Reconstitution of Partnership - Admission
Modes Of Reconstitution Of A Partnership Firm
A partnership firm is based on an agreement between partners. Any change in this agreement leads to a change in the relationship among the partners. This change is termed as the
The modes of reconstitution of a partnership firm are:
1. Admission of a New Partner:
When a new person is admitted as a partner into an existing firm. This is one of the most common modes of reconstitution and is often done to expand capital, management expertise, or leverage the reputation of the new partner.
2. Change in the Profit Sharing Ratio among the Existing Partners:
When the existing partners decide to change the ratio in which they share future profits and losses. This might happen due to changes in capital contribution, management roles, or mutual agreement.
3. Retirement of an Existing Partner:
When one or more partners leave the firm. This changes the composition of the firm and requires adjusting the accounts and settling the retiring partner's claim.
4. Death of a Partner:
Similar to retirement, the death of a partner reconstitutes the firm. Accounts need to be settled with the legal representatives of the deceased partner.
5. Amalgamation of Two or More Partnership Firms:
When two or more existing partnership firms combine to form a new partnership firm.
In each of these cases, accounting adjustments are required to reflect the changes in the partners' rights and obligations, the value of assets and liabilities, and the distribution of accumulated profits or losses.
Admission Of A New Partner
According to Section 31(1) of the Indian Partnership Act, 1932, a person cannot be introduced as a partner into a firm without the consent of all the existing partners, unless otherwise agreed upon in the partnership deed.
Reasons for admitting a new partner include:
- To increase the capital of the firm.
- To avail the management skills and expertise of the new partner.
- To enhance the reputation of the firm by including a well-known person as a partner.
- To strengthen competitive position by including a competitor or a person with valuable contacts.
When a new partner is admitted, the firm is reconstituted. The incoming partner acquires the right to share the future profits of the firm and to share in the assets of the firm.
Adjustments Required on Admission:
On the admission of a new partner, several accounting adjustments are necessary to reflect the changes accurately and ensure fairness among the partners:
1. Calculation of New Profit Sharing Ratio:
The ratio in which future profits and losses will be shared by all partners, including the new partner. (Discussed in Section I3).
2. Calculation of Sacrificing Ratio:
The ratio in which the old partners surrender their share of profit in favour of the new partner. (Discussed in Section I4).
3. Accounting for Goodwill:
Adjusting the value of goodwill of the firm, as the new partner is entitled to a share in the firm's goodwill and often compensates the old partners for it.
4. Revaluation of Assets and Reassessment of Liabilities:
Ascertaining the present value of assets and liabilities. Any increase or decrease in their value is a profit or loss, which belongs to the old partners and is distributed among them in their old profit sharing ratio.
5. Distribution of Accumulated Profits and Losses:
Any undistributed profits (Reserves, P&L A/c credit balance) or losses (P&L A/c debit balance, deferred revenue expenditure) existing on the date of admission belong to the old partners and are distributed among them in their old profit sharing ratio.
6. Adjustment of Partners' Capital Accounts:
Recording the capital contribution of the new partner and making necessary adjustments to the old partners' capital accounts based on goodwill, revaluation, and accumulated profits/losses. Sometimes, capitals are adjusted to be in the new profit sharing ratio.
These adjustments ensure that the books reflect the financial position of the firm correctly after the admission of the new partner and that the rights of the old and new partners are properly accounted for.
New Profit Sharing Ratio
When a new partner is admitted, the profit sharing ratio of the firm changes. The existing partners sacrifice a portion of their share of profit in favour of the new partner. The
The method of calculating NPSR depends on how the new partner acquires their share from the old partners. Several cases are possible:
Case 1: New Partner's Share is Given, and Old Partners' Sacrifice is NOT Specified.
It is assumed that the old partners continue to share the remaining profit in their old ratio.
Steps:
- Calculate the remaining share of profit for the old partners: $1 - New\ Partner's\ Share$.
- Distribute the remaining share among the old partners in their old profit sharing ratio.
Example 1.
A and B are partners sharing profits in the ratio 3:2. They admit C for 1/5th share in the future profits.
Answer:
C's share = $\frac{1}{5}$
Remaining share for A and B = $1 - \frac{1}{5} = \frac{4}{5}$
A's new share = Remaining Share $\times$ A's Old Share = $\frac{4}{5} \times \frac{3}{5} = \frac{12}{25}$
B's new share = Remaining Share $\times$ B's Old Share = $\frac{4}{5} \times \frac{2}{5} = \frac{8}{25}$
C's share = $\frac{1}{5}$ (To make denominators equal, multiply by 5/5) = $\frac{5}{25}$
Case 2: New Partner Acquires Share Equally from Old Partners.
Each old partner sacrifices an equal amount from their share.
Steps:
- Calculate the sacrifice made by each old partner (New Partner's Share divided by number of old partners).
- Deduct the sacrifice from each old partner's old share to get their new share.
Example 2.
