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Long Answer Questions · Q1

Q.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?

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Yes, assets and liabilities must be revalued at the time of admission of a partner. This is done to ensure the incoming partner does not gain or lose from hidden changes in asset/liability values. The revaluation is recorded through a Revaluation Account (also called Profit & Loss Adjustment Account), with the resulting profit or loss transferred to the old partners' capital accounts in their old profit-sharing ratio.

Why Revaluation is Necessary at Admission

When a new partner is admitted, the existing partnership is effectively dissolved and a new one begins. Over time, the book values of assets (like land, building, machinery) and liabilities may differ significantly from their current market values. For example, a building bought for ₹5,00,000 ten years ago might now be worth ₹12,00,000. If the firm continues with the old book value, the incoming partner would unfairly benefit from this hidden gain without paying for it.

The core principle is fairness to all partners. The old partners have built up the firm's real worth through their efforts and risk-taking. Any increase in asset values (or decrease in liabilities) belongs to them. Conversely, any decrease in asset values (or increase in liabilities) must be borne by them. The new partner should start with assets and liabilities stated at their current fair values, so that future profits and losses are shared equitably.

Accounting Treatment in the Books

The revaluation is recorded through a Revaluation Account (also called Profit & Loss Adjustment Account). This is a nominal account that captures all changes in asset and liability values.

Step 1: Record Increases and Decreases

  • Increase in asset value or decrease in liability value → Credit the Revaluation Account (it's a gain for the firm).
  • Decrease in asset value or increase in liability value → Debit the Revaluation Account (it's a loss for the firm).

The journal entries follow the golden rules of accounting:

  • For an increase in asset value: Debit the asset account, Credit Revaluation Account.
  • For a decrease in asset value: Debit Revaluation Account, Credit the asset account.
  • For an increase in liability: Debit Revaluation Account, Credit the liability account.
  • For a decrease in liability: Debit the liability account, Credit Revaluation Account.

Step 2: Transfer the Balance to Old Partners' Capital Accounts

Once all revaluation entries are posted, the Revaluation Account will show either a profit (credit balance) or a loss (debit balance). This balance is transferred to the old partners' capital accounts in their old profit-sharing ratio (the ratio that existed before the new partner joined).

  • If profit: Debit Revaluation Account, Credit Old Partners' Capital Accounts (individually).
  • If loss: Debit Old Partners' Capital Accounts (individually), Credit Revaluation Account.
Watch out

A common mistake is to share the revaluation profit/loss in the new ratio. Remember: the revaluation belongs to the period before the new partner joins, so it must be shared only among the old partners in their old ratio.

Step 3: Record the New Values in the Balance Sheet

After revaluation, the assets and liabilities appear at their revised values in the new firm's Balance Sheet. The Revaluation Account itself is closed (its balance is zero after transfer to capital accounts).

Summary of Journal Entries

DateParticularsL.F.Debit (₹)Credit (₹)
For increase in asset value:
Asset A/c Dr.xxx
To Revaluation A/cxxx
(Being increase in value of asset recorded)
For decrease in asset value:
Revaluation A/c Dr.xxx
To Asset A/cxxx
(Being decrease in value of asset recorded)
For decrease in liability:
Liability A/c Dr.xxx
To Revaluation A/cxxx
(Being decrease in liability recorded)
For increase in liability:
Revaluation A/c Dr.xxx
To Liability A/cxxx
(Being increase in liability recorded)
For transfer of profit on revaluation:
Revaluation A/c Dr.xxx
To Old Partner 1's Capital A/cxxx
To Old Partner 2's Capital A/cxxx
(Being profit on revaluation transferred to old partners in old ratio)
For transfer of loss on revaluation:
Old Partner 1's Capital A/c Dr.xxx
Old Partner 2's Capital A/c Dr.xxx
To Revaluation A/cxxx
(Being loss on revaluation transferred to old partners in old ratio)
Tip

A quick way to remember: "Increase = Credit Revaluation, Decrease = Debit Revaluation" for assets. For liabilities, it's the opposite: "Increase = Debit Revaluation, Decrease = Credit Revaluation".

✓Final answer

Yes, assets and liabilities must be revalued at the time of admission of a partner to ensure fairness — the old partners bear all pre-admission gains/losses, and the new partner starts with current values. The revaluation is recorded through a Revaluation Account, with the resulting profit or loss transferred to the old partners' capital accounts in their old profit-sharing ratio.

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