RECONSTITUTION OF PARTNERSHIP FIRM (ADMISSION OF PARTNER)

MEANING :
RECONSTITUTION OF PARTNERSHIP MEANS CHANGE IN THE FORM OF PARTNERSHIP. A
CHANGE IN THE AGREEMENT AMONG PARTNERS WHICH LEAD TO CHANGE IN THE
RELATIONSHIP BETWEEN THE PARTNERS & CHANGE IN THE P&L OF THE PARTNERS IN
THE FIRM.

DIFFERENT FORMS OF RECONSTITUTION:

1. CHANGE IN PROFIT SHARING RATIO
2. ADMISSION OF A PARTNER
3. RETIREMENT OF PARTNER
4. DEATH OF A PARTNER

ADMISSION OF A PARTNER:
A PERSON CAN BE ADMITTED AS A PARTNER ONLY WITH THE CONSENT OF ALL
EXISTING PARTNERS. NEW PARTNER BRINGS CAPITAL & GOODWILL & GETS RIGHTS IN
FUTURE PROFITS OF THE FIRM.

ACCOUNTS/STATEMENTS/ WORKINGS TO BE MADE :

1. REVALUATION / PROFIT & LOSS ADJUSTMENT A/C (NOMINAL A/C)
2. PARTNERS CAPITAL/CURRENT A/C (PERSONAL A/C)
3. CASH A/C (W.N) - TO FIND OUT CLOSING BALANCE OF CASH
4. WORKING NOTE - NEW RATIO/SACRIFICE RATIO (IF REQUIRED)
5. BALANCE SHEET OF NEW FIRM 6. JOURAL ENTRIES IF ASKED

INFORMATION PROVIDED:
1. BALANCE
*
SHEET 2. ADJUSTMENTS/INFORMATION
 TREATMENTS OF GOODWILL

BROUGHT IN CASH (PREMIUM METHOD) ALREADY IN OLD B/S PVTLY.

NO ENTRY

INC. IN VALUE - DEC. IN VALUE -

CR. REV. A/C DR. REV. A/C
CASH/RETAINED(2) CASH & WITHDRAWN(3)

CASH A/C DR CASH A/C DR

TO GOODWILL A/C TO GOODWILL A/C NOT BROUGHT IN CASH - RAISED(VALUATION METHOD)

GOODWILL A/C GOODWILL A/C

DR DR
TO OLD P.CAP. A/C TO OLD P.CAP. A/C
(S.R.) (S.R.)
RAISED & W.OFF (2)
RAISED (1)
* G/W A/C TALLY OLD P.CAP A/C DR GOODWILL A/C GOODWILL A/C
TO CASH A/C DR DR
TO OLD P.CAP. A/C TO OLD P.CAP. A/C
(% WITHDRAWN) (O.R.) (O.R.)

* G/W A/C WILL

* G/W A/C TALLY ALL P.CAP A/C DR
NOT TALLY,
TO GOODWILL A/C
HENCE WILL
(NEW RATIO)
APPEAR IN NEW
* B/S
* G/W A/C TALLY
 FEATURES OF REVALUATION A/C
1. MEANING:
AN ACCOUNT PREPARED WHILE RECONSTITUTION OF PARTNERSHIP FIRM TO
RECORD THE PROFIT OR LOSS ON REVALUATION OF ASSETS & LIABILITIES
IS CALLED REVALUATION A/C.

2. TYPE OF A/C - NOMINAL A/C

3. THE DIFFERENCE AMT. ON REVALUATION OF ASSETS & LIABILITIES IS

ONLY TO BE RECORDED

4. DR SIDE - DECREASE IN VALUE OF ASSET & INCREASE IN VALUE OF

LIABILITY
CR SIDE - INCREASE IN VALUE OF ASSET & DECREASE IN VALUE OF
LIABILITY

5. OBJECTIVE - TO FIND OUT PROFIT/LOSS ON REVLUATION OF ASSETS &

LIABILITIES

6. DEBIT BALANCE - LOSS ON REVALUATION (APPEARS ON CR SIDE)

7. CREDIT BALANCE - PROFIT ON REVALUATION (APPEARS ON DR SIDE)

8. PROFIT/LOSS IS TRANSFERRED ONLY TO OLD PARTNERS CAPITAL/CURRENT

A/C IN THEIR OLD RATIO
*
 CALCULATION OF GOODWILL
MEANING :
G/W IS THE REPUTATION, BENEFIT, NAME, FAME, IMAGE OF A BUSINESS IN TERMS OF
MONEY, WHICH ULTIMATELY HELPS TO EARN PROFIT.
GOODWILL IS ALWAYS CALCULATED ON THE BASIS OF PAST PERFORMANCE.

