ADMISSION OF PARTNER-ACCOUNTING TREATMENT

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
reconstitution of the partnership firm. This results in 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 reconstitution of the firm in various
ways such as admission of a new partner, change in profit sharing ratio, 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.

ADMISSION OF PARTNER:
When firm requires additional capital or managerial help or both for the expansion of its business a new
partner may be admitted to supplement its existing resources. According to the Partnership Act 1932, a new
partner can be admitted into the firm only with the consent of all the existing partners unless otherwise
agreed upon. With the admission of a new partner, the partnership firm is reconstituted and a new agreement
is entered into to carry on the business of the firm. A newly admitted partner acquires two main rights in the
firm
1. Right to share the assets of the partnership firm; and
2. Right to share the profits of the partnership firm. For the right to acquire share in the assets and profits of
the partnership firm, the partner brings an agreed amount of capital either in cash or in kind. Moreover, in
the case of an established firm which may be earning more profits than the normal rate of return on its
capital the new partner is required to contribute some additional amount known as premium or goodwill.
This is done primarily to compensate the existing partners for loss of their share in super profits of the firm.

TREATMENT OF GOODWILL:
Depending upon the share of profits to be given to the new partner, either a sum of money will be directly
paid by him to the old partners (through the firm or privately) or after recording new partners capital, new
partners capital account will be debited with his share of goodwill, the credit being given to the old partners
in the ratio of their sacrifice of future profits. The latter is an indirect method of payment for goodwill by the
new partner. The payment is justified became the new partner will take a share of profits which comes out of
the shares of other partners. The old partners must be compensated for such a loss.
THE VARIOUS POSSIBILITIES AS REGARDS GOODWILL ARE:
(i) The new partner brings goodwill in cash which is left in the business.
(ii) The new partner brings goodwill in cash but the cash is withdrawn by the old partners.
(iii) The amount of goodwill is paid by the new partner to the old partners privately.
(iv) The new partner does not bring in cash for goodwill as such; but an adjustment entry is passed by which
the new partners capital account is debited with his share of goodwill and the amount is credited to old
partners capital accounts in the ratio of sacrifice. This entry reduces the capital of the new partner by the
amount of his share of goodwill and results in payment for goodwill by the new partner to the old partners.

Before considering the entries to be made in the above cases, one must decide regarding the ratio in which
goodwill is to be credited to the old partners. Traditionally, goodwill was credited to the old partners in the
old profit-sharing ratio and, if the amount was to be written off as in case (v) above, it was written off to all
the partners in the new profit-sharing ratio.
There would be no doubt that this should be the case when, on the admission of a new person as partner, the
ratio as among the old partners does not change. But what if on the admission of a new partner, the profitsharing ratio of old partners as among themselves is also changed.
If one treats paying sums in respect of goodwill to old partners as compensation for their surrendering to the
new partner a part of their profits, then obviously the amount to be credited to partners should be in then
ratio of loss of profits. Suppose, A and B, sharing in the ratio of 3: 2, admit C as partner and it is agreed that
the new profit-sharing ratio is 2: 2: 1. It is obvious that B does not suffer at all on Cs admission. He
previously received 2/5ths of profits; he still receives 2/5ths of profits. It is A alone who has suffered and,
therefore, any amount brought in as goodwill by C should be credited to only A. Thus, it is proper to credit
goodwill brought in by a new partner to the old partners in the ratio in which they suffer on the admission of
the new partner.
THE ENTRIES TO BE PASSED IN THE FOUR CASES GIVEN ABOVE ARE:

ILLUSTRATION 1
A and B share profits in the ratio: A, 5/8 and B 3/8. C is admitted as partner. He brings in Rs 70,000 as his
capital and Rs 48,000 as goodwill. The new profit-sharing ratio among A, B and C respectively is agreed to
be 7: 5: 4 respectively. Pass Journal entries.

In the above illustration, the old partners have allowed the amounts of goodwill credited to their capital
accounts remain in the business. However, the arrangement may allow the old partners to wholly or partly
withdraw the amounts of goodwill credited to their capital accounts. Suppose, in the above illustration, A
and B withdraw their shares of goodwill A and B withdraw their shares of goodwill brought in by C.

THE FOLLOWING ADDITIONAL JOURNAL ENTRY WILL HAVE TO BE

PASSED:

If the case is that the amount of goodwill is paid by the new partner to the old partners privately, no entry is
passed in the books of the firm. But the calculations have to be made in the same manner as shown above.

REVALUATION OF ASSETS AND LIABILITIES:

When a new partner is admitted, it is natural that he should not benefit from any appreciation in the value of
assets which has occurred (nor should he suffer because of any fall which has occurred up to the date of
admission) in the value of assets. Similarly, for liabilities.
Therefore, assets and liabilities are revalue and the old partners are debited or credited with the net loss or
profit, as the case may be, in the ratio in which they have been sharing profits and losses hitherto. Partners
may agree that the change in the value of assets and liabilities is to be adopted and figures changed
accordingly or that the assets and liabilities should continue to appear in the books of the firm at the old
figures.
(i) Values to be altered in books. In this case, a Profit and Loss Adjustment Account (or Revaluation
Account) is opened and the following steps should be taken
(a) If the values of assets increase, the particular assets should be debited and the Revaluation Account
credited with the increases only.
(b) If the values of assets fall, the Revaluation Account should be debited and the particular assets credited
with the fall in values.
Note:
If the value of debtors, investments or stock falls, the entry should be to debit the Revaluation Account and
credit a suitable provision account. Thus, suppose it is desired to record a fall in value of investments to the
extent of Rs 9,500.
The entry is:

If there is already a provision against a particular asset and the value of that asset increases, the entry should
be to debit the Provision and credit Revaluation Account rather than to follow (a) above.
(c) Increase in the amounts of liabilities is a loss.
Hence, the entry is:

If an increase is not definite but is expected, the credit should be to a suitable provision account.
(d) Any reduction in the amounts of liabilities is a profit and hence the liabilities accounts should be debited
and Revaluation Account credited with the difference between the old and present figures.
(e) The Revaluation Account should then be closed by transfer to old partners capital (or current) accounts
in the old profit-sharing ratio. If debits exceed the credits, it is a loss and the entry is to debit partners capital
(or current) accounts and credit Revaluation Account. Reverse entry is made when the credits exceed debits.

ILLUSTRATION
The balance sheet of a partnership firm of X and Y, who were sharing profits in the ratio of 5: 3
respectively, as on 31st March, 2012 was as follows:

On the above date, Z was admitted on the following terms:

(i) Z would get 1/5th share in the profits.
(ii) Z would pay Rs 1, 20,000 as capital and Rs 16,000 for his share of goodwill.
(iii) Machinery would be depreciated by 10% and building would to be appreciated by 30%. A provision for
bad debts @ 5% on debtors would be created. An unrecorded liability amounting to Rs 3,000 for repairs to
building would be recorded in the books of account.
(iv) Immediately after Zs admission, goodwill account would be written off. Thereafter, the capital accounts
of the old partners would be adjusted through the necessary current accounts in such a manner that the
capital accounts of all the partners would be in their profit showing ratio. Prepare revaluation account,
capital accounts and the initial balance sheet of the new firm.