Accountancy · Ch 6 — Reconstitution of a Partnership Firm — Admission of a Partner
Modes of Reconstitution of a Partnership
Modes of Reconstitution of a Partnership
Reconstitution of a Partnership Firm
A partnership firm is said to be reconstituted when the existing agreement between partners is replaced by a new one. This happens whenever there is a change in the membership of the firm or a change in the profit-sharing ratio among the existing partners. The Partnership Act, 1932 does not dissolve the firm in these cases — the firm continues, but under altered terms.
The textbook identifies four distinct modes through which reconstitution can occur.
1. Admission of a New Partner
A new partner may be admitted when the firm needs additional capital or managerial expertise. Under the Partnership Act, 1932, unless the partnership deed states otherwise, a new partner can be admitted only if all existing partners unanimously agree.
Admission of a new partner requires the consent of all existing partners unless the deed provides otherwise.
Example from the textbook: Hari and Haqque are partners sharing profits in the ratio of 3:2. On April 1, 2017, they admit John as a new partner with a 1/6 share in profits. The firm now has three partners and stands reconstituted.
When a new partner is admitted, the old partnership agreement is dissolved and a new one comes into effect. The accounting implications include:
- Revaluation of assets and liabilities
- Distribution of accumulated profits or losses
- Adjustment of goodwill
- Change in profit-sharing ratios
2. Change in the Profit-Sharing Ratio Among Existing Partners
Sometimes partners decide to change their existing profit-sharing ratio without any change in the membership of the firm. This may happen due to a change in the role of a partner, additional capital brought in by one partner, or a mutual agreement to reward extra effort.
Example from the textbook: Ram, Mohan, and Sohan are partners sharing profits in the ratio of 3:2:1. With effect from April 1, 2017, they decide to share profits equally because Sohan brings in additional capital. This change in the existing agreement leads to reconstitution of the firm.
A change in profit-sharing ratio among existing partners is also a form of reconstitution because the old agreement is replaced by a new one, even though no partner leaves or joins.
The accounting treatment here involves:
- Adjusting for accumulated reserves and accumulated losses
- Revaluing assets and liabilities
- Adjusting goodwill (if any) among the partners in their sacrificing/gaining ratio
3. Retirement of an Existing Partner
Retirement means a partner withdraws from the business of the firm. This may be due to bad health, old age, or a change in business interests. If the partnership is at will, a partner can retire at any time.
Example from the textbook: Roy, Ravi, and Rao are partners sharing profits in the ratio of 2:2:1. On account of illness, Ravi retires from the firm on March 31, 2017. The firm now has only two partners and is reconstituted.
When a partner retires, the following accounting adjustments are necessary:
- Revaluation of assets and liabilities
- Calculation of the retiring partner's share of goodwill
- Settlement of the retiring partner's claim (through cash payment or transfer to a loan account)
- Adjustment of the continuing partners' capital accounts
4. Death of a Partner
A partnership may also be reconstituted upon the death of a partner, provided the remaining partners decide to continue the business.
Example from the textbook: X, Y, and Z are partners sharing profits in the ratio of 3:2:1. X dies on March 31, 2017. Y and Z decide to carry on the business, sharing future profits equally. The continuity of business by Y and Z with equal profit sharing leads to reconstitution of the firm.
The accounting treatment on the death of a partner is similar to that on retirement, with the following key differences:
- The deceased partner's claim is settled with their legal representatives
- Interest on capital and share of profit up to the date of death must be calculated
- The accounting period ends on the date of death for the deceased partner
Death of a partner does not automatically dissolve the firm. Reconstitution occurs only if the remaining partners decide to continue the business. If they decide to dissolve, it is a case of dissolution, not reconstitution.