Admission of New partner

Sometimes a new partner is needed into the business due to the following reasons:
a. When more capital is needed for the expansion of the business
b. When competent and experienced person is needed for efficient running of the business
c. To increase the goodwill of the business by taking a reputed and renowned person into
the partnership
d. To encourage a capable employee by taking him into the partnership
According to section 31 (1) of the Indian Partnership Act, a new partner can be admitted only
with the consent of all the existing partners
Following adjustments are needed at the time admission of a new partner
1. Calculation of new PSR
2. Accounting treatment of goodwill
3. Accounting treatment for revaluation of assets and liabilities
4. Accounting treatment of reserves and accumulated profits
5. Adjustment of capitals on the basis of new PSR

Calculation of New PSR
a. When only the ratio of the new partner is given, then in the absence of any agreement, it
is presumed that the old partners will continue to share the remaining profits in the
same ratio in which they were sharing before the admission of a new partner
b. Sometimes the new partner purchases his share of profit from the old partners equally.
In such case the new PSR of the old partners will be ascertained by deducting the
sacrifice made by them from their existing share of profit.
c. Sometimes the new partner purchases his share from the old partners in a particular
ratio. In such case the new PSR of old partners will be calculated after deducting the
sacrifice made by a partner from his existing share of profit.
d. Sometimes the old partners surrender a particular fraction of their share in favor of new
partner. In such cases the new partners share is calculated by adding the surrendered
portion of the share by the old partners. Old partners shares are calculated by deducting
the surrendered share from their old shares.

1. Sacrificing ratio
When there is an admission of a new partner, old partners have to surrender some of their old
shares in the favor of new partner. The ratio in which they surrender their profits is called
sacrificing ratio. Goodwill is paid to the old partners in their sacrificing ratio because the
goodwill is the amount of compensation to be paid by the new partner to the old partners for
acquiring the share of profits which they have surrendered in the favor of the new partner.
Sacrificing ratio = old ratio new ratio
2. Accounting treatment of goodwill in the admission of a new partner
There may be three situations related to treatment of goodwill
a. When the amount of goodwill is paid privately in cash to the old partners
outside the business then no entries are required to be passed.

b. When new partners bring his share of goodwill in cash, then there are two
alternatives

When amount of good will brought in by new partner is retained in the business then the
amount is credited to the capital accounts of old partners in their sacrificing ratio.

Cash a/c.dr
To premium for goodwill a/c
(Amount of goodwill brought in cash by new partners)

Premium of goodwill a/c
To old partners capital a/c
(The amount of goodwill transferred to old partners capital account in sacrificing ratio)

When goodwill brought in by new partner is withdrawn by the old partners

Old partners capital a/cdr
To cash a/c

When goodwill already appears in the books and new partner bring his share of goodwill
in cash, first of all the existing goodwill account will have to be written off. For this
purpose the old partners capital accounts are debited in their old PSR and good will
account is credited.

Old partners capital account..dr
To goodwill a/c
(goodwill is written off in old ratio)


c. When the new partner does not bring his share of goodwill in cash
AS (26) Intangible assets specifies that goodwill can be recorded in books when some
consideration in money has been paid for it. It means that only purchased goodwill can
be recorded in the books and goodwill account cannot be raised.
When the goodwill of the firm is evaluated and the new partner does not bring his share
of goodwill in cash, goodwill should be adjusted through partners capital accounts. For
this purpose new partners current account is debited from his share of goodwill and the
old partners capital accounts are credited in their sacrificing ratio.
New partners current accountdr(from his share of good will)
To old partners capital account (in sacrificing ratio)
(current account of new partner debited
from his share of Goodwill on his admission
and capital account of old partners
credited in their sacrificing ratio)

New partners current account has been debited instead of his capital account so that his
capital account is not reduced.


When goodwill already appears and a new partner does not bring in his share of goodwill
in cash, the amount of goodwill already existing is written off by debiting the capital
accounts of old partners in old ratio.
When new partner brings in only a part of his share of goodwill.


