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UNIT-1 ADMISSION OF PARTNER

INTRODUCTION

A new partner is admitted in a partnership firm due to the following reasons:

1) Need for additional capital for the expansion of the business as also the need for bringing fresh energy into the business.

2) Sometimes when an old partner retires, then it becomes necessary to admit a new partner in order to help in the proper management of the firm.

PROBLEMS ARISING ON ADMISSION OF NEW PARTNER:

The problem that will-arise on admission of a new partner will be enumerated as follows:

1) New Ratio: The share of the new comer in the future profits must also be determined, as also the new ratio of the old partners.

2) Additional Capital: the new comer also becomes a part-owner of the assets of the firm, for which he is expected to-bring some account towards his capital.

3) Goodwill: The new partner will have to pay some compensation to the existing partners for the share in the future profits of the firm that he will receive from them. The old partner will have to forego part their share in favor of the new comer. Such payment is known as Good will.

4) Reserves: Reserve Fund or any accumulated balance of Profit and loss must be distributed among the old partner s in their old profit sharing ratio before new partners is admitted.

REVALUATED OF ASSETS AND LIABILITES:

The true value of some of the assets may be more or less than the book values on the date of admission. Similarly, some of the liabilities, May not have been recorded in the books, e.g. unpaid rent. In such circumstances, if the assets and liabilities are not brought at their true values in the books, either the new partner may suffer of the existing partners may be put to loss. In order that neither party is benefited or put to loss, it is usual to make necessary changes in the values of the assets and liabilities before the new partner is admitted. The changes are brought into the books through an account called ‘Profit and Loss adjustment Account’ or ‘Revaluation Account’. The Balance of this account would show Profit or loss and it must be transferred to the old partner’s capital accounts in their old profit-sharing ratio.

DISTRIBUTION OF ACCUMULATED PROFITS:

When a new partner is admitted, there may be accumulated profit in the firms. It may be in the name of Reserve Fund or Profit and loss Account (Cr. Bal). There may be Accumulated Losses also i.e. Profit and

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loss Account (Dr. Bal) shown on the assets side of the Balance sheet. This profit or loss belongs to the old partners and must be distributed among the old partners in the old profit sharing ratio before the new partner is admitted. The entries for such distribution will be follows:

Reserve Fund A/c Dr.Workmen’s Compensation Fund A/c Dr.Profits and loss A/c Dr.

To Old partner’s Capital A/c

(Accumulated Profit distributed among partners on admission of ….)

Old partner’s Capital A/c Dr.To Profit and loss A/c

(Accumulated loss distributed among old partners on admission of….)

GOODWILL ON ADMISSION OF A NEW PARTNER:we have already seen that the new partner has to pay compensation to acquire a share in future profits and such compensation is termed as ‘GOODWILL’.

Goodwill is a valuable asset of the firm. The firm is in a position to earn more profits than other ordinary firms due to its prestige and other favorable factors. Lord Eden has said, “Goodwill is nothing but a possibility that the old customer will stick to the old firm.”

The main base for the calculation of Good will is its profit earning capacity and hence past profits are to be taken into account for the calculation.

Circumstances when computation of Good will is necessary: Usually goodwill is to be calculated under following circumstances:

1. When a new partner is admitted into a firm.2. When a partner retires of dies.3. When a firm is dissolved.4. When profit sharing ratio of partners is changed.5. When method of computation of profit is changed.

Recording goodwill on admission: Good will is an asset of the old firm, which enables it to earn extra profit in addition to the normal profit in such type of business. As the new partner will get a share in the profit, it would be proper that he will bring in the firm. The new partner may bring goodwill in cash in the firm or may pay the amount to the old partners privately outside the firm. It is possible that the new partner is not able to bring anything by way of goodwill and the old partner’s capital accounts are credited with goodwill.

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PREMIUM METHOD

1) When goodwill is brought in cash and the same is retained in the business: When the new partner brings goodwill in cash into the firm two entries must be passed. First entry would be for debiting Cash Account and crediting Goodwill Account. The same amount is credited to the Capital Account of the old partner in the second entry. As the amount of cash brought in is retained in the firm, no entry would be passed for the same.

i) When the new partner brings goodwill in cash, the entry would be :

Cash A/c Dr.To Old partners A/c

(Amount of goodwill brought in by new partners in cash)Important Note: Remember that when a new partner brings his share of Goodwill in cash, total Goodwill of the firms is not to be recorded in the books.

ii) When Goodwill is withdrawn by the old partners:

a) When the new partner brings goodwill in cash:

Cash A/c Dr.To Old partners A/c

b) When the old Partners withdraw the amount of goodwill in Cash :

Old partners A/cTo Cash A/c Dr.

REVALUTAION METHOD: When goodwill Account is raised at its full value: it may be agreed between the partners that the new partner should not bring any amount in respect of goodwill because he may be financially weak or he may be an employee of the firm having business skill and is admitted as a partner. In this case, the goodwill account is raised in the books.Important Note: Remember that when a new partner does not bring his share of Goodwill in cash, total goodwill of the firm is to be recorded in the books.When goodwill appears in the books and goodwill account is to be raised.

(a) When the value of the goodwill increases: if on revaluation, value of goodwill increases, the goodwill account is debited with the increase in its value and is credited to Old partners Capital Accounts.

Goodwill A/c Dr.To Old partners Capital A/c (Old Ratio)

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(b) When the value of goodwill decreases: It is possible that value of goodwill may decrease on revaluation at the time of admission of a new partner. So the Old partners Capital account should be debited with the excess, just as the decrease in value of any asset is debited to Profit and loss adjustment Account.

Old partners Capital A/c Dr.To Goodwill A/c (Old Ratio)

MEMORANDUM METHOD:Goodwill account raised and then written off: According to the method goodwill account is raised on admission of new partner. Then the goodwill account is written off to all partners (including new partner) in their new profit sharing ratio. The two entries passed are as follows.

(a) Goodwill A/c raised:

Goodwill A/c Dr.To Old partners Capital A/c

(Old ratio goodwill a/c raised with the full amount on C’s Admission)

(b) Writing off goodwill: it is generally written off in the books of new firm after the admission of the new partner.Journal entry for writing off the goodwill account will be as follows:

All partners Capital A/c Dr.To Goodwill A/c

(Goodwill written off in new ratio)Remember: when goodwill account is raised the old partners’ capital account is credited in their old profit sharing ratio. But when goodwill is written off all the partners’ capital account will be debited in the new profit sharing ratio.