Question 1

Identify various matters that need adjustments at the time of admission of a new partner.

Accepted Answer

At the time of admission of a new partner, adjustments are needed in the following matters:
1. Revaluation of assets and liabilities to reflect their current market value.
2. Treatment of goodwill, whether existing or new goodwill to be brought in by the new partner.
3. Adjustment of capital accounts of old partners and the new partner according to the new profit sharing ratio.
4. Calculation of new profit sharing ratio and sacrificing ratio.
5. Settlement of accumulated profits or losses, reserves, and other balances.
6. Adjustment of any undistributed profits or losses.
7. Treatment of partner’s loan accounts if any.
These adjustments ensure that the new partner joins on a fair basis and the accounts reflect the true financial position of the firm. — The admission of a new partner changes the structure of the partnership. To maintain fairness and accuracy, assets and liabilities are revalued, goodwill is adjusted, and capital accounts are recalculated. This ensures the new partner's share is correctly accounted for and old partners' interests are protected.

Question 2

Why it is necessary to ascertain new profit sharing ratio even for old partners when a new partner is admitted?

Accepted Answer

It is necessary to ascertain the new profit sharing ratio for all partners, including old partners, because the admission of a new partner changes the distribution of profits and losses among all partners. The old partners may have to sacrifice a part of their share in favor of the new partner. Without determining the new profit sharing ratio, it is impossible to correctly adjust capital accounts, goodwill, and profit distribution. This ensures clarity and fairness in the partnership agreement post-admission. — Admission of a new partner dilutes the profit share of existing partners. Calculating the new profit sharing ratio helps in determining how much each old partner sacrifices and how much the new partner gains, which is essential for proper accounting and legal clarity.

Question 3

What is sacrificing ratio? Why is it calculated?

Accepted Answer

Sacrificing ratio is the ratio in which the old partners sacrifice their share of profits in favor of the new partner. It is calculated by finding the difference between the old profit sharing ratio and the new profit sharing ratio of the old partners.

Sacrificing Ratio = Old Profit Sharing Ratio – New Profit Sharing Ratio

It is calculated to determine how much share of profit each old partner is giving up to the new partner. This ratio is important for adjusting goodwill and capital accounts when a new partner is admitted. — Since the new partner acquires a share in the profits, old partners must give up some portion of their share. The sacrificing ratio quantifies this sacrifice, which is essential for fair adjustment of goodwill and capital contributions.

Question 4

On what occasions sacrificing ratio is used?

Accepted Answer

Sacrificing ratio is used on the following occasions:
1. Admission of a new partner – to determine the share of goodwill or capital that old partners sacrifice in favor of the new partner.
2. Retirement or death of a partner – to calculate the share of profit that remaining partners gain from the outgoing partner.
3. Change in profit sharing ratio among existing partners – to adjust goodwill and capital accounts accordingly.

It helps in fair adjustment of goodwill and capital accounts among partners when profit sharing ratios change. — Whenever there is a change in the profit sharing ratio, the sacrificing ratio helps in quantifying the amount of profit share given up or gained by partners, which is essential for accounting adjustments.

Question 5

If some goodwill already exists in the books and the new partner brings in his share of goodwill in cash, how will you deal with existing amount of goodwill?

Accepted Answer

When goodwill already exists in the books and the new partner brings his share of goodwill in cash, the existing goodwill account is written off by debiting old partners’ capital accounts in their old profit sharing ratio and crediting the goodwill account. Then, the new partner’s share of goodwill brought in cash is credited to the old partners’ capital accounts in the sacrificing ratio.

Steps:
1. Write off existing goodwill:
 Dr. Old Partners’ Capital Accounts
 Cr. Goodwill Account
2. New partner brings goodwill in cash:
 Dr. Cash/Bank Account
 Cr. Old Partners’ Capital Accounts (in sacrificing ratio)

This ensures that the goodwill account is cleared and old partners are compensated for the goodwill sacrificed to the new partner. — Existing goodwill is removed from the books to avoid duplication. The new partner’s goodwill contribution is credited to old partners as compensation for their sacrifice. This maintains fairness and correct accounting.

Question 6

Why there is need for the revaluation of assets and liabilities on the admission of a partner?

Accepted Answer

Revaluation of assets and liabilities is necessary on the admission of a partner to reflect their true current market value. This is important because:
1. The new partner should join the firm on a fair basis, paying for the actual worth of the firm.
2. It ensures that the capital accounts of all partners reflect the true financial position.
3. It helps in adjusting accumulated profits or losses and reserves correctly.
4. It prevents any partner from gaining or losing unfairly due to outdated book values.

Thus, revaluation provides a fair basis for admission and correct accounting. — Assets and liabilities may have appreciated or depreciated since their last valuation. Revaluation ensures that the new partner’s capital contribution and profit sharing are based on the current financial status of the firm.

Question 7

Do you advise that assets and liabilities must be revalued at the time of admission of a partner? If so, why? Also describe how is this treated in the book of account?

