Admission of a New Partner

When a firm needs extra capital, managerial help, or both to expand, it may admit a new partner. Under the Partnership Act, 1932, a new partner can be admitted only with the consent of all existing partners, unless the partnership deed says otherwise. Admission reconstitutes the firm — the old agreement ends and a new one is made to carry on the business.

A newly admitted partner gets two main rights:

1. Right to share the assets of the firm.
2. Right to share the profits of the firm.

To acquire these rights, the new partner brings an agreed amount of capital — either in cash or in kind (like assets). But if the firm is well-established and earning more than the normal rate of return on its capital (i.e., earning super profits), the new partner is also required to bring an additional amount called premium or goodwill. This compensates the existing (sacrificing) partners for giving up a part of their share in those super profits.

At the time of admission, the following six points need attention:

1. New profit sharing ratio — the ratio in which all partners (old + new) will share future profits.
2. Sacrificing ratio — the ratio in which the old partners give up their share of profit in favour of the new partner.
3. Valuation and adjustment of goodwill — determining the value of the firm's goodwill and adjusting it among partners.
4. Revaluation of assets and reassessment of liabilities — updating the book values of assets and liabilities to their current fair values.
5. Distribution of accumulated profits (reserves) — sharing existing reserves or accumulated profits/losses among the old partners.
6. Adjustment of partners’ capitals — making the capitals of all partners proportionate to the new profit-sharing ratio, if agreed.

New Profit Sharing Ratio

When a new partner is admitted, the old partners sacrifice a part of their share in favour of the new partner. The new profit sharing ratio is the ratio in which all partners (including the new one) will share future profits and losses.

If the new partner acquires his share entirely from one old partner, the new ratio is calculated by deducting the sacrificed share from the old partner's share. If the new partner acquires his share from all old partners in a certain proportion, each old partner's new share = old share – sacrificed share.

Sacrificing Ratio

The sacrificing ratio is the ratio in which the old partners have agreed to sacrifice their share of profit in favour of the new partner.

This ratio is important because the new partner's goodwill (premium) is distributed among the old partners in this ratio.

Valuation and Adjustment of Goodwill

Goodwill is the value of the firm's reputation and ability to earn super profits. At the time of admission, the new partner compensates the old partners for their sacrifice of super profits by bringing in a premium for goodwill.

Accounting treatment for goodwill (when the new partner brings his share in cash):

1. For premium brought in by the new partner:

   • Debit: Cash/Bank A/c (with the amount brought in)
   • Credit: Premium for Goodwill A/c (with the amount brought in)

2. For distributing the premium among sacrificing partners:

   • Debit: Premium for Goodwill A/c
   • Credit: Old Partners' Capital A/c (in sacrificing ratio)

If the new partner cannot bring the premium in cash, the adjustment is done through his capital account.

Revaluation of Assets and Reassessment of Liabilities

When a new partner enters, the firm's assets and liabilities are revalued to reflect their current worth. Any increase or decrease in value is a gain or loss for the old partners (since it relates to the period before admission).

A Revaluation Account (also called Profit & Loss Adjustment Account) is opened.

• Increase in asset value → Debit Asset A/c, Credit Revaluation A/c
• Decrease in asset value → Debit Revaluation A/c, Credit Asset A/c
• Increase in liability → Debit Revaluation A/c, Credit Liability A/c
• Decrease in liability → Debit Liability A/c, Credit Revaluation A/c

The balance of the Revaluation Account (profit or loss) is transferred to the old partners' capital accounts in their old profit sharing ratio.

Distribution of Accumulated Profits (Reserves)

Any accumulated profits (like General Reserve, Profit & Loss A/c credit balance) or accumulated losses belong to the old partners. They must be distributed among the old partners in their old profit sharing ratio before the new partner is admitted.

• For accumulated profits/reserves:

  • Debit: Reserve/Profit & Loss A/c
  • Credit: Old Partners' Capital A/c (in old ratio)

• For accumulated losses:

  • Debit: Old Partners' Capital A/c (in old ratio)
  • Credit: Profit & Loss A/c (debit balance)

Adjustment of Partners’ Capitals

Often, the partners agree that their capitals should be proportionate to the new profit sharing ratio. This is done either by bringing in additional cash or by withdrawing excess capital.

The steps are:

1. Calculate the total capital of the new firm (based on the new partner's capital and his share, or as agreed).
2. Determine each partner's proportionate capital = Total Capital × (New Share of that Partner).
3. Compare with the existing capital (after all adjustments for goodwill, revaluation, reserves).
4. If existing capital is less → partner brings in the shortfall.
5. If existing capital is more → partner withdraws the excess.

Journal Entry Formats

For premium for goodwill brought in by new partner:

For distribution of premium among sacrificing partners:

For revaluation of assets:

For revaluation of liabilities: