Partnership Accounts - Admission of a Partner

 

Partnership Accounts

Admission of a Partner

Part A: Discussion of relevant accounting theories including different formulae, formats and tables

Part B: 8 Illustrations with Solutions

 

Part A

Introduction

A person may be admitted as a new partner into a partnership firm with the consent of all the existing partners. Whenever a new partner is admitted, it has the effect of bringing the old partnership to an end and transferring the business to a new partnership.

 

When a new partner is admitted into an existing firm following different aspects are required to be taken into consideration:

1.  Calculation of new profit sharing ratio (PSR),

2.  Calculation of sacrificing ratio,

3.  Valuation of goodwill,

4.  Accounting treatment of goodwill,

5.  Admission by contribution of capital,

6.  Admission by purchase of an interest,

7.  Preparation of revaluation account or memorandum revaluation account,

8.  Accounting treatment of reserves,

9.  Adjustment of capital.

 

Calculation of new profit sharing ratio

When a new partner is admitted into an existing firm he is entitled to a share of future profits of the firm. In effect, there will be a change in the old profit sharing ratio. The new partner may acquire his share of profit either from one partner or from all the existing partners. At the time of calculating the new profit sharing ratio the above matters are required to be taken into consideration.

 

In this connection it should be noted that, unless otherwise agreed, the profit sharing ratio between the existing partners will remain the same.

 

Calculation of sacrificing ratio

When a new partner is admitted into the partnership firm for a certain share of profit, the combined shares of the old partners will be reduced. The ratio in which the old partners are surrendering their share of profit in favour of the new partner is called sacrificing ratio. Any one partner or all the existing partners may sacrifice in favour of the new partner.

 

          Sacrificing Share = Old Share – New Share

 

If the PSR between the old partners remain unchanged even after the admission of the new partner, the sacrificing ratio will be same as the old PSR of the old partners.

 

Valuation of goodwill

There are two types of goodwill on the basis of acquisition:

1. Purchased goodwill: It arises only when a business is acquired for a price (payable in cash or otherwise) which is in excess of the value of net assets of the business taken over. Here the goodwill is the excess amount paid for the acquisition over the net assets of the business taken over.

 

          Purchased goodwill = Purchase consideration – Net assets taken over

 

2. Non-purchased goodwill: It is the goodwill which is generated internally from within the business operations over a period of time. In short, non-purchased goodwill is an internally generated goodwill. As per Para – 35 of AS – 26, “internally generated goodwill should not be recognised as an asset” and accordingly, should not be shown in the balance sheet of the firm. If it is there it should be written off by debiting all the existing / old partners’ accounts. Only purchased goodwill should be recorded in the books of accounts and should be shown in the balance sheet.

 

Valuation of goodwill depends on assumptions made by the valuer. Methods to be adopted in valuing goodwill will depend upon the circumstances of each particular case. Therefore, the figure computed as goodwill cannot be an exact one.

 

Methods of valuation of goodwill

Following are the different methods available for valuation of goodwill:

1.  Average profit method,

2.  Super profit method,

3.  Capitalisation of average profit method,

4.  Capitalisation of super profit method,

5.  Annuity method, and

6.  Weighted average profit method.

 

1. Average profit method

Goodwill = (Average maintainable trading profit after tax) x (Number of years’ purchase)

 

2. Super profit method

Goodwill = (Super profit) x (Number of years’ purchase)

Where, Super profit = (Average maintainable trading profit after tax) – (Normal profit)

Normal profit = (Capital employed or average capital employed as required by the given problem) x (Normal rate of return)

 

Note: Normal rate of return is the rate of return (i.e. profit after tax) on capital employed or average capital employed, as the case may be, which can be expected for a similar business in the similar industry.

 

3. Capitalisation of average profit method

Goodwill = [(Average maintainable trading profit after tax) ÷ (Normal rate of return)]                – Net tangible assets

Where, Net tangible asset = (All assets excluding intangible and fictitious assets at book values) – (Current liabilities and provisions at book values)

 

4. Capitalisation of super profit method

Goodwill = (Super profit) ÷ (Normal rate of return)

 

5. Annuity method

Goodwill =  (Super profit) x [Present value of an annuity of Rs 1 for ..... years at.... (%-age) rate of interest]

 

6. Weighted average profit method

Goodwill = (Weighted average maintainable trading profit after tax) x (Number of years’ purchase)

Where, (a) Weighted average maintainable trading profit after tax =                [P1W1 + P2W2 + P3W3 + ........ + PnWn] ÷ [W1 + W2 + W3 + ........ + Wn]

(b) P1, P2, P3......... Pn are profits of Year: 1, Year: 2, Year: 3............. Year: n

(c) W1, W2, W3...... Wn are weights of Year: 1, Year: 2, Year: 3.......... Year: n

 

Computation of capital employed and average capital employed

Asset side approach

	Particulars	Rs
	All assets at market price (excluding intangible, non-trading and fictitious assets) as at the end of the year	×××
Less	Current liabilities and provisions at market price as at the end of the year	×××
=	Capital employed	×××
Less	Half of average maintainable trading profit after tax	×××
=	Average capital employed	×××

 

Notes:

1. If assets, current liabilities and provisions are taken at market price as at the beginning of the year, half of average maintainable trading profit after tax is to be added to the capital employed to arrive at the average capital employed.

2. Example of intangible asset: goodwill (non-purchased), patents, copyrights, etc.

3. Example of non-trading asset: non-trading investments.

4. Example of fictitious asset: preliminary expenses.

 

Liability side approach

Capital employed = Share capital + Reserves and surplus + Long-term debts – Intangible assets

        – Non-trading assets – Fictitious assets.

 

Note: Share capital and long-term debts should be taken at market price either as at the beginning or as at the end of the year, as the case may be.

 

Computation of average maintainable trading profit after tax

 

	Particulars	Year: 1 Rs	Year: 2 Rs	Year: 3 Rs	Total Rs
	Profit before tax	×××	×××	×××	×××
Add	Interest on long-term debts (i.e. secured loans and unsecured loans), if the long-term debts are part of capital employed	×××	×××	×××	×××
Add	Abnormal loss in any of the year	×××	×××	×××	×××
Less	Abnormal gain in any of the year	×××	×××	×××	×××
Add	Under-valuation of closing stock	×××	×××	×××	×××
Add	Over-valuation of opening stock	×××	×××	×××	×××
Less	Over-valuation of closing stock	×××	×××	×××	×××
Less	Under-valuation of opening stock	×××	×××	×××	×××
Less	Income from non-trading assets (e.g. interest on investments)	×××	×××	×××	×××
Add	Purchase of fixed asset treated as a revenue expense and debited to Profit and Loss Account	×××	×××	×××	×××
Less	Depreciation on fixed asset purchase of which is treated as a revenue expense and debited to Profit and Loss Account	×××	×××	×××	×××
Add	Depreciation on decrease in the value of fixed assets	×××	×××	×××	×××
Less	Depreciation on increase in the value of fixed assets	×××	×××	×××	×××
Less	Reasonable expected managerial remuneration	×××	×××	×××	×××
=	Adjusted profit before tax	×××	×××	×××	×××
Less	Income tax	×××	×××	×××	×××
=	Maintainable trading profit after tax	×××	×××	×××	××× (A)

 

Average maintainable trading profit after tax = (A) ÷ 3

 

Accounting treatment of goodwill

For the purpose of accounting goodwill is considered to be of two types:

a) Existing goodwill appearing in the balance sheet on the date of admission, and

b) Revalued goodwill as on the date of admission.

Both existing goodwill and revalued goodwill in this case should be non-purchased goodwill, because purchased goodwill is treated in accounts like any other fixed assets.

 

Existing goodwill

When a new partner is admitted the existing goodwill, if any, should be written off immediately by debiting old partners in the old profit sharing ratio on the basis of the assumption that this existing goodwill is a Non-purchased goodwill.

 

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Old partners’ capital A/c……………………       Dr
	To Goodwill A/c

 

Revalued goodwill

Situation: 1

When the new partner brings in his share of revalued goodwill in cash

 

Journal entries

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
1.	For new partner’s share of revalued goodwill:
	Bank A/c…...................................      Dr
	To Goodwill premium A/c
2.	For new partner’s share of revalued goodwill distributed to the old partners in their sacrificing ratio:
	Goodwill premium A/c…………       Dr
	To Old partners’ capital A/c

 

Situation: 2

When the new partner does not bring in his share of revalued goodwill in cash

 

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	For new partner’s share of revalued goodwill distributed to the old partners in their sacrificing ratio:
	New partner’s capital A/c……      Dr
	To Old partners’ capital A/c

 

Situation: 3

When the new partner brings in only a part of his share of revalued goodwill in cash and does not bring in the other part in cash

 

Journal entries

1.  Journal entries for the share of revalued goodwill brought in cash will be same as situation: 1

2.  Journal entry for the share of revalued goodwill which is not brought in cash will be same as situation: 2

 

Situation: 4

When the new partner pays his share of revalued goodwill to the old partners privately

 

Journal entries

No accounting treatment is required under this situation.

 

Situation: 5

When the old partners withdraw some of the goodwill premium brought in by the new partner

 

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	For goodwill premium withdrawn by the old partners in their sacrificing ratio:
	Old partners’ capital A/c……     Dr
	To Bank A/c

 

Situation: 6

When the new partner brings in his own goodwill as part of his capital contribution, this goodwill, once the new partner is admitted, has to be written off by debiting all the partners including the new partner in the new PSR.

 

Computation of hidden goodwill

Sometimes in the problem value of revalued goodwill of the firm is not given, nor any instruction as to how has the goodwill to be revalued. In that case it should be understood that the goodwill is hidden so far as the given problem is concerned. Such hidden goodwill has to be computed as follows:

	Particulars	Rs
	Total capital of the firm on the basis of new partner’s capital and his share of profit	×××
Less	Total existing capital of the old partners (including current account balances)	(×××)
Less	Capital of the new partner	(×××)
Less	Reserves as on the date of admission including P/L A/c credit balance	(×××)
Add	Goodwill appearing in the balance sheet as on the date of admission (if any)	×××
Add	Fictitious assets as on the date of admission	×××
Add	P/L A/c debit balance	×××
Less	Profit on revaluation of assets and liabilities as on the date of admission	(×××)
Add	Loss on revaluation of assets and liabilities as on the date of admission	×××
	HIDDEN GOODWILL	×××

 

Preparation of revaluation account

Every time whenever there is any admission, retirement or death of a partner, a revaluation account is prepared to arrive at profit or loss on revaluation of assets and liabilities. The profit or loss on revaluation is transferred to all the existing / old partners’ capital accounts in their existing / old PSR. A revaluation account can be prepared as follows:

 

Revaluation account

Particulars	Rs	Particulars	Rs
To Decrease in the value of assets	×××	By Increase in the value of assets	×××
To Increase in the value of liabilities   and provisions	×××	By Decrease in the value of liabilities and provisions	×××
To Partners’ capital A/c (profit on revaluation – in the old PSR)	×××	By Partners’ capital A/c (loss on revaluation – in the old PSR)	×××
	×××		×××

 

Notes:

1.  Increase or decrease in the value of reserves, provisions and funds are usually taken to partners’ capital account. But if the reserves, provisions and funds are created with respect to any particular asset appearing in the balance sheet, then the increase or decrease in the value of corresponding reserves, provisions and funds is taken to revaluation account.

2.  Provident Fund will neither be taken to partners’ capital account nor to revaluation account.

3.  Any increase or decrease in Workmen’s Compensation Fund will be taken to partners’ capital account and then the net value of the fund will be shown in the balance sheet.

 

Illustration:

Workmen’s compensation fund of Rs 10,000 appears in the balance sheet of a partnership firm at the time of admission of a new partner and it is estimated that only Rs 6,000 is required to be maintained in the future. Explain the accounting treatment of workmen’s compensation fund under the given circumstances. Assume that A and B are existing partners sharing profits and losses in the ratio of 5:3.

 

Solution:

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Workmen’s compensation fund A/c……   Dr		4,000
	To A’s capital A/c			2,500
	To B’s capital A/c			1,500
	(Being the amount of Workmen’s Compensation Fund to the extent not required to be maintained in the future transferred to the existing partners’ capital accounts in the old profit sharing ratio 5:3.)

 

In the new balance sheet after the admission of the new partner workmen’s compensation fund will appear as Rs 6,000 in the liability side. Workmen’s compensation fund will never be accounted through revaluation account.

 

4.  Investments made are always subject to risk. Its value may increase or decrease. There is always uncertainty. It is, therefore, necessary that an Investment Fluctuation Fund is created out of profit, so that any loss due to decrease in the value of investment may be met out of the Investment Fluctuation Fund.

Profit or loss on revaluation of investment will be transferred directly to Partners’ Capital Accounts. Alternatively, it may be routed to Partners’ Capital Accounts through Revaluation Account. In case of change in profit sharing ratio or in case of admission of new partner, profit or loss on the revaluation of investment will be transferred to old partners’ capital accounts in the old profit sharing ratio. Let us discuss these issues through an illustration.

 

Illustration:

A, B and C are partners sharing profits in the ratio of 5:3:2. They have admitted D into the partnership on 1^st April, 2015 for 1/5^th share. An extract of their balance sheet on the date of D’s admission is as follows:

Balance sheet as on 1-4-2015

Liabilities	Rs	Assets	Rs
Investment Fluctuation Fund	3,500	Investment (at cost)	50,000

 

Show the accounting treatment in the following cases:

i.      There is no change and no other information is given about investment.

ii.     The market value of investment is Rs 47,000.

iii.    The market value of investment is Rs 52,000.

iv.   The market value of investment is Rs 50,000.

v.    The market value of investment is Rs 45,000.

 

Solution:

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
Case (i)	No entry is required
Case (ii)	Investment Fluctuation Fund A/c.....    Dr		500
	To A’s Capital A/c			250
	To B’s Capital A/c			150
	To C’s Capital A/c			100
Case (iii)	Investment Fluctuation Fund A/c......    Dr		3,500
	Investment A/c……………………       Dr		2,000
	To A’s Capital A/c			2,750
	To B’s Capital A/c			1,650
	To C’s Capital A/c			1,100
Case (iv)	Investment Fluctuation Fund A/c.....      Dr		3,500
	To A’s Capital A/c			1,750
	To B’s Capital A/c			1,050
	To C’s Capital A/c			700
Case (v)	A’s Capital A/c..................................      Dr		750
	B’s Capital A/c.............................           Dr		450
	C’s Capital A/c.............................           Dr		300
	To  Investment Fluctuation Fund			1,500

 

Important notes:

i.      Increase/decrease in the value of investment has been determined by comparing the book value of the investment as mentioned in the given balance sheet (i.e. Rs 50,000 – 3,500 = Rs 46,500) with the market value.

ii.     Increase in the value of investment i.e. excess of the market value over the book value has been credited to old partners’ capital accounts in the old profit sharing ratio. In the same manner, the decrease in the value of investment (i.e. book value – market value) has been debited to old partners’ capital accounts in the old profit sharing ratio.

iii.    Alternatively, entries regarding increase and decrease in the value of investment can also be passed through Revaluation A/c.

 

Preparation of memorandum revaluation account

Sometimes the old partners may decide to show the assets and liabilities in the new balance sheet after admission of a partner in their original values as appearing in the balance sheet before such admission. In such cases a memorandum revaluation account is prepared instead of revaluation account. The memorandum revaluation account will be prepared as follows:

 

Memorandum revaluation account

Particulars	Rs	Particulars	Rs
To Decrease in the value of assets	×××	By Increase in the value of assets	×××
To Increase in the value of liabilities and provisions	×××	By Decrease in the value of liabilities and provisions	×××
To Partners’ capital A/c (profit on revaluation – in the old PSR)	×××	By Partners’ capital A/c (loss on revaluation – in the old PSR)	×××
	×××		×××
To Increase in the value of assets	×××	By Decrease in the value of assets	×××
To Decrease in the value of liabilities and provisions	×××	By Increase in the value of liabilities and provisions	×××
To Partners’ capital A/c (loss on    revaluation – in the new PSR)	×××	By Partners’ capital A/c (profit on revaluation – in the new PSR)	×××
	×××		×××

 

Accounting treatment of reserve and accumulated profits

Any reserve (not created against any particular asset) and profit and loss account (credit balance) appearing in the balance sheet at the time of admission of a new partner will be distributed to the existing / old partners in their existing / old PSR.

 

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Reserve A/c……………………          Dr
	Profit and loss A/c (credit balance)…     Dr
	To Existing partners’ capital A/cs     (in the old PSR)

 

Accounting treatment of accumulated losses, Advertisement Suspense Account and Deferred Revenue Expenditure Account

Profit and loss account (debit balance), advertisement suspense account and deferred revenue expenditure account appearing in the balance sheet at the time of admission of a new partner will be distributed to the existing / old partners in their existing / old PSR.

 

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Existing partners’ capital A/cs   (in old PSR)    Dr
	To Profit and loss A/c (debit balance)
	To Advertisement suspense A/c
	To Deferred revenue expenditure A/c

 

Adjustment of capital

When a new partner is admitted into the partnership, he has to introduce certain amount of capital. The amount of capital to be brought in by the new partner will depend upon the agreement between the partners. In some cases, the capital of the new partner is determined on the basis of the adjusted combined capital of the old partners.

 

Sometimes, after admission of a new partner, all partners may decide to make their capital balances proportionate to the new PSR. In that case in order to maintain the capital balances accordingly, some partners may have to introduce new capital to make up the deficit of their capital and some other partners may have to withdraw excess capital.

 

Admission by contribution of capital

When a new partner is admitted into the firm, he usually contributes to the capital of the firm. The new partner may make such contribution either by bringing in cash or by bringing in some assets (net of liabilities) or by bringing in both cash and other assets (net of liabilities).

 

Journal entry

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Cash A/c……………………………     Dr
	Debtors A/c……………………            Dr
	Stock A/c……………………                Dr
	Plant and machinery A/c…………...      Dr
	Furniture and fittings A/c.............           Dr
	Goodwill A/c…………………...           Dr
	To Creditors A/c
	To New partner’s capital A/c

 

Admission by purchase of an interest

When a new partner is admitted into a partnership firm by purchasing an interest from one or more of the old partners, neither the total assets nor the total capital of the partnership firm is affected. Whatever money is brought in by the new partner by way of capital or goodwill premium is withdrawn by the old partners. Money brought in by the new partner as capital will be withdrawn by the old partners in their capital ratio, whereas money brought in by the new partner as goodwill premium will be withdrawn by the old partners in their sacrificing ratio.

Part B

 

Illustration: 1

Arun and Anand were partners sharing profits in the ratio of 3:2. Their position as on 31st March, 2019 was as under:

Liabilities	Rs	Assets	Rs
Arun’s Capital	12,000	Land and Buildings	8,000
Anand’s Capital	10,000	Plant and Machinery	10,000
General Reserve	12,000	Stock in Trade	12,000
Workmen’s Compensation Fund	4,000	Sundry Debtors	11,000
Sundry Creditors	12,000	Cash at Bank	9,000
	50,000		50,000

 

They decided to admit Ashok for a 20% profit on the following terms:

a.    The liability on Workmen’s Compensation Fund is to be determined at Rs 2,000;

b.    Ashok to bring in Rs 3,000 as premium for goodwill out of his share of Rs 3,600. He is also to bring in Rs 20,000 as his capital;

c.    General Reserve is to be maintained at its original value;

d.    Rs 2,000 out of creditors to be paid at 5% discount.

 

Pass the necessary journal entries to give effect to the above arrangement, show the capital accounts of the partners and prepare the Balance Sheet of the new firm.

 

Solution:

Books of Arun, Anand and Ashok

Journal Entries

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
31.3.19	Workmen’s Compensation Fund A/c…….   Dr		2,000
	To Arun’s Capital A/c			1,200
	To Anand’s Capital A/c			800
	(Value of liability reduced)
31.3.19	Bank A/c…………………     Dr		23,000
	To Ashok’s Capital A/c			20,000
	To Goodwill Premium A/c			3,000
	(Goodwill premium and capital brought in by Ashok)
31.3.19	Goodwill Premium A/c………………   Dr		3,000
	Ashok’s Capital A/c………………   .    Dr		600
	To Arun’s Capital A/c			2,160
	To Anand’s Capital A/c			1,440
	(Ashok’s share of goodwill premium including the amount brought in by him distributed to Arun and Anand in their sacrificing ratio 3: 2)
31.3.19	Ashok’s Capital A/c……………        Dr		2,400
	To Arun’s Capital A/c			1,440
	To Anand’s Capital A/c			960
	(General reserve adjusted by crediting the old partners in their sacrificing ratio 3: 2)

31.3.19	Creditors’ A/c………………………       Dr		2,000
	To Bank A/c			1,900
	To Revaluation A/c			100
	(A Creditor is paid off after 5% discount allowed by him and credited to Revaluation A/c)
31.3.19	Revaluation A/c……………………       Dr		100
	To Arun’s Capital A/c			60
	To Anand’s Capital A/c			40
	(Profit on revaluation distributed to old partners in the old profit sharing ratio 3: 2)

 

Partners’ Capital A/cs

Particulars	Arun	Anand	Ashok	Particulars	Arun	Anand	Ashok
Arun			360	Bal. b/d	12,000	10,000
Anand			240	Bank			20,000
Arun			1,440	W. C. Fund	1,200	800
Anand			960	G/W Prem	1,800	1,200
Bal. c/d	16,860	13,240	17,000	Ashok	360	240
				Ashok	1,440	960
				Revaluation	60	40
	16,860	13,240	20,000		16,860	13,240	20,000

 

Balance sheet as at 01.04.2019

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital:			Fixed assets:
Arun	16,860		Land and buildings		8,000
Anand	13,240		Plant and machinery		10,000
Ashok	17,000	47,100	Current assets:
General reserve		12,000	Stock in trade		12,000
W. C. Fund		2,000	Debtors		11,000
Creditors		10,000	Cash at bank (W.N.)		30,100
		71,100			71,100

 

  Working note:

	Rs
Cash at bank as per the given balance sheet	9,000
ADD: Capital brought in by Ashok	20,000
ADD: Goodwill premium brought in by Ashok	3,000
LESS: Amount paid to creditors	(1,900)
Cash at bank for the new balance sheet	30,100

 

Note:

Sacrificing ratio of old partners is same as their old profit sharing ratio, because profit sharing ratio between them does not change after the admission of the new partner.

 

Illustration: 2

Baisakhi and Srabani are partners sharing profits and losses in proportion to their capitals. Their Balance Sheet as on 31st March, 2019 is given below:

Liabilities	Rs	Assets	Rs
Creditors	15,000	Freehold Premises	10,000
General Reserve	2,100	Machinery	3,500
Baisakhi’s Capital	20,000	Furniture	1,750
Srabani’s Capital	15,000	Office Equipment	550
		Stock in Trade	14,100
		Debtors	17,500
		Bills Receivable	3,060
		Cash at Bank	1,590
		Cash in hand	50
	52,100		52,100

 

On 1st April, 2019 they admit Poushali on the following conditions:

i.      Poushali should bring in Rs 10,000 as capital and to pay Rs 3,500 for goodwill as she will get 1/4th share in profits;

ii.     A provision of 2% is to be raised against debtors and stock is to be reduced by 5%;

iii.    Fixed assets are to be revalued as follows: Freehold Premises at Rs 12,650, Machinery at Rs 2,800, Furniture at Rs 1,540, and Office equipments at Rs 495;

iv.   Partners agreed that the values of assets and liabilities should remain unaltered.

