There may be chances that the partnership firm needs more capital, expertise, managerial capacity etc with regards to the expansion plan. The best option is the admission of a new partner to the firm.
Therefore, to do so, all the partners need to arrive at a common consent for the appointment of a new partner.
Section 31 of the Indian Partnership Act, 1932 provides the provisions for the admission of a partner.
The person appointed as a new partner must be capable of becoming a partner in the firm as per the law. The new partner will be liable for any act of the old partners done before he joined the firm.
Table of Contents
Admission of Partner – Common Challenges
When they decided to appoint a new partner to the existing partnership firm, then the question arises how much capital the new partner needed to bring to the business, How many shares of profit that we can give to him, who all the existing partners may sacrifice their profit sharing ratio and who all gain.
They also need to decide as to the accumulated profit disbursement and valuation of the assets and liabilities etc.
Here we are trying to describe the common challenges faced by the firm when they admit a new partner to the firm.
1. Decide the Profit Sharing among Partners
At the time of admission of partners to the partnership firm, they can get a share in the profit in the firm.
This share of profit is sacrificed by the existing partners. The ratio of sacrifice may be different from one partner to another. It may be done by all partners or any one of the partners.
The profit-sharing ratio among the old partners before admission of partners is called the Old Ratio.
The new profit-sharing ratio, among all the partners including the new partner, is called New Ratio.
There is one more ratio to measure the sacrifice of the old partners, which is called the sacrifice ratio.
Sacrifice Ratio is the difference between the old partners’ profit share under the old ratio and new profit share under the new ratio.
Mr A and Mr.B were partners in a partnership firm. Their profit sharing ratio was 3:2. They decided the admission of partner Mr C. The new partner will get a share of 1/5 share of the profit of the firm.
How can we calculate the new profit sharing ratio after the admission of a partner?.
New Partner’s Share (Mr C) = 1/5
Balance share in the Firm = 4/5 ( 1- 1/5 )
Now we need to calculate the new shares of Mr A & Mr.B
By using simple mathematics, we can find it as given below.
Mr A’s new share of Profit = 4/5 (Balance share) X 3/5 ( Old Ratio )= 12/25
Mr B’s new share of Profit = 4/5 (Balance share) X 2/5 ( Old Ratio )= 8/25
We need to convert Mr C’s share as follows 1/5= 5/25
So the new profit sharing ratio of the firm = 12:8:5
A’s New Share of Profit = 12/25
B’s New Share of Profit = 8/25
C’s New Share of Profit = 8/25
= Old partner profit share under old ratio – Profit share under new ratio
If there is no change in the old ratio among the old partners, the Sacrificing Ratio will be the old ratio itself.
(We need these ratios to solve the other problems of admissions of partner)
2. How much capital needed to introduce the new partner
There are some special cases where the new partner will not bring capital, but the existing partners may use his expertise or any other resources in the business.
These kind of partners are rare.
Usually, the new capital requirements of the firm are decided based on the new partner’s capital and his agreed-profit sharing ratio.
Here the old partners may get a chance to withdraw their excess share of capital if any or need to invest if any shortage.
The new profit sharing ratio of the firm is given below, after the admission of the partner.
Mr A’s Share = 12
Mr B’s share = 8
Mr C’s share =5
Mr A and Mr B invested in the business as capital INR 100,000 and INR 90,000.
Mr C is the new partner, brings INR 50000 as his Capital for his share in the firm. How to adjust the other partners’ capital account base on Mr C’s profit.
Mr C brings INR 50000 for his share of 5/25.
Required capital of Mr A = 50000 X 12/25 X 25/5 = INR 120,000
Mr A’s actual capital invested is INR 100,000.
So Mr A needs to bring INR 20,000 ( 120000-100000).
Required capital of Mr B = 50000 X 8/25 X 25/5 = INR 80,000.
Mr B’s actual capital invested is INR 90,000.
So Mr B can withdraw INR 10,000 ( 90000-80000).
So the capital of the new firm is as follows
Mr A’s Capital = INR 120,000.
Mr B’s Capital = INR 80,000.
Mr C’s Capital = INR 50,000
The total capital of the firm is INR 250,000.
3. Determine the exact value of assets and liabilities
When a new partner enters an existing partnership, we need to evaluate the assets and liabilities.
Why do we need to evaluate the assets and liabilities?
We need transparency with regards to the assets which showing in the balance sheet. These assets may or may not possess the present realizable value. These are in book value only. Same like, liabilities also may or may not show its real status.
In this situation, the only way to find the exact position is to prepare a Revaluation Account of assets and liabilities.
Usually, we can evaluate the assets and liabilities whenever there is a change in the profit-sharing ratio. This will help partners to share their exact rights on the investment.
Revaluation Account is the account which will debit with that amount when the asset’s value decrease and value of liabilities increase. This account will credit with that amount when the asset’s value increase and value of liabilities decrease.
The excess of credit over the debit side is profit and the excess of debit side over the credit side is the loss.
The format of the Revaluation Account is given below.
4. What will do if the New Partner Pay a Premium for Goodwill at the time of admission of Partner
What is goodwill?
Goodwill is a real but intangible asset which helps the firm to earn more profit as compared to its competitors.
Goodwill is the amount paid more than its Net assets. In other words, it is the difference between the Purchase price of the company and the fair market value of assets and liabilities.
Para 16 of AS 10 specifies that goodwill can be recorded in the books only when some consideration in money or money’s worth has been paid for it. It means that only purchased goodwill can be recorded in the books. At the time of admission, retirement or death of partners, goodwill can not be raised in the books of the firm because no consideration in money or money’s worth has been paid for it
There is a chance that the partner may pay some money as a premium for goodwill.
1. Suppose the new partner brings cash for goodwill
In this case, the partners will share this money in their sacrificing ratio. So they can get compensation for the share they sacrificed
The Accounting Entry will be as follows
Bank A/c Dr.
To Old Partners Capital Account.
2. Suppose the new partner is not able to pay any premium
We need to note that as per the new accounting standards, we can not raise the goodwill account when a partner enter the firm. As per the recent accounting standards, raising of the goodwill account and its subsequent writing off is not allowed.
The Accounting Entry will be as follows.
New Partners Capital A/c Dr. ( Amount of Goodwill)
To Old Partners Capital A/c ( Sacrificing Ratio )
5. Accumulated profit and loss in the firm
Accumulated profit and loss in the firm, these belong to the old partners only. So before entering the new partner, we need to transfer the balance of accumulated profit or loss to old partners in their old profit sharing ratio.
Example : 3
Mr A and Mr B were partners sharing profit and losses in the 3:2. They decided to admit Mr C as a new partner to the firm. Their balance sheet was showing a General Reserve ( Accumulated Profit ) of INR 50000.
How to treat the General Reserve at the time of admission of a partner.
The accumulated profit of the firm needs to distribute among the old partners in their old profit sharing ratio.
The journal entry for the distribution is given below.
These are the common challenges faced by the partnership firm when they decided the admission of partners to the firm. Once the partners finalized a decision on all these technical matters, the next step is the amendment in the Partnership Deed to make a new one.