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NCERT Class 12 Accountancy Chapter 2 Reconstitution of a Partnership Firm- Admission of a Partner
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Reconstitution of a Partnership Firm- Admission of a Partner
Chapter: 2
| PART – I |
Short Questions Answer:
1. Identify various matters that need adjustments at the time of admission of a new partner.
Ans: Following are the other important points which require attention at the time of admission of a new partner:
(i) New profit sharing ratio.
(ii) Sacrificing ratio.
(iii) Valuation and adjustment of goodwill.
(iv) Revaluation of assets and Reassessment of liabilities.
(v) Distribution of accumulated profits (reserves) and.
(vi) Adjustment of partners’ capitals.
2. Why is it necessary to ascertain a new profit sharing ratio even for old partners when a new partner is admitted?
Ans: When a new partner is admitted he acquires his share in profits from the old partners. In other words, on the admission of a new partner, the old partners sacrifice a share of their profit in favour of the new partner.
3. What is sacrificing ratio? Why is it calculated?
Ans: The ratio in which the old partners agree to sacrifice their share of profit in favour of the incoming partner is called sacrificing ratio. The sacrifice by a partner is equal to:
Old Share of Profit – New Share of Profit.
The goal of determining the sacrifice ratio is to calculate the goodwill that the new partner has brought in and the share of the foregoing partners.
4. On what occasions sacrificing ratio is used?
Ans: When a new partner is admitted in the partnership firm and the amount of the goodwill brought by him/her is transferred among the old partners in a sacrificing ratio of the old partners.
5. If some goodwill already exists in the books and the new partner brings in his share of goodwill in cash, how will you deal with existing amount of goodwill?
Ans: The amount of premium brought in by the new partner is shared by the existing partners in their ratio of sacrifice. If this amount is paid to the old partners directly (privately) by the new partner, no entry is passed in the books of the firm.
6. Why is there a need for the revaluation of assets and liabilities on the admission of a partner?
Ans: At the time of admission of a new partner, it is always desirable to ascertain whether the assets of the firm are shown in books at their current values. It is necessary to revalue assets and liabilities so that the incoming partner does not suffer from the previous values stated in the balance sheet. In case the assets are overstated or understated, these are revalued.
| Long Answer Questions |
1. Do you advise that assets and liabilities must be revalued at the time of admission of a partner? If so, why? Also describe how this is treated in the book of account?
Ans: yes, at the time of admission, the partners agree that their capitals should also be adjusted so as to be proportionate to their profit sharing ratio. In such a situation, if the capital of the new partner is given, the same can be used as a base for calculating the new capitals of the old partners. The capitals thus ascertained should be compared with their old capitals after all adjustments relating to goodwill reserves and revaluation of assets and liabilities, etc. have been made; and then the partner whose capital falls short, will bring in the necessary amount to cover the shortage and the partner who has a surplus, will withdraw the excess amount of capital.
The journal entries recorded for revaluation of assets and reassessment of liabilities are as follows:
(i) For increase in the value of an asset.
Asset A/c Dr.
To Revaluation A/c (Gain)
(ii) For reduction in the value of an asset.
Revaluation A/c Dr.
To Asset A/c (Loss)
(iii) For appreciation in the amount of a liability.
Revaluation A/c Dr.
To Liability A/c (Loss)
(iv) For reduction in the amount of a liability.
Liability A/c Dr.
To Revaluation A/c (Gain)
(v) For an unrecorded asset.
Asset A/c Dr.
To Revaluation A/c (Gain)
(vi) For an unrecorded liability.
Revaluation A/c Dr.
To Liability A/c (Loss)
(vii) For transfer of gain on Revaluation if credit balance.
Revaluation A/c Dr.
To Old Partners Capital A/cs
(viii) For transferring loss on revaluation.
Old partner’s Capital A/cs Dr.
To Revaluation A/c
2. What is goodwill? What factors affect goodwill?
Ans: Goodwill is also one of the special aspects of partnership accounts which requires adjustment (also valuation if not specified) at the time of reconstitution of a firm viz., a change in the profit sharing ratio, the admission of a partner or the retirement or death of a partner.