Show the necessary accounts and prepare the opening Balance Sheet of the new firm.

 

Solution:

Memorandum Revaluation A/c

Particulars	Rs	Particulars	Rs
To Stock in trade	705	By Freehold Premises	2,650
To Machinery	700
To Furniture	210
To Provision for bad debts	350
To Office equipment	55
To Partners’ capital:
Baisakhi (4/7)              360
Srabani  (3/7)              270	630
	2,650		2,650
To Freehold Premises	2,650	By Stock in trade	705
		By Machinery	700
		By Furniture	210
		By Provision for bad debts	350
		By Office equipment	55
		By Partners’ capital:
		Baisakhi  (12/28)          270
		Srabani   (9/28)           203
		Poushali   (7/28)          157	630
	2,650		2,650

 

Partners’ Capital A/cs

Particulars	Baisakhi	Srabani	Poushali	Particulars	Baisakhi	Srabani	Poushali
Baisakhi			300	Balance b/d	20,000	15,000
Srabani			225	Bank			10,000
Memo Rev	270	203	157	Poushali (G/R)	300	225
Balance c/d	22,390	16,792	9,318	G/W Premium	2,000	1,500
				Memo Rev	360	270
	22,660	16,995	10,000		22,660	16,995	10,000

 

Balance sheet as at 01.04.2019

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital:			Fixed assets:
Baisakhi	22,390		Freehold premises		10,000
Srabani	16,792		Machinery		3,500
Poushali	9,318	48,500	Furniture		1,750
General reserve		2,100	Office equipment		550
Creditors		15,000	Current assets:
			Stock in trade		14,100
			Debtors		17,500
			Bills receivable		3,060
			Cash at bank (1,590+10,000+3,500)		15,090
			Cash in hand		50
		65,600			65,600

 

  Working notes:

  Computation of new profit sharing ratio:

Baisakhi’s new share	= 3/4 × 4/7 = 12/28
Srabani’s new share	= 3/4 × 3/7 = 9/28
Poushali’s new share	= 1/4 = 7/28
∴ New Profit Sharing Ratio	Baisakhi: Srabani: Poushali = 12: 9: 7

 

Note:

Sacrificing ratio of old partners is same as their old profit sharing ratio, because profit sharing ratio between them does not change after the admission of the new partner.

 

Illustration: 3

K and L are two partners sharing profits and losses in the ratio of 5: 3. Their Balance Sheet as at 30th June, 2019 is as follows:

Liabilities	Rs	Rs	Assets	Rs	Rs
Creditors		30,000	Furniture		40,000
Reserve		14,000	Patent		10,000
Capital Accounts:			Stock in Trade		20,000
K	40,000		Debtors	44,000
L	50,000	90,000	Less: Reserve for bad debts	5,000	39,000
			Cash in hand		25,000
		1,34,000			1,34,000

 

On 1st July, 2019, they take M into partnership. M brings Rs 25,000 as his capital and brings Rs 3,600 as his share of goodwill. The new profit sharing ratio of K, L and M is 2: 4: 1. Patent is written off from the books and a reserve for bad debts is created at 5%. Reserve appears in the books of new firm at its original figure.

 

Show the necessary Journal entries to carry out the above transactions and prepare a Balance Sheet of the new firm as at 1st July, 2019.

 

Solution:

Books of K, L and M

Journal Entries

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
01.07.19	Bank A/c…………………………      Dr		28,600
	To M’s Capital A/c			25,000
	To Goodwill Premium A/c			3,600
	(Goodwill premium and capital brought in by Ashok)
01.07.19	Goodwill Premium A/c…………         Dr		3,600
	L’s Capital A/c (3,600 × 56/8 × 11/56)..  Dr		4,950
	To K’s Capital A/c (3,600 × 56/8 × 19/56)			8,550
	(Goodwill premium brought in by M and contributed by the gaining partner L in proportion of his gain credited to the only sacrificing partner K in proportion of his sacrifice)
01.07.19	Reserve A/c………………………    Dr		14,000
	To K’s Capital A/c			8,750
	To L’s Capital A/c			5,250
	(Reserve written off by crediting the old partners in old profit sharing ratio 5: 3)
01.07.19	K’s Capital A/c………………        Dr		4,000
	L’s Capital A/c………………         Dr		8,000
	M’s Capital A/c………………       Dr		2,000
	To Reserve A/c			14,000
	(Reserve raised again in the books by debiting all the partners including the new partner in new profit sharing ratio 2: 4: 1)
01.07.19	Revaluation A/c………………       Dr		10,000
	To Patent A/c			10,000
	(Patent written off from the books)
01.07.19	Reserve for bad debts A/c……        Dr		2,800
	To Revaluation A/c			2,800
	(Reserve for bad debts reduced to 5% of debtors)
01.07.19	K’s Capital A/c………………         Dr		4,500
	L’s Capital A/c…………………      Dr		2,700
	To Revaluation A/c			7,200
	(Loss on revaluation transferred to old partners’ capital accounts in old profit sharing ratio 5: 3)

 

Partners’ Capital A/cs

Particulars	K	L	M	Particulars	K	L	M
Reserve	4,000	8,000	2,000	Balance b/d	40,000	50,000
Revaluation	4,500	2,700		Bank			25,000
K’s Capital		4,950		G/W Premium	3,600
Balance c/d	48,800	39,600	23,000	L’s Capital	4,950
				Reserve	8,750	5,250
	57,300	55,250	25,000		57,300	55,250	25,000