METHODS:
1. AVERAGE PROFIT METHOD 2. SUPER PROFIT METHOD

AVERAGE PROFIT METHOD:

UNDER THIS METHOD G/W IS CALCULATED ON THE AVG. BASIS OF PAST NO. OF YRS. OF
PROFIT. IT IS ASSUMED THAT THE FIRM WILL MAINTAIN THE AVG. PROFIT FOR CERTAIN
NO. OF YRS. & SO THE G/W IS CALCULATED ON THE BASIS OF CERTAIN NO. OF YRS
PURCHASE OF AVG. PROFIT.
STEPS:
1. CALCULATE TOTAL PROFIT
2. CALCULATE AVG. PROFIT
3. APPLY FORMULA

G/W = AVG. PROFIT × NO. OF YRS. PURCHASE

EG: CALCULATE G/W OF THE FIRM, IF NEW PARTNER FOR 1/5TH SHARE WILL BRING CASH
FOR HIS SHARE, IF G/W IS BASED ON 2 YRS. PURCHASE OF PROFITS OF LAST 5 YRS.
1) 60000 2) 45000 3) 75000 4) 30000 5) 45000(LOSS)

TOTAL PROFIT = 60000 + 45000 + 75000 + 30000 - 45000 = 165000

AVG. PROFIT = 165000/5 = 33000
G/W OF THE FIRM = AVG. PROFIT X NO. OF YRS OF PURCHASE = 33000 X 2 = 66000
NEW PARTNER'S SHARE IS I/5TH HENCE 66000/5 = 13200 Rs. WILL BE BROUGHT AS CASH
FOR G/W.
 CALCULATION OF GOODWILL
SUPER PROFIT METHOD:
IT IS THE PROFIT EARNED OVER & ABOVE THE NORMAL PROFIT. IF A FIRM EARNS EXTRA
PROFIT THAN THE NORMAL STANDARD PROFIT, THIS IS BECAUSE OF REPUTATION OF
THE FIRM. SO SUPER PROFIT CAN BE CONSIDERED AS THE BASE FOR CALCULATION
OF GOODWILL.

CAPITAL EMPLOYED:
IT IS THE AMOUNT OF CAPITAL USED BY FIRM TO START & RUN BUSINESS.(A-L)

NORMAL RATE OF RETURN: (%)

IT IS THE RATE OF RETURN NORMALLY EARNED BY THE FIRMS IN THE SAME INDUSTRY.

STEPS:
1. CALCULATE AVG. PROFIT
2. CALCULATE NORMAL PROFIT
3. CALCULATE SUPER PROFIT
3. APPLY FORMULA FOR G/W

G/W = SUPER PROFIT × NO. OF YRS. PURCHASE

NORMAL ROFIT = CAPITAL EMPLOYED × N.R.R.

SUPER PROFIT = AVG PROFIT － NORMAL PROFIT

 CALCULATION OF GOODWILL
STEPS:
1. CALCULATE AVG. PROFIT
2. CALCULATE NORMAL PROFIT
3. CALCULATE SUPER PROFIT
3. APPLY FORMULA
G/W = SUPER PROFIT × NO. OF YRS. PURCHASE
NORMAL ROFIT = CAPITAL EMPLOYED × N.R.R.

