A business firm seeks new partners with business expansion being one of the driving motives. As per the Partnership Act, 1932, a new partner can be admitted into the firm with the consent of all the existing partners, unless otherwise agreed upon.
With the admission of a new partner, there is a reconstitution of the partnership firm and all the partners get into a new agreement for carrying out the business of the firm.
The following conditions led to the addition of a new partner:
- When the firm is in an expansion mode and requires fresh capital.
- When the new partners possess expertise, which can be beneficial for the business expansion of the firm.
- When the partner in question is a person of reputation and adds goodwill to the firm.
The following adjustments need to be made at the time of admission of a new partner
- Calculating the new profit-sharing ratio along with the sacrificing ratio.
- Accounting for goodwill.
- Revaluation of assets and liabilities.
- Adjustment of capital as per new profit-sharing ratio.
With the admission of a new associate, the partnership enterprise is restructured and a new agreement is entered into; to carry on the trading concern of the enterprise. A newly added partner obtains 2 primary rights in the enterprise:
- Right to share the assets of the partnership firm
- Right to share the profits of the partnership 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 partner’s capital, new partner’s 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(ii) The new partner brings goodwill in cash but the cash is withdrawn by the old partners.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 partner’s 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.
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 revalued 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.
Capitals of Partners to be Proportionate to Profit-Sharing Ratio:
It is often agreed on admission of a partner that the capitals of all partners should be in proportion to their respective shares in profits. The starting point may be the new partner’s capital or the new partner himself may be required to bring in capital equal to his share in the firm. If the new partner’s capital is given, one should find out the total capital of the firm on the basis of his share.
Adjustment of Capital and Change in Profit Sharing Ratio Among Existing Partners
Few significant points which require observation during the admission of a new partner are mentioned below:
- Sacrificing ratio
- New profit-sharing ratio
- Revaluation of assets and Reassessment of liabilities
- Valuation and adjustment of goodwill
- Adjustment of partners’ capitals
- Distribution of accumulated profits (reserves)