that the goodwill is adjusted among the old partners in their sacrificing ratio.
The admission of a new partner involves several adjustments in the partnership firm. Understanding the concepts of profit-sharing ratio, revaluation of assets and liabilities, capital adjustments, and goodwill treatment is crucial for accurate financial reporting. Always document the changes in the partnership deed and ensure all entries are correctly recorded in the books of accounts.