SUPER PROFIT = AVG PROFIT － NORMAL PROFIT

EG : CALCULATE THE G/W AT 3 YEAR'S PURCHASE OF SUPER PROFIT, FROM THE FOLL.
INFORMATION:
A)PROFITS OF LAST FIVE YRS. :
1) 80000 2)95000 3) 110000 4) 40000(LOSS) 5) 85000
B) CAPITAL EMPLOYED : 350000 C)N.R.R. IS 12%

AVG. PROFIT = 80000 + 95000 + 110000 + 85000 － 40000 = 330000

5 5
= 66000
NORMAL PROFIT = 350000 × 12
100
= 42000

SUPER PROFIT = 66000 － 42000

=24000

GOODWILL = 24000 × 3
= 72000
 JOURNAL ENTRIES
1. FOR TRANSFER OF GENERAL RESERVE TO OLD PARTNER'S CAPITAL
A/C:
GENERAL RESERVE A/C DR
TO A'S CAPITAL A/C
TO B'S CAPITAL A/C
(O.R)

2. FOR TRANSFER OF UNDISTRIBUTED PROFIT/LOSS TO OLD

PARTNER'S CAPITAL A/C:

UNDISTRIBUTED LOSS - ASSET SIDE UNDISTRIBUTED PROFIT - LIABILITY

A'S CAPITAL A/C DR P&L A/C A/C DR
B'S CAPITAL A/C DR TO A'S CAPITAL A/C
TO P&L A/C TO B'S CAPITAL A/C
(O.R) (O.R)

3. FOR CAPITAL BROUGHT IN BY NEW PARTNER 'C':

CASH/BANK A/C DR
TO C'S CAPITAL A/C A/C

4. GOODWILL TREATMENT ENTRIES: (DEPENDING UPON THE INF.)

*
 JOURNAL ENTRIES
5. FOR ENTRIES IN REVALUATION A/C - DR. SIDE :
REVALUATION A/C A/C DR
TO ASSET A/C (FALL IN VALUE)
TO LIABILITY A/C (INC. IN VALUE)
6. FOR ENTRIES IN REVALUATION A/C - CR. SIDE :
ASSET A/C (INC. IN VALUE) DR
LIABILITY A/C (DEC. IN VALUE) DR
TO REVALUATION A/C

7. FOR LIABILITY PAID IN CASH WITH DISCOUNT (LESSER VALUE)

LIABILITY A/C DR
TO CASH/BANK A/C
TO REVALUATION A/C (DIS.)

8. FOR LIABILITY PAID IN CASH WITH HIGHER VALUE (INT. ETC)

LIABILITY A/C DR
REVALUATION A/C (H.V) DR
TO CASH/BANK A/C
9.FOR RECORDING UNRECORDED ASSET (NOT GIVEN IN B/S BUT IS GIVEN IN
ADJ):
ASSET A/C DR
* THIS ASSET WILL APPEAR IN NEW B/S
TO REVALUATION A/C
 JOURNAL ENTRIES
10. FOR CREATING NEW /UNRECORDED LIABILITY : (NOT IN B/S BUT
GIVEN IN ADJ.)
REVALUATION A/C DR
TO LIABILITY A/C THIS LIABILITY WILL APPEAR IN NEW B/S

11. FOR TRANSFER OF PROFIT/LOSS ON REVALUATION TO OLD PARTNER'S

CAPITAL A/C: (CLOSING OF REVALUATION/C)

PROFIT ON REVALUATION - CR BAL

REVALUATION A/C DR
TO A'S CAPITAL A/C
TO B'S CAPITAL A/C
(O.R.)

LOSS ON REVALUATION - DR BAL

A'S CAPITAL A/C DR
B'S CAPITAL A/C DR
TO REVALUATION A/C
(O.R.)

*
 NEW RATIO
1. MEANING :
WHEN A NEW PARTNER IS ADMITTED IN PARTNERSHIP FIRM THE PROFIT
SHARING RATIO OF EXISTING PARTNERS CHANGE & THERE IS A NEED TO
CALCULATE NEW PROFIT SHARING RATIO INCLUDING THE NEW PARTNER.

THIS RATIO IS TO BE CALCULATED ONLY WHEN:

1. WRITING OFF GOODWILL
2. CAPITAL ADJUSTMENT

NEW RATIO = BALANCE OF 1 × OLD RATIO

BALANCE OF 1 = 1 - SHARE OF PROFIT GIVEN TO NEW PARTNER

EG. 1 : IF A & B ARE PARTNERS SHARING P& L IN RATIO 3:1. THEY ADMIT C FOR 1/4 TH SHARE IN
PROFIT. CALCULATE NEW RATIO.

