Chapter – 3: Admission of a Partner

Presentation

Reconstitution of a partnership Firm- Admission of a partner

Partnership is the result of an agreement between partners for sharing profit of the business.Any changes in the relationship  among partners, the existing  agreement comes to end and a new agreement comes into being.

Reconstitution of a partnership means change in the nature of relationship amongst members.

Different Modes/ Occasion of  Reconstitution
  1. Admission of a new partner
  2. Change in the profit sharing ratio of existing partners
  3. Retirement of a partner
  4. Death of a partner

1-ADMISSION OF A PARTNER

      Inclusion of a person  as a new partner  to an existing partnership firm is called Admission of a Partner. A firm requires additional capital or managerial help or both for the expansion of its business a new partner may be admitted.When the time of admission the partnership is reconstituted  with a new fresh agreement.

An incoming partner acquires two main rights in the firm, they are:-

  • Right to share the asset of the firm              – For this he should bring Capital
  • Right to share the profit of the firm             – For this he should bring Goodwill/Premium

Accounting adjustments on Admission of  a Partner

  1. Capital of the new partner
  2. Calculation of new profit sharing ratio
  3. Calculation of sacrificing ratio
  4. Treatment of Goodwill
  5. Revaluation of assets and liabilities
  6. Distribution of reserves and accumulated profits and losses
  7. Adjustment of capital accounts  of  partners

A-Capital  of New partner

   At the time of admission an incoming partner brings capital in cash or assets.

Cash / Asset   A/c          Dr  
          To New partner’s capital A/c

(Cash or assets brought as capital)

                 Ex:              Cash           A/c                        Dr       50,000     
                                    Land         A/c                          Dr    100,000
                                              To New Partner’s capital    A/c              1,50,000

Q1 – Manu and Sanu are partners in a firm sharing profits in the ratio of 3:2.They decided to admit Amal in to partnership for 1/5 th share of profit.Amal brings Rs.40,000 cash and land worth Rs.80,000 towards his capital contribution.Give journal entry to record the capital brought by amal.

B-Calculation of New profit sharing ratio

New profit sharing ratio is the ratio in which all partners,including new partner share the future profit and losses.

The new profit sharing ratio will be calculated by how the new partner acquires his share from the old partners

  1. New partner gets  share  from total  profit (Ex:   1/5 from total profit) –

              New profit sharing ratio of old partner = remaining share X Old profit sharing ratio of partner

Q2 – Anil and Vishal are partners sharing profits in the ratio of 3:2. They admitted Sumit as a new partner for 1/5 share in the future profits of the firm. Calculate new profit sharing ratio of Anil, Vishal and Sumit.

Ans:NPSR 12:8:5.

Q3 – A and B are partners sharing profits and losses in the ratio of 3:2. C is admitted for 1/6th share of profits.calculate new profit sharing ratio o the partners.

Ans : 3:2:1

  1. New partner may acquire equally with the old partner

              New Ratio of old partner =  Old ratio  –  portion given to new partner

Q4 –  A and B are partners sharing profits and losses in the ratio of 5:3 . C is admitted in the firm with ⅕ th share in the profits which he acquired equally from both ,i.e, 1/10 from A and 1/10 from B . Calculate the new profit sharing ratio.
Ans :21:11:8

Q5 – Akshay and Bharati are partners sharing profits in the ratio of 3:2. They admit Dinesh as a new partner for 1/5th share in the future profits of the firm which he gets equally from Akshay and Bharati. Calculate new profit sharing ratio of Akshay, Bharati and Dinesh.

Ans: 5:3:2

  1. New partner acquire it in some agreed ratio

              New Ratio of old partner =  Old ratio  –  portion acquired by new partner

Q6 –  A and B are partners sharing profits and in the ratio of 3:1. C is admitted in the firm with ⅛ th share , which he acquires 1/32 from A and 3/32 from B . Calculate the new profit sharing ratio.