In simple words, goodwill can be defined as “the present value of a firm’s anticipated excess earnings” or as “the capitalised value attached to the differential profit capacity of a business”. Thus, goodwill exists only when the firm earns super profits. Any firm that earns normal profits or is incurring losses has no goodwill.
The main factors affecting the value of goodwill are as follows:
(i) Nature of business: A firm that produces high value added products or having a stable demand is able to earn more profits and therefore has more goodwill.
(ii) Location: If the business is centrally located or is at a place having heavy customer traffic, the goodwill tends to be high.
(iii) Efficiency of management: A well-managed concern usually enjoys the advantage of high productivity and cost efficiency. This leads to higher profits and so the value of goodwill will also be high.
(iv) Market situation: The monopoly condition or limited competition enables the concern to earn high profits which leads to higher value of goodwill.
(v) Special advantages: The firm that enjoys special advantages like import licences, low rate and assured supply of electricity, long-term contracts for supply of materials, well –
known collaborators, patents, trademarks, etc. enjoy higher value of goodwill.
3. Explain various methods of valuation of goodwill.
Ans: The important methods of valuation of goodwill are as follows:
(i) Average Profits Method: Under this method, the goodwill is valued at the agreed number of ‘years’ purchase of the average profits of the past few years. It is based on the assumption that a new business will not be able to earn any profits during the first few years of its operations. Hence, the person who purchases a running business must pay in the form of goodwill a sum which is equal to the profits he is likely to receive for the first few years. The goodwill, therefore, should be calculated by multiplying the past average profits by the number of years during which the anticipated profits are expected to accrue.
(ii) Super Profits Method: The basic assumption in the average profits method of calculating goodwill is that if a new business is set up, it will not be able to earn any profits during the first few years of its operations. Hence, the person who purchases an existing business has to pay in the form of goodwill a sum equal to the total profits he is likely to receive for the first ‘few years’. But it is contended that the buyer’s real benefit does not lie in total profits; it is limited to such amounts of profits which are in excess of the normal return on capital employed in similar business. Therefore, it is desirable to value, goodwill on the basis of the excess profits and not the actual profits. The excess of actual profits over the normal profits is termed as super profits.
Normal Profit = Firm’s Capital × Normal Rate of Return/100
Firms capital includes partners capital and reserves and surplus but excludes fictitious assets and goodwill.
(iii) Capitalisation Method: Under this method the goodwill can be calculated in two ways:
(a) Capitalisation of Average Profits: Under this method, the value of goodwill is ascertained by deducting the actual firm’s capital in the business from the capitalised value of the average profits on the basis of normal rate of return.
This involves the following steps:
(i) Ascertain the average profits based on the past few years’ performance.
(ii) Capitalise the average profits on the basis of the normal rate of return to ascertain the capitalised value of average profits as follows:
Average Profits × 100/Normal Rate of Return.
(iii) Ascertain the actual firm’s capital (net assets) by deducting outside liabilities from the total assets (excluding goodwill and fictitious assets).
Firms’ Capital = Total Assets (excluding goodwill) – Outside Liabilities Where outside Liabilities include both long term and short term Liabilities.
(iv) Compute the value of goodwill by deducting net assets from the capitalised value of average profits, i.e. (ii) – (iii).
4. If it is agreed that the capital of all the partners should be proportionate to the new profit sharing ratio, how will you work out the new capital of each partner? Give examples and state how necessary adjustments will be made.
Ans: When a new partner is admitted he acquires his share in profits from the old partners. In other words, on the admission of a new partner, the old partners sacrifice a share of their profit in favour of the new partner. But, what will be the share of the new partner and how he will acquire it from the existing partners is decided mutually among the old partners and the new partner. However, if nothing is specified as to how does the new partner acquire his share from the old partners; it may be assumed that he gets it from them in their profit sharing ratio. In any case, on admission of a new partner, the profit sharing ratio among the old partners will change keeping in view their respective contribution to the profit sharing ratio of the incoming partner. Hence, there is a need to ascertain the new profit sharing ratio among all the partners. This depends upon how the new partner acquires his share from the old partners for which there are many possibilities.
Example:
Sujit’s share = ⅕
Remaining share = 1- ⅕ = ⅘.
