Unit 2: Reconstitution of a Partnership Firm – Admission of a Partner

The following matters need adjustment when adding a new partner:

1. Capital Adjustment among partners.

2. Revised calculation of profit sharing ratio.

3. Evaluating and adjusting the goodwill of partners who are sacrificing their share.

4. Accumulated profits, reserves and losses should be distributed to old partners as per the old ratio that was agreed upon.

5. Revaluation of the Liabilities and Assets to determine the current value and distribution of profit or loss as per the old ratio.

At the time of admission of a new partner, the existing partners sacrifice their present profit-sharing ratio to make way for a share in profit sharing to the new partner, which results in reducing their profit. Therefore, it is essential to determine the new profit-sharing ratio for old partners on the occasion of adding a new partner, as it creates a more justified share of profit.

The portion of the profit-sharing ratio that is sacrificed by current partners when a new partner joins the firm is called as sacrificing ratio. It is calculated as the difference between the old profit-sharing ratio and the new profit-sharing ratio.

Sacrificing ratio = Old profit sharing ratio – New profit sharing ratio

It is compulsory to determine this ratio, as the new partner has to reimburse the existing partner for making the sacrifice of profit. It is paid to them as goodwill.

Sacrificing ratio needs to be used in these occasions:

1. When it is mutually decided by the partners of the firm to change the profit-sharing ratio among the partners.

2. A new partner is introduced in the firm, and accordingly, the sum contributed by the new partner is distributed as goodwill based on the sacrificing ratio of existing partners.

The goodwill that exists in the firms before the arrival of a new partner must be written off between the existing partners in the ratio of their profit sharing as previously decided. The following journal entry needs to be passed:

Old Partner’s Capital A/c

Dr.

To Goodwill A/c

(Being goodwill written off in the old ratio between existing partners)

When a new partner gets admitted to the firm, there is a need to revalue the Liabilities and Assets of the firm to determine the true value on that day. Revaluation is helpful as the value of Liabilities and Assets may increase or decrease, and as such, their values in the old balance sheet may not be 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 to be prepared, and the associated profits or losses need to be distributed between the existing partners of the firm.