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CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner Notes

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner Notes

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CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner Notes

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CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner Notes

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner : REVALUATION OF ASSETS AND LIABILITIES The actual value of the assets and liabilities may be different from their book value as shown by the balance sheet. So Revaluation account is prepared at the time of admission of a new partner to record any increase/decrease in the value of assets and liabilities.The value of some assets may increase with time and some may show a decrease. Similarly some liabilities may also show a increase/decrease in the value.

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Admission of a Partner: Goodwill, Revaluation and Other Calculations!

Treatment of Goodwill:

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner :  Depending upon the share of profits to be given to the new partner, either a sum of money will be directly paid by him to the old partners (through the firm or privately) or after recording new partner’s capital, new partner’s capital account will be debited with his share of goodwill, the credit being given to the old partners in the ratio of their sacrifice of future profits. The latter is an indirect method of payment for goodwill by the new partner. The payment is justified became the new partner will take a share of profits which comes out of the shares of other partners. The old partners must be compensated for such a loss.

The various possibilities as regards goodwill are:

(i) The new partner brings goodwill in cash which is left in the business.

(ii) The new partner brings goodwill in cash but the cash is withdrawn by the old partners.

(iii) The amount of goodwill is paid by the new partner to the old partners privately.

(iv) The new partner does not bring in cash for goodwill as such; but an adjustment entry is passed by which the new partner’s capital account is debited with his share of goodwill and the amount is credited to old partners’ capital accounts in the ratio of sacrifice. This entry reduces the capital of the new partner by the amount of his share of goodwill and results in payment for goodwill by the new partner to the old partners.

Before considering the entries to be made in the above cases, one must decide regarding the ratio in which goodwill is to be credited to the old partners. Traditionally, goodwill was credited to the old partners in the old profit-sharing ratio and, if the amount was to be written off as in case (v) above, it was written off to all the partners in the new profit-sharing ratio.

There would be no doubt that this should be the case when, on the admission of a new person as partner, the ratio as among the old partners does not change. But what if on the admission of a new partner, the profit-sharing ratio of old partners as among themselves is also changed.

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner :  If one treats paying sums in respect of goodwill to old partners as compensation for their surrendering to the new partner a part of their profits, then obviously the amount to be credited to partners should be in then ratio of loss of profits. Suppose, A and B, sharing in the ratio of 3: 2, admit C as partner and it is agreed that the new profit-sharing ratio is 2: 2: 1. It is obvious that B does not suffer at all on Cs admission. He previously received 2/5ths of profits; he still receives 2/5ths of profits. It is A alone who has suffered and, therefore, any amount brought in as goodwill by C should be credited to only A. Thus, it is proper to credit goodwill brought in by a new partner to the old partners in the ratio in which they suffer on the admission of the new partner.

The entries to be passed in the four cases given above are:

Sample Data for Goodwill Calculation

Illustration 1:

A and B share profits in the ratio: A, 5/8 and B 3/8. C is admitted as partner. He brings in Rs 70,000 as his capital and Rs 48,000 as goodwill. The new profit-sharing ratio among A, B and C respectively is agreed to be 7: 5: 4 respectively. Pass Journal entries.

Illustration on Goodwill Calculation -1

In the above illustration, the old partners have allowed the amounts of goodwill credited to their capital accounts remain in the business. However, the arrangement may allow the old partners to wholly or partly withdraw the amounts of goodwill credited to their capital accounts. Suppose, in the above illustration, A and B withdraw their shares of goodwill A and B withdraw their shares of goodwill brought in by C.

Then, the following additional journal entry will have to be passed:

Illustration on Goodwill Calculation -1

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner :  If the case is that the amount of goodwill is paid by the new partner to the old partners privately, no entry is passed in the books of the firm. But the calculations have to be made in the same manner as shown above.

Illustration 2:

A and B are partners sharing profits and losses in the ratio 3:2 respectively. They admit C as partner who is unable to bring goodwill in cash but pays Rs 96,000 as his capital. The goodwill of the firm is to be valued at two years’ purchase of three years’ profits. The profits for the three years were Rs 30,000, Rs 24,000 and Rs 27,000. An adjustment entry is to be passed for C’s share of goodwill. The new ratio will be 5: 2: 2. Pass journal entries.