Ans:23:5:4

Q7 – Anshu and Nitu are partners sharing profits in the ratio of 3:2. They admitted Jyoti as a new partner for 3/10 share which she acquired 2/10 from Anshu and 1/10 from Nitu. Calculate the new profit sharing ratio of Anshu, Nitu and Jyoti.

Ans : 4 : 3 : 3.

  1. New partner acquire it wholly from one partner

              New Ratio of that partner =  Old ratio  –  portion given to new partner

Q8 – A and B are partners in a firm sharing profits and losses in the ratio of 4:1. C is admitted in to partnership with ¼ th share in profits which he acquires wholly from A. Calculate the new profit sharing ratio.

Ans: 11:4:5

Q9 – Das and Sinha are partners in a firm sharing profits in 4:1 ratio. They admitted Pal as a new partner for 1/4 share in the profits, which he acquired wholly from Das. Determine the new profit sharing ratio of the partners.

Ans :  11:4:5

  1. New partner acquire it in the form of certain fraction of old partners share in profit

New Ratio of old partner =  Old ratio  –  portion given to new partner(old ratio X  Fraction    given to new partner)

Q10 – A and B are partners sharing profits in the ratio of 3:1. C is admitted as a partner in the firm. A surrendered 1/32 of his share and B 3/32 of his share in favour of C. Calculate the new profit sharing ratio.

Ans:93:29:6

Q11 –  Ram and Shyam are partners in a firm sharing profits in the ratio of 3:2. They admit Ghanshyam as a new partner. Ram sacrificed 1/4 of his share and Shyam 1/3 of his share in favour of Ghanshyam. Calculate new profit sharing ratio of Ram, Shyam and Ghanshyam.

Ans :  27:16:17

C- Calculation of sacrificing Ratio

The ratio in which the old partners have agreed to sacrifice their share in favor of new partner is called sacrificing ratio.

           The newly admitted partner is required to compensate the old partners for his  right to share in the future profits of the firm. The compensation or premium brought by new partner must be shared by the old partners in the sacrificing ratio.

Sacrificing ratio = Old ratio  of a partner – New ratio of a partner

Q12 – Rohit and Mohit are partners in a firm sharing profits in the ratio of 5:3. They admit Bijoy as a new partner for 1/7 share in the profit. The new profit sharing ratio will be 4:2:1. Calculate the sacrificing ratio of Rohit and Mohit.

Ans: Sacrificing ratio among Rohit and Mohit will be 3:5.

Some times ,while the admission of a new partner, old partners rearrange their shares in profits.In such a way that some of the old partners may also gain additional shares in profits.in such a case , the gaining old  partner will also be required to compensate the partner who makes the sacrifice.

       Gaining Ratio = New share  –  Old share

Q13 –Ramesh and Suresh are partners in a firm sharing profits in the ratio of 4:3. They admitted Mohan as a new partner. The profit sharing ratio of Ramesh, Suresh and Mohan will be 2:3:1. Calculate the gain or sacrifice of old partner.

Ans:Ramesh Sacrifice – 10/42 , Suresh’s Gain – 3/42

D-Treatment of Good will

A well established business can earn more profit compared to a newly set up business because of its good name,reputation  and business connections.The monetary value of such an advantage is known as Goodwill. It can be defined as “ the present value of a firm’s anticipated excess earnings”. 

The excess super and extra ordinary profit earned is termed as Goodwill.

Factors affecting the value of goodwill

  1. Location of business
  2. Nature of business
  3. Efficiency of management
  4. Time factor
  5. Market situations
  6. Special advantages

Need for valuation of Goodwill

Arises Under the following circumstances:-

  1. Change the profit sharing ratio of the existing partners
  2. Admission of a partner
  3. Retirement of a partner
  4. Death of a partner
  5. Dissolution / sale of partnership
  6. Amalgamation of firms.

Methods of valuation of goodwill

        Usually the method of valuation of goodwill will be mentioned in the partnership deed.The important methods are:-

  1. Average profit method
  2. Weighted average profit method
  3. Super profit method
  4. Capitalisation method
    1. Capitalisation of average profit
    2. Capitalisation of Super profit

1-Average profit method(Simple average method)

Under this method goodwill is valued a certain years of purchase of the average profit of the given number of years.