X and Y are partners sharing profits in the ratio 7:3. They admit Z for 1/5th share, which he acquires equally from X and Y.
Answer:
Z's share = $\frac{1}{5}$
Number of old partners = 2 (X and Y)
Sacrifice by X = $\frac{1}{5} \times \frac{1}{2} = \frac{1}{10}$
Sacrifice by Y = $\frac{1}{5} \times \frac{1}{2} = \frac{1}{10}$
X's new share = X's Old Share - Sacrifice by X = $\frac{7}{10} - \frac{1}{10} = \frac{6}{10}$
Y's new share = Y's Old Share - Sacrifice by Y = $\frac{3}{10} - \frac{1}{10} = \frac{2}{10}$
Z's share = $\frac{1}{5}$ (multiply by 2/2) = $\frac{2}{10}$
Case 3: New Partner Acquires Share in a Particular Ratio from Old Partners.
Old partners sacrifice in a specified ratio.
Steps:
- Calculate the sacrifice made by each old partner (New Partner's Share multiplied by their share in the sacrificing ratio).
- Deduct the sacrifice from each old partner's old share to get their new share.
Example 3.
P and Q are partners sharing profits in the ratio 5:3. They admit R for 1/4th share, which he acquires from P and Q in the ratio 2:1.
Answer:
R's share = $\frac{1}{4}$
R acquires from P = R's Share $\times$ P's share in sacrificing ratio = $\frac{1}{4} \times \frac{2}{3} = \frac{2}{12}$
R acquires from Q = R's Share $\times$ Q's share in sacrificing ratio = $\frac{1}{4} \times \frac{1}{3} = \frac{1}{12}$
P's new share = P's Old Share - Acquired by R from P = $\frac{5}{8} - \frac{2}{12}$ (Find Common Denominator, 24) = $\frac{15}{24} - \frac{4}{24} = \frac{11}{24}$
Q's new share = Q's Old Share - Acquired by R from Q = $\frac{3}{8} - \frac{1}{12}$ (Find Common Denominator, 24) = $\frac{9}{24} - \frac{2}{24} = \frac{7}{24}$
R's share = $\frac{1}{4}$ (multiply by 6/6) = $\frac{6}{24}$
Case 4: Old Partner Sacrifices a Specific Fraction/Amount from their Share.
The fraction or amount sacrificed by old partners is directly given.
Steps:
- Deduct the specified sacrifice from each old partner's old share to get their new share.
- Sum up the sacrifices of old partners to find the new partner's share.
Example 4.
M and N are partners sharing profits in the ratio 3:2. M sacrifices 1/5th of his share, and N sacrifices 1/4th of his share in favour of O, the new partner.
Answer:
M's sacrifice = $\frac{1}{5}$ of M's Old Share = $\frac{1}{5} \times \frac{3}{5} = \frac{3}{25}$
N's sacrifice = $\frac{1}{4}$ of N's Old Share = $\frac{1}{4} \times \frac{2}{5} = \frac{2}{20}$
M's new share = M's Old Share - M's Sacrifice = $\frac{3}{5} - \frac{3}{25}$ (CD 25) = $\frac{15}{25} - \frac{3}{25} = \frac{12}{25}$
N's new share = N's Old Share - N's Sacrifice = $\frac{2}{5} - \frac{2}{20}$ (CD 20) = $\frac{8}{20} - \frac{2}{20} = \frac{6}{20}$
O's share = M's Sacrifice + N's Sacrifice = $\frac{3}{25} + \frac{2}{20}$ (CD 100) = $\frac{12}{100} + \frac{10}{100} = \frac{22}{100} = \frac{11}{50}$
New shares: M = $\frac{12}{25} = \frac{48}{100}$, N = $\frac{6}{20} = \frac{30}{100}$, O = $\frac{11}{50} = \frac{22}{100}$.
Check total: $\frac{48}{100} + \frac{30}{100} + \frac{22}{100} = \frac{100}{100} = 1$.
It is important to carefully read the problem statement to identify which case applies and calculate the NPSR accordingly.
Sacrificing Ratio
The
Calculation of Sacrificing Ratio:
The sacrificing ratio is the ratio of the amounts of sacrifice made by each old partner.
Example 5. Calculating Sacrificing Ratio (from Example 1).
A and B are partners sharing profits in the ratio 3:2 (Old Ratio = 3/5, 2/5). They admit C for 1/5th share. New Profit Sharing Ratio is 12:8:5 (New Ratio = 12/25, 8/25, 5/25).
Answer:
A's Sacrifice = A's Old Share - A's New Share = $\frac{3}{5} - \frac{12}{25}$ (CD 25) = $\frac{15}{25} - \frac{12}{25} = \frac{3}{25}$
B's Sacrifice = B's Old Share - B's New Share = $\frac{2}{5} - \frac{8}{25}$ (CD 25) = $\frac{10}{25} - \frac{8}{25} = \frac{2}{25}$
Sacrificing Ratio of A and B = Sacrifice by A : Sacrifice by B = $\frac{3}{25} : \frac{2}{25} = 3 : 2$.