 

Balance sheet as at 01.07.2019

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital:			Fixed assets:
K	48,800		Furniture		40,000
L	39,600		Current assets:
M	23,000	1,11,400	Stock in trade		20,000
Reserve		14,000	Debtors	44,000
Creditors		30,000	Less: Reserve for b/d	(2,200)	41,800
			Cash in hand (25,000 + 28,600)		53,600
		1,55,400			1,55,400

 

  Working notes:

  Computation of sacrificing ratio:

K’s sacrifice	= 5/8 – 2/7 = 19/56
L’s sacrifice	= 3/8 – 4/7 = (11/56)

 

Only K sacrifices. L actually gains. Therefore, for adjusting goodwill premium ‘Goodwill Premium A/c’ will be debited for the amount of premium brought in by the new partner M and ‘L’s Capital A/c’ will be debited for L’s contribution towards goodwill premium as he gains. Only ‘K’s Capital A/c’ will be credited as he is the only sacrificing partner.

 

Amount to be debited to L’s Capital A/c	= (Rs 3,600 × 56/8 × 11/56) = Rs 4,950
Amount to be credited to K’s Capital A/c	= (Rs 3,600 × 56/8 × 19/56) = Rs 8,550

 

Illustration: 4

Red and White are partners in a firm sharing profits and losses in the ratio of 3: 2. On 1.7.2019 the positions of the firm as follows:

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital Accounts:			Buildings		50,000
Red	1,50,000		Machinery		2,50,000
White	98,000	2,48,000	Furniture		40,000
General Reserve		84,000	Stock in Trade		60,000
Sundry Creditors		1,70,000	Sundry Debtors		90,000
			Cash in hand		12,000
		5,02,000			5,02,000

 

Blue joined the firm as a partner from this date and the following terms and conditions were agreed upon:

a.    Red, White and Blue will share the future profits of the firm in the ratio 5: 3: 2, respectively;

b.    Blue would first pay Rs 10,000 as his share of Goodwill and this sum is to be retained in the business;

c.    The value of Machinery is to be increased by Rs 20,000 and stock is to be written down by 10%;

d.    Blue would introduce such an amount of Capital in Cash which should be proportionate to the combined capital accounts of Red and White after making all adjustments.

 

It was decided that the Capital Accounts of Red and White would be adjusted on the basis of Blue’s Capital by opening Current Accounts.

 

Show the Capital Accounts of the partners and the Balance Sheet of the firm after Blue’s admission.

 

Solution:

Revaluation A/c

Particulars	Rs	Particulars	Rs
To Stock in trade	6,000	By Machinery	20,000
To Partners’ capital:
Red (3/5)                 8,400
White (2/5)              5,600	14,000
	20,000		20,000

 

Partners’ Capital A/cs

Particulars	Red	White	Blue	Particulars	Red	White	Blue
Current A/c		8,700		Balance b/d	1,50,000	98,000
Balancec/d	2,22,500	1,33,500	89,000	Revaluation	8,400	5,600
				Gen Reserve	50,400	33,600
				G/W Premium	5,000	5,000
				Bank  (W.N. 1)			89,000
				Current A/c	8,700
	2,22,500	1,42,200	89,000		2,22,500	1,42,200	89,000

 

Balance sheet as at 01.07.2019

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital:			Fixed assets:
Red	2,22,500		Buildings		50,000
White	1,33,500		Machinery (2,50,000 + 20,000)		2,70,000
Blue	89,000	4,45,000	Furniture		40,000
Sundry Creditors		1,70,000	Current assets:
Current A/c (White)		8,700	Stock in trade	60,000
			Less: Reduction in value	6,000	54,000
			Sundry Debtors		90,000
			Cash in hand   (12,000+10,000+89,000)		1,11,000
			Current A/c (Red)		8,700
		6,23,700			6,23,700

 

Working notes:

1.    Computation of sacrificing ratio:

Red’s sacrifice	= 3/5 – 5/10 = 1/10
White’s sacrifice	= 2/5 – 3/10 = 1/10
∴ Sacrificing ratio	Red: White = 1: 1

 

2.    Computation of new capital balances of the partners:

Combined capital of Red and White after Blue’s admission	2,13,800 + 1,42,200 = 3,56,000
Total capital of the firm after Blue’s admission	3,56,000 × 10/8 = 4,45,000
∴ Red’s new capital	4,45,000 × 5/10 = 2,22,500
White’s new capital	4,45,000 × 3/10 = 1,33,500
Blue’s new capital	4,45,000 × 2/10 = 89,000

 

 

Illustration: 5

Partners Quick and Slow in a firm are sharing profits and losses in the ratio of 3: 2. The Balance Sheet of the firm as on 31st March, 2019 was as under:

 

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital Accounts:			Furniture and Fixtures		60,000
Quick	1,20,000		Office Equipment		30,000
Slow	77,000	1,97,000	Motor Car		75,000
General Reserve		30,000	Stock in Trade		50,000
Sundry Creditors		96,000	Sundry Debtors		90,000
			Cash at Bank		18,000
		3,23,000			3,23,000

 

Smooth was admitted as a new partner with effect from 1st April, 2019 and it was agreed that he would bring some private furniture worth Rs 10,000 and private stock costing Rs 8,000 and in addition contribute Rs 50,000 cash towards capital. He would also bring proportionate share of goodwill which is to be valued at two years’ purchase of the average profits of the last three years.

 

The profits of the last three years were:

	Rs
2018-19	52,000
2017-18	32,000
2016-17	28,000

 

However, on a checking of the past records, it was noticed that on 1.4.2017 a new furniture costing Rs 8,000 was purchased but wrongly debited to revenue and in 2018-19 a purchase invoice for Rs 4,000 dated 25.3.2019 has been omitted in the books. The firm charges depreciation on Furniture @ 10% p.a. under the written down value method. Your calculation of goodwill is to be made on the basis of correct profits.