Illustration on Goodwill Calculation -2Illustration 3:

X and Y were partners sharing profits in the ratio of 5:4 respectively. On 1st April, 2012 they admitted Z as a new partner; all the partners agreeing to share future profits equally. On the date of admission of the new partner, there was a goodwill account in the old firm’s ledger showing a balance of Rs 18,000. The current value of firm’s goodwill was placed at Rs 36,000. Z paid Rs 50,000 by way of his capital. He also paid an appropriate amount for his share of goodwill. X and Y wrote off the goodwill account before Z’s admission.

Pass the necessary journal entries.

Illustration on Goodwill Calculation -3

Illustration on Goodwill Calculation -3

Revaluation of Assets and Liabilities:

When a new partner is admitted, it is natural that he should not benefit from any appreciation in the value of assets which has occurred (nor should he suffer because of any fall which has occurred up to the date of admission) in the value of assets. Similarly, for liabilities.

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner :  Therefore, assets and liabilities are revalued and the old partners are debited or credited with the net loss or profit, as the case may be, in the ratio in which they have been sharing profits and losses hitherto. Partners may agree that the change in the value of assets and liabilities is to be adopted and figures changed accordingly or that the assets and liabilities should continue to appear in the books of the firm at the old figures.

(i) Values to be altered in books. In this case, a Profit and Loss Adjustment Account (or Revaluation Account) is opened and the following steps should be taken

(a) If the values of assets increase, the particular assets should be debited and the Revaluation Account credited with the increases only.

(b) If the values of assets fall, the Revaluation Account should be debited and the particular assets credited with the fall in values.

Note:

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner : If the value of debtors, investments or stock falls, the entry should be to debit the Revaluation Account and credit a suitable provision account. Thus, suppose it is desired to record a fall in value of investments to the extent of Rs 9,500.

The entry is:

Revaluation Account Entry

If there is already a provision against a particular asset and the value of that asset increases, the entry should be to debit the Provision and credit Revaluation Account rather than to follow (a) above.

(c) Increase in the amounts of liabilities is a loss.

Hence, the entry is:

Revaluation Account Entry

If an increase is not definite but is expected, the credit should be to a suitable provision account.

(d) Any reduction in the amounts of liabilities is a profit and hence the liabilities accounts should be debited and Revaluation Account credited with the difference between the old and present figures.

(e) The Revaluation Account should then be closed by transfer to old partners’ capital (or current) accounts in the old profit-sharing ratio. If debits exceed the credits, it is a loss and the entry is to debit partners’ capital (or current) accounts and credit Revaluation Account. Reverse entry is made when the credits exceed debits.

Illustration:

A and B share profits in the proportions of three-fourths and one-fourth respectively.

Their balance sheet on March 31, 2012 was as follows:

On April 1, 2012 C was admitted into partnership on the following terms:

(1) That C pays Rs 40,000 as his capital for a fifth share.

(2) That C pays Rs 20,000 for goodwill. Half of this sum is to be withdrawn by A and B.

(3) That Stock and Fixtures be reduced by 10% and a Provision for Doubtful Debts amounting Rs 950 be created on Sundry Debtors and Bills Receivable.

(4) That the value of Land and Buildings be appreciated by 20%.

(5) There being a claim against the firm of damage, a liability to the extent of Rs 1,000 should be created.

(6) An item of Rs 650 included in Sundry Creditors is not likely to be claimed and hence should be written off.

Pass journal entries for the above-mentioned transactions excluding cash transactions; prepare cash book and important ledger accounts. Also prepare the balance sheet of the firm immediately after Cs admission. Assume the profit-sharing ratio as between A and B has not changed.

Solution of Illustration -4

Solution of Illustration -4

Solution of Illustration -4

(ii) When values are not to be altered. In this case, the increases and decreases in the values of assets and liabilities are entered in a Memorandum Revaluation Account without passing corresponding entries in the assets and liability accounts. The balance is transferred to old partners’ capital accounts in the old profit-sharing ratio. Then, entries passed in Memorandum Revaluation Account for increases and decreases in the values of assets and liabilities are reversed, again without passing any entry in the assets and liability accounts. The balance of Memorandum Revaluation Account is, this time, transferred to all partners (including the new one) in the new profit-sharing ratio.