Note: In Case 1 (where the new partner's share is taken from the remaining profit in the old ratio), the Sacrificing Ratio is equal to the Old Profit Sharing Ratio among the old partners.
Example 6. Calculating Sacrificing Ratio (from Example 2).
X and Y are partners sharing profits in the ratio 7:3 (Old Ratio = 7/10, 3/10). They admit Z for 1/5th share, which he acquires equally from X and Y. New Profit Sharing Ratio is 3:1:1 (New Ratio = 3/5, 1/5, 1/5 or 6/10, 2/10, 2/10).
Answer:
X's Sacrifice = X's Old Share - X's New Share = $\frac{7}{10} - \frac{6}{10} = \frac{1}{10}$
Y's Sacrifice = Y's Old Share - Y's New Share = $\frac{3}{10} - \frac{2}{10} = \frac{1}{10}$
Sacrificing Ratio of X and Y = Sacrifice by X : Sacrifice by Y = $\frac{1}{10} : \frac{1}{10} = 1 : 1$.
Note: In Case 2 (where the new partner acquires share equally), the Sacrificing Ratio is equal (1:1).
Example 7. Calculating Sacrificing Ratio (from Example 3).
P and Q are partners sharing profits in the ratio 5:3 (Old Ratio = 5/8, 3/8). They admit R for 1/4th share, which he acquires from P and Q in the ratio 2:1. New Profit Sharing Ratio is 11:7:6 (New Ratio = 11/24, 7/24, 6/24).
Answer:
P's Sacrifice = P's Old Share - P's New Share = $\frac{5}{8} - \frac{11}{24}$ (CD 24) = $\frac{15}{24} - \frac{11}{24} = \frac{4}{24}$
Q's Sacrifice = Q's Old Share - Q's New Share = $\frac{3}{8} - \frac{7}{24}$ (CD 24) = $\frac{9}{24} - \frac{7}{24} = \frac{2}{24}$
Sacrificing Ratio of P and Q = Sacrifice by P : Sacrifice by Q = $\frac{4}{24} : \frac{2}{24} = 4 : 2 = 2 : 1$.
Note: In Case 3, the Sacrificing Ratio is the same as the ratio in which the new partner acquires their share.
In most cases, calculating the Sacrificing Ratio involves finding the difference between the old share and the new share. The sacrificing ratio is crucial for distributing goodwill brought in by the new partner.
Change In Profit Sharing Ratio Among The Existing Partners
Sometimes, the existing partners in a firm may decide to change the ratio in which they share future profits and losses without admitting a new partner or a partner retiring. This also constitutes a reconstitution of the firm.
This changes the relative share of each partner in the firm's future profits. One or more partners gain a share, while others lose or sacrifice a share.
Adjustments Required:
When the profit sharing ratio changes among existing partners, the following adjustments are typically required:
1. Calculation of Sacrificing Ratio and Gaining Ratio:
Partners whose share decreases are 'sacrificing' partners, and partners whose share increases are 'gaining' partners. The ratio of sacrifice and gain needs to be calculated.
The total sacrifice must equal the total gain.
2. Accounting for Goodwill:
The goodwill of the firm needs to be adjusted to compensate the sacrificing partners for giving up a share of future profits (for which goodwill exists) to the gaining partners. The gaining partner(s) compensate the sacrificing partner(s) in their gaining and sacrificing ratios.
3. Revaluation of Assets and Liabilities:
Assets and liabilities are revalued, and the profit or loss on revaluation is distributed among the partners in their
4. Distribution of Accumulated Profits and Losses:
Undistributed profits or losses existing before the change in ratio are distributed among the partners in their
5. Adjustment of Capital Accounts:
Partners' capital accounts are adjusted to reflect the impact of revaluation, accumulated profits/losses, and goodwill adjustments.
Example 8. Change in Profit Sharing Ratio.
A and B are partners sharing profits in the ratio 2:1. With effect from 1st April 2024, they agree to share profits equally (1:1).
Answer:
Old Ratio: A = 2/3, B = 1/3.
New Ratio: A = 1/2, B = 1/2.
A's Sacrifice/Gain = Old Share - New Share = $\frac{2}{3} - \frac{1}{2}$ (CD 6) = $\frac{4}{6} - \frac{3}{6} = \frac{1}{6}$ (Sacrifice)
B's Sacrifice/Gain = Old Share - New Share = $\frac{1}{3} - \frac{1}{2}$ (CD 6) = $\frac{2}{6} - \frac{3}{6} = -\frac{1}{6}$ (Gain)
A sacrifices 1/6th share, and B gains 1/6th share. The sacrificing ratio is 1:0 (only A sacrifices), and gaining ratio is 0:1 (only B gains).
Accounting for these adjustments ensures that the change in profit sharing ratio is implemented fairly, recognising the changes in the value of the firm's assets, liabilities, and goodwill that have occurred under the old agreement.