 

On revaluation value of Stock is to be reduced by 5% and Motor car is worth Rs 85,000. Smooth duly paid the required amount for goodwill and cash towards capital.

 

It was decided that the future profits of the firm would be shared as Quick — 50%, Slow — 30% and Smooth — 20%.

 

Assuming that the abovementioned arrangements were duly carried out, show the Capital Accounts of the partners and the Balance Sheet of the firm after Smooth’s admission.

 

Solution:

Revaluation A/c

Particulars	Rs	Particulars	Rs
To Stock in trade	2,500	By Motor car	10,000
To Partners’ capital:
Quick (3/5)                  4,500
Slow  (2/5)                  3,000	7,500
	10,000		10,000

 

Computation of profit after adjustment

Particulars	2016-17	2017-18	2018-19	Total
Profit before adjustment	28,000	32,000	52,000	1,12,000
Add: Purchase of furniture wrongly debited to Trading A/c		8,000		8,000
Less: Depreciation on above furniture @ 10% p.a. under WDV Method		(800)	(720)	(1,520)
Less: Purchase Invoice omitted in the books			(4,000)	(4,000)
Profit after adjustment	28,000	39,200	47,280	1,14,480

 

Increase in profit after adjustment (Rs 1, 14,480 – Rs 1, 12,000) i.e. Rs 2,480 is to be credited to the old partners in their old profit sharing ratio by debiting Profit and Loss Adjustment A/c.

 

Valuation of goodwill and Smooth’s share of goodwill:

Average profit after adjustment = Rs 1, 14,480 ÷ 3 = Rs 38,160

Goodwill = Rs 38,160 × 2 = Rs 76,320

Smooth’s share of goodwill = Rs 76,320 × ²/₁₀ = Rs 15,264

 

  Computation of sacrificing ratio:

Quick’s sacrifice	= 3/5 – 5/10 = 1/10
Slow’s sacrifice	= 2/5 – 3/10 = 1/10
∴ Sacrificing ratio	Quick: Slow = 1: 1

 

Partners’ Capital A/cs

Particulars	Quick	Slow	Smooth	Particulars	Quick	Slow	Smooth
				Balance b/d	1,20,000	77,000
				Bank			50,000
				Revaluation	4,500	3,000
				Gen Reserve	18,000	12,000
				Furniture			10,000
				Stock			8,000
Balance c/d	1,51,620	1,00,624	68,000	G/W Premium	7,632	7,632
				P/L Adj.	1,488	992
	1,51,620	1,00,624	68,000		1,51,620	1,00,624	68,000

 

Balance sheet as at 01.04.2019

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital:			Fixed assets:
Quick	1,51,620		Furniture	60,000
Slow	1,00,624		Add: Brought by Smooth	10,000
Smooth	68,000	3,20,244	Add: Wrong debit to                     Trading A/c	8,000
Sundry Creditors	96,000		Less: Increase in                            Depreciation	(1,520)	76,480
Add: Omitted Invoice	4,000	1,00,000	Office equipment		30,000
			Motor car	75,000
			Add: Increase in value	10,000	85,000
			Current assets:
			Stock in trade	50,000
			Add: Brought by Smooth	8,000
			Less: Reduction in value	(2,500)	55,500
			Sundry Debtors		90,000
			Cash in bank	18,000
			Add: Brought by Smooth:
			Capital	50,000
			G/W Premium	15,264	83,264
		4,20,244			4,20,244

 

Illustration: 6

Partners A and B in a firm are sharing profits and losses in the ratio of 3: 2. Their Balance Sheet as on 31.12.2019 stood as follows:

Liabilities	Rs	Rs	Assets	Rs	Rs
Sundry Creditors		20,000	Goodwill		12,000
Capital Accounts:			Fixtures and Fittings		250
A	12,000		Stock in Trade		10,750
B	30,000	42,000	Sundry Debtors	21,000
			Less: Reserve for b/d	1,000	20,000
			Cash in hand		15,000
			Profit and Loss Account		4,000
		62,000			62,000

 

On 1.1.2020 they admit C as a partner on the following terms:

a.    The new profit sharing ratio of A, B and C becomes 5: 3: 2;

b.    Agreed value of Goodwill is Rs 20,000 and C brings the necessary premium for Goodwill in cash, half of which is retained in the business. Book value of Goodwill should remain undisturbed;

c.    The Reserve for bad debts is to be raised to 10% of Sundry Debtors;

d.    Stock-in-trade is to be revalued at Rs 12,000 but the effect is not be shown in the books;

e.    Fixtures and Fittings are to be reduced to Rs 150;

f.     C should bring further sum in cash in order to make his capital equal to ¹/₅^th of the combined adjusted capital of A and B.

 

Show the necessary journal entries and the Capital Accounts of the partners and also prepare the Balance Sheet of the new firm as at 1.1.2020.

 

Solution:

Books of A, B and C

Journal Entries

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
01.01.20	Goodwill A/c…………………………      Dr		8,000
	To A’s Capital A/c			4,800
	To B’s Capital A/c			3,200
	(Goodwill raised in old profit sharing ratio)
01.01.20	A’s Capital A/c…………………………    Dr		4,000
	B’s Capital A/c…………………………   Dr		2,400
	Bank A/c………………………………     Dr		1,600
	To Goodwill A/c			8,000
	(Goodwill written off in new profit sharing ratio while C brings his share of non-purchased goodwill in cash)
01.01.20	A’s Capital A/c…………………………    Dr		400
	B’s Capital A/c…………………………    Dr		400
	To Bank A/c			800
	(Half of the goodwill premium withdrawn by A and B in their sacrificing ratio 1: 1)
01.01.20	A’s Capital A/c……………………………   Dr		2,400
	B’s Capital A/c…………………………      Dr		1,600
	To Profit and loss A/c			4,000
	(Accumulated loss distributed among old partners in old profit sharing ratio)