Accepted Answer

Yes, it is advisable to revalue assets and liabilities at the time of admission of a partner. This is because the admission of a new partner changes the composition of the firm and the value of assets and liabilities may have changed since the last valuation. Revaluation ensures that the new partner's share in the firm is calculated on the current value of assets and liabilities, thus maintaining fairness among all partners.

In the books of account, the revaluation is recorded in a Revaluation Account (also called Profit and Loss on Revaluation Account). Any increase in asset values or decrease in liabilities is credited to the Revaluation Account, and any decrease in asset values or increase in liabilities is debited to the Revaluation Account. The balance of this account (profit or loss on revaluation) is then transferred to the old partners' capital accounts in their old profit sharing ratio. — Step 1: Identify assets and liabilities whose values have changed.
Step 2: Calculate increase or decrease in values.
Step 3: Pass journal entries to record revaluation:
- Debit Revaluation Account for decrease in assets or increase in liabilities.
- Credit Revaluation Account for increase in assets or decrease in liabilities.
Step 4: Transfer the balance of Revaluation Account to old partners’ capital accounts in old profit sharing ratio.
This process ensures that the new partner is admitted on a fair basis and old partners are compensated for any change in asset or liability values.

Question 8

What is goodwill? What factors affect goodwill?

Accepted Answer

Goodwill is an intangible asset that represents the reputation, brand value, customer loyalty, and other non-physical assets of a business which contribute to its earning capacity beyond the value of its tangible assets.

Factors affecting goodwill include:
1. Reputation of the firm
2. Location of the business
3. Quality of goods and services
4. Customer base and loyalty
5. Market conditions and competition
6. Profitability and earning capacity
7. Relationship with suppliers and employees
8. Trade connections and business agreements
9. Brand value and trademarks
10. Past record of the firm

These factors influence the value of goodwill as they affect the future earning potential of the business. — Goodwill arises due to the firm's ability to earn profits above the normal expected return on its assets. Factors listed above contribute to this ability and thus affect the value of goodwill.

Question 9

Explain various methods of valuation of goodwill.

Accepted Answer

Various methods of valuation of goodwill are:

1. Average Profit Method: Goodwill is valued by multiplying the average profit of past years by a certain number of years’ purchase.

2. Super Profit Method: Goodwill = Super Profit × Number of years’ purchase, where Super Profit = Actual Profit - Normal Profit.

3. Capitalization Method: Goodwill = Total Capitalized Value of the Firm - Capital Employed.

4. Annuity Method: Goodwill is calculated as the present value of super profits expected to be earned in future.

5. Market Value Method: Goodwill is the difference between the purchase price of the firm and the net asset value.

Each method has its own applicability depending on the availability of data and nature of business. — Step 1: Calculate average profit or super profit as per method.
Step 2: Determine number of years’ purchase or capitalization rate.
Step 3: Apply formula to calculate goodwill.
Step 4: Use market data if available for market value method.

Example: If average profit is ₹50,000 and goodwill is valued at 3 years’ purchase, then goodwill = 50,000 × 3 = ₹1,50,000.

Question 10

If it is agreed that the capital of all the partners should be proportionate to the new profit sharing ratio, how will you work out the new capital of each partner? Give examples and state how necessary adjustments will be made.

Accepted Answer

When the capital of all partners is to be proportionate to the new profit sharing ratio, the total capital of the firm is fixed first. Then, each partner’s capital is calculated by multiplying the total capital by their share in the new profit sharing ratio.

Example: Suppose total capital is fixed at ₹3,00,000 and new profit sharing ratio is A: 3/5, B: 2/5.

Then, A’s capital = 3,00,000 × 3/5 = ₹1,80,000
B’s capital = 3,00,000 × 2/5 = ₹1,20,000

Adjustments: If the existing capital of a partner is less than the new capital, the partner has to bring in the additional amount. If it is more, the excess amount is withdrawn by the partner.

Journal entries are passed to record the cash brought in or cash paid to partners for adjustment of capital. — Step 1: Fix total capital of the firm.
Step 2: Calculate each partner’s capital as per new profit sharing ratio.
Step 3: Compare with existing capital and calculate difference.
Step 4: Partners bring in or withdraw the difference.
Step 5: Pass journal entries for cash and capital adjustments.

This ensures that capital is aligned with profit sharing ratio.

Question 11

Explain how will you deal with goodwill when new partner is not in a position to bring his share of goodwill in cash.

Accepted Answer

When the new partner is not able to bring his share of goodwill in cash, the goodwill is treated as 'goodwill brought in by partners' and is adjusted through the capital accounts of the old partners.

The new partner’s share of goodwill is credited to the old partners’ capital accounts in their old profit sharing ratio. The new partner’s capital account is not credited with goodwill.

Journal entry:
No cash is received for goodwill.

Old partners’ capital accounts Dr.
To New partner’s capital account

This entry is passed to adjust the goodwill internally without actual cash transaction.

This method ensures that old partners are compensated for their share of goodwill without cash inflow from the new partner. — Step 1: Calculate new partner’s share of goodwill.
Step 2: Credit old partners’ capital accounts with their share of goodwill.
Step 3: Debit new partner’s capital account with total goodwill amount.
Step 4: Pass journal entry without cash.

