Q.Why is it necessary to revalue the assets and liabilities of a firm at the time of admission of a new partner, and why is the resulting profit or loss on revaluation shared by the OLD partners in their OLD profit-sharing ratio, and never by the new partner?

Assets and liabilities recorded in the books may no longer reflect their true worth by the time a new partner joins, and any gain or loss they represent built up entirely before the new partner arrived. Revaluing them keeps the new partner's entry fair to everyone.

If assets/liabilities were carried forward at old book values, any undervaluation or overvaluation already existing would silently pass into the new partnership and would end up being shared with the incoming partner too, even though it arose entirely during the old partners' stewardship of the firm, before the new partner had any stake in it. Revaluing them and crediting/debiting the resulting profit or loss to the old partners in their old ratio ensures the new partner starts on a clean, fairly stated balance sheet, sharing only in changes that occur AFTER their admission.

Why revaluation is necessary on admission of a partner

A firm's books record assets and liabilities at values decided at various points in the past — original cost less depreciation, original amount payable, an old estimate of doubtful debts, and so on. By the time a new partner is admitted, several of these values may have drifted away from the assets' and liabilities' true current worth: a building may have appreciated well beyond its book value, stock may include some obsolete items, a debt earlier thought doubtful may now be irrecoverable, or a liability may have been settled for less than its recorded amount.

If the new partner is admitted while these under- or over-stated figures remain unchanged in the books, two unfair outcomes follow:

1. The new partner's capital contribution (usually fixed with reference to the recorded net worth of the firm) would be based on incorrect figures.
2. Any future realisation of the hidden gain or loss (for example, when the building is eventually sold, or the doubtful debt is finally written off) would be shared among ALL partners, including the new partner — even though the gain or loss economically belongs to the period BEFORE the new partner joined and was earned or incurred entirely under the old partners' management.

Why the profit or loss goes to the OLD partners in the OLD ratio

The entire purpose of revaluation is to settle this pre-admission gain or loss with the people who owned that gain or loss in the first place — the old partners, in the same ratio in which they shared profits and losses before admission (their old ratio). Crediting or debiting the new partner would mean the new partner benefits from (or is penalised by) events that occurred before they had any stake in the firm, which is neither logical nor fair.

Mechanically, this is achieved by opening a Revaluation Account (a nominal account): it is debited with any decrease in asset value, increase in liability, or newly-recognised unrecorded liability, and credited with any increase in asset value, decrease in liability, or newly-recognised unrecorded asset. The balancing figure — profit or loss on revaluation — is then transferred to the old partners' capital accounts, strictly in their old profit-sharing ratio (never the new or sacrificing ratio, since this profit/loss has nothing to do with the new partner's admission itself).

Once this is done, the assets and liabilities appear in the new firm's balance sheet at their true, updated values, and every partner starts the new partnership on a fair and transparent footing.

A common mistake is to share the revaluation profit or loss in the NEW ratio (thinking it relates to the 'new' firm) instead of the OLD ratio — remember the gain/loss arose before admission, so it always goes to the old partners in the OLD ratio. Another mistake is to think revaluation changes the figures shown in the Revaluation Account itself in the new balance sheet — actually, it is the REVISED asset/liability values (not the Revaluation Account) that appear in the new balance sheet.