01.01.20	Revaluation A/c………………………         Dr		1,200
	To Reserve for bad debts A/c			1,100
	To Fixtures and Fittings A/c			100
	(Reserve for bad debts raised and value of Fixtures and Fittings reduced)
01.01.20	A’s Capital A/c……………………………   Dr		720
	B’s Capital A/c……………………………   Dr		480
	To Revaluation A/c			1,200
	(Loss on revaluation transferred to old partners’ capital accounts in old profit sharing ratio 3: 2)
01.01.20	Stock in trade A/c…………………………    Dr		1,250
	To A’s Capital A/c			750
	To B’s Capital A/c			500
	(Value of stock raised in old profit sharing ratio)
01.01.20	A’s Capital A/c……………………………     Dr		625
	B’s Capital A/c…………………………         Dr		375
	C’s Capital A/c…………………………        Dr		250
	To Stock in trade A/c			1,250
	(Value of stock written off in new profit sharing ratio)

 

Partners’ Capital A/cs

Particulars	A	B	C	Particulars	A	B	C
Goodwill	4,000	2,400		Balance b/d	12,000	30,000
Bank	400	400		Goodwill	4,800	3,200
P/L A/c	2,400	1,600		Stock	750	500
Revaluation	720	480		Bank (b/f)			7,820
Stock	625	375	250
Balance c/d	9,405	28,445	7,570
	17,550	33,700	7,820		17,550	33,700	7,820

 

Balance sheet as at 01.01.2020

Liabilities	Rs	Rs	Assets	Rs	Rs
Capital:			Fixed assets:
A	9,405		Goodwill		12,000
B	28,445		Fixtures and Fittings	250
C	7,570	45,420	Less: Reduction in value	100	150
Sundry Creditors		20,000	Current assets:
			Stock in trade		10,750
			Sundry Debtors	21,000
			Less: Reserve for b/d	2,100	18,900
			Cash in hand	15,000
			Add: Brought by C:
			Capital	7,820
			G/W Premium	1,600
			Less: G/W withdrawn	(800)	23,620
		65,420			65,420

 

Working notes:

1.    Computation of sacrificing ratio:

A’s sacrifice	= 3/5 – 5/10 = 1/10
B’s sacrifice	= 2/5 – 3/10 = 1/10
∴ Sacrificing ratio	A: B = 1: 1

 

2.    Computation of C’s Capital:

Combined capital of A and B after C’s admission	= 9,405 + 28,445 = Rs 37,850
∴ C’s Capital	= Rs 37,850 × 1/5 = Rs 7,570

 

Illustration: 7

The following was the balance sheet of Sun and Moon as at 31.03.2022:

Liabilities	Rs	Assets	Rs
Capital:		Property	35,000
Sun                  50,000		Motor Car	7,500
Moon                41,000	91,000	Furniture	1,000
Loan (Sun)	5,000	Sundry Debtors	25,000
General Reserves	5,000	Stock-in-trade	45,000
Sundry Creditors	15,000	Cash	4,000
Outstanding expenses	1,500
	1,17,500		1,17,500

 

The profit sharing ratio between Sun and Moon was 3: 2. They decided to admit Pluto as a new partner from 1^st April, 2022 on the following terms and conditions:

    1.    Property and Motor Car to be re-valued at Rs 45,000 and Rs 6,500 respectively and 5% provision to be created on debtors.

    2.    Pluto should pay premium for goodwill to be valued at 2 years’ purchase of last 3 years’ average profits. Such amount of premium was to be credited to old partners’ loan accounts.

    3.    Pluto should pay Rs 37,500 as capital.

    4.    The new profit sharing ratio should be 2: 1: 1.

    5.    Last 3 years’ profits were Rs 5,000, Rs 6,000 and Rs 7,500.

 

The last 3 years’ books of account, on Verification, disclosed the following discrepancies:

 

2019- 20

Bad debts previously written off recovered Rs 400, credited to Debtors Account. Closing stock was undervalued by Rs 1,250.

 

2020- 21

Furniture purchased for Rs 300 debited to Purchases Account. Depreciation was provided @ 10% on reducing balance method. Closing stock was overvalued by Rs 2,000.

 

2021- 22

A purchase invoice of Rs 1,000 was omitted from the books of account and closing stock was undervalued by Rs 1,000.

 

Pass the journal entries at the time of admission of Pluto and prepare the Balance Sheet just after his admission.

Illustration: 8

P and Q are partners sharing profits and losses in the ratio of 5: 4. On 1^st April, 2021 they admitted their manager R into partnership for 1/5^th share of profits. As a manager, R was receiving a salary of Rs 60,000 per year and a commission of 5% on the net profit after charging such salary and commission. It is, however, agreed that any excess over his former remuneration to which R becomes entitled as a partner is to be borne by Q.

 

The profits of the firm for the year ended 31^st March, 2022 amounted to Rs 4, 27,500. You are required to show the division of profits among the partners.

 

 

Solution:

R’s remuneration per year as manager:

Particulars	Rs
Salary	60,000
Commission [(Rs 4,27,500 – 60,000) × 5/105]	17,500
Total	77,500

 

R’s share of profit as partner = Rs 4,27,500 × 1/5 = Rs 85,500

Therefore, portion of R’s share of profit to be borne by Q = Rs 85,500 – 77,500 = Rs 8,000.

 

P’s share of profit (considering R as manager)

= (Rs 4,27,500 – 77,500) × 5/9 = Rs 1,94,444

 

Q’s share of profit

= [(Rs 4,27,500 – 77,500) × 4/9] – 8,000 = Rs 1,47,556

 

Q’s share of profit (alternative calculation)

= Total profit – P’s share – R’s share

= Rs 4,27,500 – 1,94,444 – 85,500 = Rs 1,47,556