3. Accounting treatment of reserves and accumulated profits/Losses when there
is change in PSR
a. If there is change in the PSR, then the reserves and accumulated profits existing in the
books of the firm should be transferred to partners capital account in their old profit
sharing ratio. The reason for such transfer is that these reserves and accumulated
profits/losses have come into existence before the change in PSR and hence belong to the
partners in their old PSR

For transfer of reserves and accumulated profits
Reserve a/c..dr
P&L a/cdr
Workmens compensation reserve a/c..dr (excess of reserve over actual
liability)
Investment fluctuation reserve a/cdr (excess of reserve over difference
between book value and market value)

To old partners capital account (in old ratio)


For transfer of accumulated losses
Old partners capital account dr
To Profit & Loss a/c
To deferred revenue expenditure a/c

b. When reserves and accumulated profit/losses are not to be transferred to
capital accounts
In case of change in PSR, the reserves and accumulated profits appearing in the balance
sheet and partners decide to leave the reserves and accumulated profits undistributed, it
will be necessary to pass an adjusting entry for the same. This is because at present the
partners are entitled to share such reserves and profits in the old PSR whereas in future
they will be entitled to share such profits and reserves in the new profit sharing ratio.
Hence the gaining partner must compensate the sacrificing partner that share of
reserves and profits which is proportionate to the share gained by him.


4. Accounting for revaluation of asset and liabilities when there is change in the
PSR of existing partners
Assets and liabilities of a firm must be revalued at the time of change in the PSR. The reason
is that the actual value of the asset and liabilities may be different from those shown in the
balance sheet. Revaluation of assets and liabilities belongs to the period prior to the change
in the PSR and hence must be shared by the partners in the old PSR.

Revaluation of assets and liabilities may be given effect in two different ways
a. When revised values are to be recorded in the books: in this case revaluation of asset and
liabilities is done with help of new account called revaluation account. Sometimes it is
also called as P&L adjustment a/c


Revaluation Account
Particulars Amount Particulars Amount

To decrease in the value of assets
To increase in the value of liabilities
To unrecorded liabilities
To Profit on revaluation transferred
to partners capital account (in old
ratio)



.

.
.

By increase in value of asset
By decrease in value of liabilities
By unrecorded assets
By loss on revaluation transferred to
partners capital account (in old
ratio)

.

.
.

If the credit side of the account exceeds, it reveals profit and if the debit side is in excess, it will
reveal a loss. Such a profit or loss will be divided between all partners in their old PSR.
1. When revaluation account shows profit
Revaluation a/c..dr
To partners capital a/c
(profit on revaluation credited to partners a/c)

2. When revaluation a/c shows loss
Partners capital a/c..dr
To revaluation a/c
(loss on revaluation debited to partners capital a/c)


b. When revised values are not to be recorded in the books. In that case the memorandum
revaluation account is prepared. It is divided into two parts. First part is prepared to
record the increase or decrease in the value of assets and liabilities in usual way. The
profit or loss on revaluation in the first part of this account is transferred to old partners
capital account in old PSR.

In order to complete the double entry, entries made in the first part of the Memorandum
Revaluation account are reversed in the second part again without passing any entries in
the accounts of asset and liabilities in ledger. The balance of the second part of
memorandum revaluation account is transferred to capital account of all partners
including the new partner in the new PSR.

Note:
1. Hidden goodwill: if the value of goodwill is not given in the question, in such
case the amount of goodwill is calculated on the basis of the total capital of the firm and
profit sharing ratio of partners.
2. Sometimes the capital of new partner is not given in the question. He may be
required to bring in proportionate capital. In such cases the new partners capital will be
calculated on the basis of the capitals of the old partners remaining after all adjustment
and revaluation.
3. Adjustment of old partners capital accounts on the basis of new partners
capital
Sometimes on the admission of a new partner it is decided that the capitals of old
partners will be adjusted on the basis of new partners capital to make them
proportionate to their share of profits.
In such questions, first of all the entire capital of the new firm is determined on the basis
of new partners capital. Then the capital of each partner is determined by dividing the
total capital according to his PSR.
If the existing capital of any partner is in excess of his newly calculated capital, the excess
amount is either paid off immediately or credited to his current account

Old partners capital a/c.dr
To bank a/c or partners current a/c

If the existing capital of any partner is less than his newly calculated capital
Bank a/c or partners current a/c..dr
To partners capital a/c