Ajit’s new share ⅗ of ⅘ = 12/25
Vinod’s new share = ⅖ of ⅘ = 8/25.
New profit sharing ratio of Anil, Vishal and Sumit will be 12:8:5.
Note: It has been assumed that the new partner acquired his share from old partners in old ratio.
5. Explain how you will deal with goodwill when a new partner is not in a position to bring his share of goodwill in cash.
Ans: Goodwill not brought by the new partner will be debited to the current account of the new partner while sacrificing partners’ capital accounts will be credited for their respective shares.
When the new partner does not bring the share of goodwill, there exists two possibilities:
(a) Goodwill does not exist in the books. and
(b) Goodwill exists in the books.
Goodwill does not exist in the books When goodwill does not exist in the books, sacrificing partners are credited with their share of goodwill and the new partner is debited by the amount of goodwill not brought by him.
The journal entry in this case is:
Incoming (New) Partners Current A/c Dr.
To Sacrificing Partners Capital A/c (individually)
(Account of goodwill not brought in by new partner)
Sometimes the new partner brings part of the premium for goodwill in cash. In such a situation, new partners current account will be debited by the amount not brought by new partner.
6. Explain various methods for the treatment of goodwill on the admission of a new partner?
Ans: As stated earlier, the incoming partner who acquires his share in the profits of the firm from the existing partners brings in additional amount to compensate them for loss of their share in super profits. It is termed as his share of goodwill.
(i) When the new Partner brings goodwill in cash: The amount of premium brought in by the new partner is shared by the existing partners in their ratio of sacrifice. If this amount is paid to the old partners directly (privately) by the new partner, no entry is passed in the books of the firm. But, when the amount is paid through the firm, which is generally the case.
(ii) When the new partner does not bring goodwill in cash, partly or fully: Goodwill not brought by the new partner will be debited to current account of new partner while sacrificing partners’ capital accounts will be credited for their respective shares.
When the new partner does not bring the share of goodwill, there exists two possibilities:
(a) Goodwill does not exist in the books. and
(b) Goodwill exists in the books. Goodwill does not exist in the books.
7. How will you deal with the accumulated profits and losses and reserves on the admission of a new partner?
Ans: At the time of admission of a new partner, it is always desirable to ascertain whether the assets of the firm are shown in books at their current values. In case the assets are overstated or understated, these are revalued. Similarly, a reassessment of the liabilities is also done so that these are brought in the books at their correct values. At times there may also be some unrecorded assets and liabilities of the firm. These also have to be brought into the books of the firm. For this purpose the firm has to prepare the Revaluation Account. The gain or loss on revaluation of each asset and liability is transferred to this account and finally its balance is transferred to the capital accounts of the old partners in their old profit sharing ratio.
In other words, the revaluation account is credited with increase in the value of each asset and decrease in its liabilities because it is a gain and is debited with decrease in the value of assets and increase in its liabilities is debited to revaluation account because it is a loss. Similarly unrecorded assets are credited and unrecorded liabilities are debited to the revaluation account. If the revaluation account finally shows a credit balance then it indicates net gain and if there is a debit balance then it indicates net loss.
8. At what figures the value of assets and liabilities appear in the books of the firm after revaluation has been due. Show with the help of an imaginary balance sheet.
Ans: Before Revaluation:
| Liabilities | Amount | Assets | Amount |
| Sundry creditors | 50,000 | Cash and Cash Equivalents | 100000 |
| Bills payable | 20,000 | Property, Plant, and Machinery | 200000 |
| Wages | 50,000 | Account receivable | 10,000 |
| Total long-term liabilities | 30,000 | Inventory | 100000 |
| Owner equity | 2,60,000 | ||
| Total | 4,10,000 | Total | 4,10,000 |
After Revaluation:
| Liabilities | Amount | Assets | Amount |
| Sundry creditors | 70,000 | Cash and Cash Equivalents | 1,50,000 |
| Bills payable | 50,000 | Property, Plant, and Machinery | 3,00,000 |
| Wages | 80,000 | Account receivable | 10,000 |
| Total long-term liabilities | 80,000 | Inventory | 200000 |
| Owner equity | 3,80,000 | ||
| Total | 6,60,000 | Total | 6,60,000 |