BALANCE OF 1 = 1_ 1 = 3
4 4

NEW RATIO OF A = 3 × 3 NEW RATIO OF B = 3 × 1 NEW RATIO OF C = 16 - 12

4 4 4 4

= 9 = 3 = 4
16 16 16

HENCE N.R = 9 : 3 : 4

*
 NEW RATIO
NEW RATIO = BALANCE OF 1 × OLD RATIO
EG. 2 : IF A & B ARE PARTNERS SHARING P& L IN RATIO 1 : 2. THEY ADMIT C FOR 1/5 TH SHARE IN
PROFIT. CALCULATE NEW RATIO.
BALANCE OF 1 = 1_ 1 = 4
5 5

NEW RATIO OF A = 4 × 1 NEW RATIO OF B = 4 × 2 NEW RATIO OF C = 15 - 12

5 3 5 3

= 4 = 8 = 3
15 15 15

HENCE N.R = 4 : 8 : 3
EG.3 : IF A & B ARE PARTNERS SHARING P& L IN RATIO 1 : 1. THEY ADMIT C FOR 1/3 RD SHARE IN
PROFIT. CALCULATE NEW RATIO.

BALANCE OF 1 = 1- 1 = 2
3 3

NEW RATIO OF A = 2 × 1 NEW RATIO OF B = 2 × 1 NEW RATIO OF C = 6 - 4

3 2 3 2

= 2 = 2 = 2
6 6 6

HENCE N.R = 2 : 2 : 2
N.R = 1 : 1 : 1

*
 SACRIFICE RATIO
1. MEANING :
WHEN A NEW PARTNER IS ADMITTED IN PARTNERSHIP FIRM THE OLD
PARTNERS HAVE TO SACRIFICE THEIR SHARE OF PROFIT TO NEW
PARTNER, THE RATIO IN WHICH THE OLD PARTNERS SACRIFICE THEIR
SHARE OF PROFIT IS CALLED SACRIFICE RATIO.

IT IS TO BE CALCULATED ONLY FOR:

1. RETAINING G/W WHEN G/W IS BROUGHT IN CASH (PREMIUM METHOD)

SACRIFICE RATIO = OLD RATIO － NEW RATIO

EG. 1 : IF A & B ARE PARTNERS SHARING P& L IN RATIO 3:1. THEY ADMIT C FOR 1/4 TH SHARE IN
PROFIT. CALCULATE NEW RATIO.
BALANCE OF 1 = 1_ 1 = 3
4 4

NEW RATIO OF A = 3 × 3 NEW RATIO OF B = 3 × 1 NEW RATIO OF C = 16 - 12

4 4 4 4

= 9 = 3 = 4
16 16 16

HENCE N.R = 9 : 3 : 4
SACRIFICE R. OF A = 3 _ 9 SACRIFICE R. OF B = 1 _ 3
4 16 4 16 GENERALLY S.R. AND O.R.
ARE EQUAL.
= 12 - 9 = 4-3 ONLY IF N.R. IS ALREADY
16 16 CALCULATED & GIVEN
IN PROBLEM, THEN S.R
= 3 =
1 MAY BE DIFFERENT THEN
16 16 THE OLD RATIO.
* HENCE S.R OF A&B = 3 : 1
 SACRIFICE RATIO
NEW RATIO = BALANCE OF 1 × OLD RATIO
EG. 2 : IF A & B ARE PARTNERS SHARING P& L IN RATIO 1 : 2. THEY ADMIT C FOR 1/5 TH SHARE IN
PROFIT. CALCULATE NEW RATIO.
BALANCE OF 1 = 1_ 1 = 4
5 5

NEW RATIO OF A = 4 × 1 NEW RATIO OF B = 4 × 2 NEW RATIO OF C = 15 - 12

5 3 5 3

= 4 = 8 = 3
15 15 15

HENCE N.R = 4 : 8 : 3
SACRIFICE R. OF A = 1 _ 4 SACRIFICE R. OF A = 2 _ 8
3 15 3 15

= 5-4 = 10 - 8
15 15

= 1 = 2
15 15
HENCE S.R. OF A& B = 1 : 2