In the illustration above, the Memorandum Revaluation Account and the capital accounts will appear as follows if this method is to be followed:

Memorandum Revaluation Account

Journal entries regarding revaluation in the case discussed above will be:

Journal Entries Regarding Revaluation

New Profit-Sharing Ratio:

Finding out the new profit-sharing ratio might involve a little calculation. The language of the agreement is the most important factor. In some cases, the new ratio is given. In others, only the share to be given to the new partner is given; the assumption is that as amongst the old partners, the ratio does not change. In such a case, one should deduct from 1 the share of the new partner and then divide the remainder among the old partners in the old ratio. Suppose, A and B are partners sharing profits and losses in the ratio of 5: 3 respectively. They admit C and agree to give him 3/10 of the profits.

Then, the new ratio will be calculated as follows:

Profit Sharing Ratio

In certain cases, the incoming partner “purchases” his share from the other partners in different proportions. Suppose, A and B sharing profits in the ratio of 5: 3 respectively admit C giving him a 3/10 share of profits of the firm. If C acquires 4/20 share from A and 2/20 share from B, the new ratio will be

Profit Sharing Ratio

Example:

Doctors Glucose and Cibazol have a practice producing Rs 3,72,900 per annum, which they divide in proportions of 17/33 and 16/33. They admit Dr. Zambuck to partnership on the basis of his buying, at 2 years’ purchase, 5/17 of Dr. Glucose’s share and 4/16 of Dr. Cibazol’s share. After the lapse of three years, they permit Dr. Zambuck to purchase a further 1/12 of their remaining shares. How much did Dr. Zambuck pay to each of the others on each occasion, and what is the ultimate share of each partner in the practice?

At first, Dr. Zambuck buys 5/17 of Dr. Glucose’s share. That comes to (5/17) x (17/33) or 5/33 Dr. Glucose’s share, therefore, is (17/33)-(5/33) or 12/33. Dr. Zambuck acquires (4/16)x (16/33) or 4/33 from Dr. Cibazol whose share, therefore, is (16/33)-(4/33) = 12/33. Total share of Dr. Zambuck is [(5/33) + (4/33)] or 9/33. Goodwill is valued at Rs 3,72,900 x 2 or Rs 7,45,800. Therefore, Dr.

Zambuck has to pay Rs 7,45,800 x 9/33 or Rs 2,03,400 which is shared by Dr. Glucose and Cibazol in the ratio of 5 : 4 (the ratio in which they lose profits). Rs 1, 13,000 will go to Dr. Glucose and Rs 90,400 to Dr. Cibazol. The new ratio is 12/33,12/33 and 9/33.

Later, Dr. Zambuck acquires 1/12 of each partner’s share. Hence, he acquires 12/33 x 1/12 or 1/33 from both the other partners. The share of Dr. Glucose is reduced to 12/33-1/33 or 11/33. So also for Dr. Cibazol. The share of Dr. Zambuck comes to be 9/33 + 1/33 + 1/33 = 11/33. Hence, all partners are now equal. Dr. Zambuck will have to pay 7,45,800 x 1/33 or ? 22,600 to each of the other two partners by way of goodwill.

Reserves, etc., Created Out of Profits:

Reserves existing at the time of the admission of a new partner should always be transferred to the capital or current accounts of the old partners in the profit-sharing ratio. Students should remember to do this even if the question is silent on the point.

Capitals of Partners to be Proportionate to Profit-Sharing Ratio:

It is often agreed on admission of a partner that the capitals of all partners should be in proportion to their respective shares in profits. The starting point may be the new partner’s capital or the new partner himself may be required to bring in capital equal to his share in the firm. If the new partner’s capital is given, one should find out the total capital of the firm on the basis of his share.

Then the capital required of other partners should be ascertained. Suppose, C is admitted in a firm with a 1/4 share of the profits of the firm. C contributes Rs 15,000 as his capital, A and B, the other two partners, were sharing profits in the ratio of 3: 2.

Then, the required capital of A and B should calculate as follows:

CBSE Class 12 Commerce Accounting For Partnership Firms Admission Of A Partner Notes

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