                Goodwill = Average profit  X  No.of years purchase

                Average profit = Total profit for past few years /   No.of year

Ex:  profits for 3 years, 30,000 , 40,000 , 20000, GW is 3 year purchase of Average profit
Average Profit ==30000+40000+200003=30000Goodwill = Ap X 3 year Purchase of AP,   = 30000 X 3 = 120000
  • Loss also be considered ( 40000+30000-1000(loss)   AP= 60000)
  • Abnormal Gain or Loss not included in profit   (Total Profit 37500, abnormal gain 2500,so ,profit  is 37500 – 2500 =35000)

Questions

Q14 –The profit for the five years of a firm are as follows – year 2013 Rs. 4,00,000; year 2014 Rs. 3,98,000; year 2015 Rs. 4,50,000; year 2016 Rs. 4,45,000 and year 2017 Rs. 5,00,000. Calculate goodwill of the firm on the basis of 4 years purchase of 5 years average profits.

Ans: Rs. 17,54,400

Q15 –  Calculate the amount of goodwill at three year’s purchase of the last five years’s average profits.The firm earned profits during the first three years at Rs.25,000,Rs.23,000 and Rs.30,000 and suffered losses of Rs.10,000 and Rs.8,000 in the 4th and 5th year.

Ans:36,000

Q16 – The following were the profits of a firm for the last three years.Year ending Dec.31

2008 – 3,75,5000 ( Including an abnormal gain of Rs.25,000)
2009 – 6,00,000 (After charging an abnormal loss of Rs.50,000)
2010 – 2,60,000 (excluding Rs.60,000 payable on the insurance of plant and machinery)

Calculate the value of goodwill on the basis of two year’s purchase of the average profits for the last three years.

Ans:8,00,000

2-Weighted average profit method

In simple average profit method the weightage  given for all years is equal.It is considered to be better to give higher weightage to profit in recent years  than those of  the earlier years.Here weight like 1,2,3…given to the respective years(Weighted average method should be used only if specified)

                          Goodwill = Weighted AP  X No.of years Purchase

                            Weighted AP =  Product total / Weight total

Ex:   

YearProfitWeightProduct(Profit X Weight)
201150001      (Assign the weight)5000
20128000216000
Total weight = 3Total product = 21000

                      Weighted AP =    21000/3 = 7000

                      GW = 7000  X No.of year purchase

Questions

Q17 – The profits of a firm for the five years ending 31st March were as follows.

2012-13  – 23,000
2013-14  – 23,000
2014-15  – 24,000
2015-16  – 26,000
2016-17  – 20,000

Calculate the value of goodwill on the basis of three year’s purchase of weighted average profits.The appropriate weights for the last five years were 1,2,3,4 and 5 respectively.

Ans:69,000

Q18 – The profits of firm for the five years are as follows: 

Year         Profit (Rs.)
2012–13    – 20,000
2013–14    – 24,000
2014–15    – 30,000
2015–16    – 25,000
2016–17    – 18,000
Calculate the value of goodwill on the basis of three years’ purchase of weighted average profits based on weights 1,2,3,4 and 5 respectively.

Ans :  Rs. 69,600

3-Super Profit Method

The goodwill under the super profit method is ascertained by multiplying the super

profits by certain number of years’ purchase.Super profit is the excess of actual profit over the normal profit.Normal profit is termed as normal rate of return on capital employed .

Steps involved in the calculation of Goodwill

  1. Calculate the Average profit
  2. Ascertain  the Normal profit,  Normal profit = Capital employed  X normal rate of return
  3. Calculate the Super Profit , Super profit = Average Profit – Normal Profit

       Calculate the Goodwill by multiplying the super profit by the decided number of years

Questions

Q 19 – Profits of the firm for the last five years were:

2010   –   35,000
2011   –   45,000
2012   –  32,000
2013   –  28,000
2014   –  20,000

The capital employed to the firm is Rs.2,50,000. A fair return on the capital having regard to the risk involved is 10%.