This maintains the accounting balance and recognizes goodwill internally.

Question 12

Explain various methods for the treatment of goodwill on the admission of a new partner?

Accepted Answer

The various methods for the treatment of goodwill on admission of a new partner are:

1. Goodwill brought in cash by the new partner and credited to old partners in their old profit sharing ratio.

2. New partner not bringing goodwill in cash, goodwill is adjusted through partners’ capital accounts.

3. Goodwill raised in the books and then written off against partners’ capital accounts.

4. Goodwill written off against profit and loss account.

5. Goodwill raised and transferred to a separate goodwill account.

Each method has different accounting treatment but the objective is to compensate old partners for their share of goodwill and adjust the new partner’s share accordingly. — Step 1: Identify the method agreed upon.
Step 2: Pass journal entries accordingly:
- For cash brought in, debit cash and credit old partners’ capital accounts.
- For adjustment through capital accounts, debit new partner’s capital and credit old partners’ capital accounts.
- For writing off goodwill, debit goodwill account and credit partners’ capital accounts.

This ensures proper recognition and adjustment of goodwill on admission.

Question 13

How will you deal with the accumulated profits and losses and reserves on the admission of a new partner?

Accepted Answer

On the admission of a new partner, accumulated profits, losses, and reserves are adjusted to reflect the true financial position of the firm.

Treatment:
1. Accumulated profits and reserves are credited to old partners’ capital accounts in their old profit sharing ratio.

2. Accumulated losses are debited to old partners’ capital accounts in their old profit sharing ratio.

3. This adjustment ensures that the new partner does not get any share of past profits or losses.

Journal entries:
- For accumulated profits:
 Accumulated Profits Account Dr.
 To Old Partners’ Capital Accounts

- For accumulated losses:
 Old Partners’ Capital Accounts Dr.
 To Accumulated Losses Account

This treatment ensures fairness and correct capital balances. — Step 1: Identify accumulated profits, losses, and reserves.
Step 2: Transfer these to old partners’ capital accounts in old profit sharing ratio.
Step 3: Pass journal entries accordingly.
Step 4: New partner’s capital account is not affected by past profits or losses.

This maintains equity among partners.

Question 14

At what figures the value of assets and liabilities appear in the books of the firm after revaluation has been due. Show with the help of an imaginary balance sheet.

Accepted Answer

After revaluation, assets and liabilities appear in the books at their revalued amounts.

Example:
Suppose a firm has the following balance sheet before revaluation:

Assets:
Cash ₹10,000
Debtors ₹20,000
Stock ₹30,000
Machinery ₹40,000

Liabilities:
Creditors ₹15,000
Loan ₹25,000

Assume after revaluation:
- Stock is valued at ₹35,000 (increase of ₹5,000)
- Machinery is valued at ₹38,000 (decrease of ₹2,000)
- Creditors are ₹14,000 (decrease of ₹1,000)

Revaluation Account:
- Debit: Machinery ₹2,000
- Credit: Stock ₹5,000, Creditors ₹1,000

Balance of Revaluation Account is profit of ₹4,000 (5,000 + 1,000 - 2,000)

Revaluation profit is credited to old partners’ capital accounts.

Revalued Balance Sheet:

Assets:
Cash ₹10,000
Debtors ₹20,000
Stock ₹35,000
Machinery ₹38,000

Liabilities:
Creditors ₹14,000
Loan ₹25,000

Capital accounts adjusted accordingly.

This shows assets and liabilities at their revalued figures. — Step 1: Determine revalued amounts of assets and liabilities.
Step 2: Record revaluation profit or loss in Revaluation Account.
Step 3: Adjust partners’ capital accounts with revaluation profit or loss.
Step 4: Prepare balance sheet showing assets and liabilities at revalued figures.

This reflects true financial position after admission of new partner.

Question 15

A and B were partners in a firm sharing profits and losses in the ratio of 3:2. They admit C into the partnership with 1/6 share in the profits. Calculate the new profit sharing ratio?

Accepted Answer

Given: A:B = 3:2, C's share = 1/6

Step 1: Total share of A and B = 1 - 1/6 = 5/6
Step 2: A's new share = (3/5) × (5/6) = 3/6 = 1/2
Step 3: B's new share = (2/5) × (5/6) = 2/6 = 1/3
Step 4: C's share = 1/6

New profit sharing ratio = A:B:C = 1/2: 1/3: 1/6
Find common denominator = 6
= 3:2:1 — The new profit sharing ratio is calculated by deducting C's share from A and B's combined share and then distributing it in their old ratio.

A's new share = (Old share of A / Sum of old shares of A and B) × (1 - C's share)
Similarly for B.

Finally, express all shares with a common denominator to get the ratio.

Reconstitution of a Partnership Firm

Reconstitution of a Partnership Firm — Study Notes

Introduction

Admission of a Partner

Treatment of Goodwill on Admission

Practice Questions — Reconstitution of a Partnership Firm

Reconstitution of a Partnership Firm — Study Guides & Articles

All 4 Chapters in Accountancy-I