Revaluation of Assets and Liabilities, and Distribution of Reserves

On the date a new partner is admitted, the values of assets and liabilities recorded in the firm's books may no longer reflect their true current worth — a building may have appreciated, stock may have become partly obsolete, a provision for doubtful debts may need updating, or a liability may no longer be payable in full. If these assets and liabilities are carried into the new partnership at their old book values, any hidden profit or loss they represent would end up being shared with the new partner too — which is unfair, because that gain or loss arose entirely from events before the new partner joined the firm.

To prevent this, assets and liabilities are revalued to their current worth on admission, and the resulting profit or loss on revaluation is given entirely to the old partners, in their old profit-sharing ratio — never to the new partner, and never in the new or sacrificing ratio.

Preparing the Revaluation Account (or Profit and Loss Adjustment Account)

The Revaluation Account is a nominal account opened specially for this purpose. It is:

• Debited with:
  • Decrease in the value of any asset
  • Increase in the amount of any liability
  • Any liability that existed but was not recorded in the books (an "unrecorded liability" now brought into account)
• Credited with:
  • Increase in the value of any asset
  • Decrease in the amount of any liability
  • Any asset that existed but was not recorded in the books (an "unrecorded asset" now brought into account)

The balancing figure of the Revaluation Account is either a profit on revaluation (if the credit side total exceeds the debit side total) or a loss on revaluation (if the debit side exceeds the credit side). This balance is transferred entirely to the old partners' capital accounts in their old profit-sharing ratio — a profit is credited to them, a loss is debited to them.

It is worth noting that the revalued figures (the new, adjusted values of the assets and liabilities) are the figures that appear in the balance sheet of the reconstituted firm after admission — the Revaluation Account itself does not appear in the new balance sheet; only its effect (through the partners' capital accounts and the updated asset/liability figures) does.

Distribution of accumulated reserves and undistributed profits

Apart from assets and liabilities, the old balance sheet may also show accumulated reserves and profits that were set aside or carried forward by the old firm — for example, a General Reserve, a Reserve Fund, the credit balance of the Profit and Loss Account, or a Workmen Compensation Reserve in excess of any actual claim against it. Since these amounts were earned and accumulated entirely during the period before the new partner joined, they too belong wholly to the old partners, in their old profit-sharing ratio, and are transferred out of these reserve/reserve-fund accounts into the old partners' capital accounts before (or at the time of) admission — exactly the same principle as revaluation, applied to reserves instead of to individual assets and liabilities.