Calculate the value of goodwill on the basis of three year’s purchase.

Ans: 21000

Q 20 – The books of a business showed that the firm’s capital employed on December 31, 2015, Rs. 5,00,000 and the profits for the last five years were: 2010–Rs. 40,000: 2012-Rs. 50,000; 2013-Rs. 55,000; 2014- Rs.70,000 and 2015-Rs. 85,000.

 You are required to find out the value of goodwill based on 3 years purchase of the super profits of the business, given that the normal rate of return is 10%.

Ans :Rs. 30,000

Q21 – The profit for the last five years of a firm were as follows :

Year   Profit

2014   –  62,000

2015   –  58,000

2016   –  84,000

2017   –  78,000

2018   –  80,000

Capital employed in the firm is  5,00,000. Calculate the value of goodwill on the basis of 3 years purchase of Super Profit, assuming that the normal rate of return on capital employed is 12%.( March 2020)

Ans :37200

Q 22 –  Consider the following information and calculate Goodwill by super profit method

  1. Total capital employed Rs.1,00,000
  2. Normal rate of return 8%
  3. Average profit for the last 5 years Rs.12,000
  4. Remuneration to partners Rs.3,000
  5. Goodwill is estimated at 3 years purchase of super profit. (May 2013)

Ans:3,000

4-Capitalisation Method

Under this method Goodwill can be calculated by

  1. Capitalising of average profit
  2. Capitalising Super profit

a)Capitalising average profit

Goodwill is ascertained by deducting the Net tangible asset  from the total capitalised value  of average profit.

                        Net tangible asset = Total tangible asset – liabilities outside

Capitalised value is calculated by capitalising the Average profit on the basis of Normal rate of return

                Steps involved in the calculation of Goodwill

  1. Find out the average profits of the past few years
  2. Capitalise the average profits on the basis of normal rate of return.This will give 

               total capitalised value of business.

               Capitalised value = average profit  X Normal rate of return 

  1. Ascertain the actual capital employed by deducting the outsiders liability from total assets(excluding goodwill)
  2. Compute the value of Goodwill by deducting net asset from the total value of business.
Questions

Q 23 – A business has earned average profits of Rs.80,000 during the last few years and the normal rate of return in the similar type of business is 10%.Find out the value of goodwill by capitalisation method,given that the assets of the firm amount to Rs.7,50,000 and liabilities to Rs.1,00,000.

Ans:1,50,000

Q 24 – A business has earned as average profit of Rs.1,00,000 during the last few years and the normal rate of return in similar business is 10%. Find out the value of goodwill by capitalisation method.given that the value of net assets of the business is Rs.8,20,000   ( June 2012)
As :1,80,000

Q25 –  A business has earned average profits of Rs.1,44,000 during the last few years and the Normal rate of return in similar type of business is 12%.The net assets of the firm are Rs.8,20,000. Arun and company are decided to acquire the business.Help him to calculate the Goodwill by capitalisation method.                                                                                                       (March 2014) Ans :3,80,000

b)Capitalisation of Super profit

Here total value of business is calculated by capitalising the value of super profits on the    basis of normal rate of return.

Steps –Calculating Goodwill

  1. Calculate the average profit
  2. Calculate the total capital employed (Total assets-Out sider’s liability)
  3. Calculate the normal profit on capital employed at the Normal rate of return

               Normal Profit =  capital employed  X Normal rate of return

  1. Calculate super profit( Average profit – Normal profit)
  2. Find out Goodwill = Super profit X Normal rate of return
Questions

Q 26 –  Following relate to the profit earned by a firm for the last four years

2012  – 15,000
2013  – 25,000
2014  – 65,000
2015  – 75,000
The total assets of the firm are Rs.6,40,000 and outside liabilities Rs.1,40,000. Normal rate of return is 6%. Calculate goodwill of the firm under capitalisation of super profit method.