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Partnership Accounting CA Foundation Notes

Partnership Accounting – CA Foundation, CPT notes, PDF

This article is about Partnership accounting for CA foundation CPT students. we also provide PDF file at the end.

partnership accounting

partnership accounting

What we will study in this chapter:

We will study in this chapter the general points relating to partnership useful for accounting.

We will study accounting adjustment in case of admission, retirement, death and change in profit showing ratio commonly known as change in constitution.

THIS CHAPTER IS DIVIDED INTO FOLLOWING SECTIONS:

♦     General Points relating to Partnership.

♦     Profit sharing.

♦     Change in constitution.

♦     Goodwill: Meaning, Calculation & Adjustment.

INTRODUCTION

Many businesses are constituted (organized) in partnership form. The terms and conditions as mutually agreed upon, govern inter-relationship among partners as well as accounting. There is Indian partnership Act that also provides certain useful norms.

When change in constitution takes place (i.e. Admission, Retirement, Death or Change in profit sharing ratio) partner’s mutual rights may get disturbed (i.e. somebody will be gainer and somebody will be looser) unless certain adjustment related to unaccounted or undivided old profits/loss is made.

The new ratio has been agreed to apply to future profits / losses. But if there exists any unaccounted or undivided profit or loss of old period, then that also will get divided in future, in new ratio instead of old ratio, to that extent someone will gain and someone will loose. This is to be adjusted at the time of change in constitution.

Dissolution of firm is not included in foundation syllabus. Dissolution and other advance features are covered in Intermediate syllabus.

GENERAL POINTS RELATING TO PARTNERSHIP

22.1     PARTNERSHIP:

♦     Partnership is a relationship between two or more persons to do some commercial activity for mutual benefit.

♦     The activity is carried as mutually agreed for and on behalf of all.

♦     The organisation so created is commonly known as firm.

22.2     PARTNERSHIP DEED:

♦     Partners may put in writing the details of their mutually agreed terms and conditions to run and manage the partnership.

♦     Such document is known as partnership deed.

♦     This will help to avoid misunderstanding or future disputes among the partners.

22.3     MINOR AS PARTNER:

♦     Minor being not eligible to enter into any contract cannot become a partner.

♦     But section 30 of partnership Act permits that a minor can be included to the benefit of partnership.

♦     Hence, minor will not be liable for losses.

♦     When he becomes major, within 6 months he has to decide either to become partner or not.

22.4     ISSUES ON WHICH PARTNERSHIP DEED IS SILENT:

♦     In the absence of any provision in partnership deed, following provisions of partnership Act are applicable :

  1. Profit/Loss sharing ratio will be equal,
  2. No interest is to be allowed on capital,
  3. No interest is to be charged on drawings,
  4. 6% per annum interest is to be given on partner’s loan,
  5. No salary is to be paid to any partner,
  6. Interest and salary, if payable, will be paid only if there is profit unless agreement provides otherwise.

♦     Student should use above, whenever question is silent with regard to this items.

Illustration 22.1: Black and White are partners started business with capital Rs. 30,000 and Rs. 20,000. Profits for the year ended 31st March, 2006 amounts to Rs. 27,100. It is agreed that 5% interest on capital as such shall be allowable. There is no agreement regarding sharing of profits or partnership salary.

Black is a whole time partner whereas white does not attend business regularly. Black claims Rs. 600 salary p.m. and 6096 of balance profit. White advanced Rs. 10,000 loan and he now claims 1096 interest.

Show distribution of profit by a statement.

Solution :

♦     Salary was not agreed among them hence Black’s claim of salary will not be sustainable.

♦     Interest on Loan u’as not agreed by them hence as per law 696 interest will be allowed to White & not 1096.

♦     Interest on Capital was agreed among them @596, hence will be allowed.

♦     Profit sharing ratio was not agreed among them hence, they will be treated as equal partners i.e. 50:50, Black’s claim of 6096 will not be sustainable.

Profit & Loss Appropriation Account

ParticularsRs.ParticularsRs.
To Interest on Whites Loan a/cBy Net Profit as per P&L a/c27,100
White 10,000 × 6% =600
To Interest on Capital a/c
Black 30,000 × 596 =1,500
White 20,000 × 5% =1,0002,500
To Balance Profit transferred
Black 24,000 × 5096 =12,000
White 24,000 × 50% =12,00024,000
27,10027,100

22.5     SYSTEM OF CAPITAL ACCOUNT MAINTENANCE:

♦     To run the business the partners bring in cash, goods or other assets etc. which is called as their capital.

♦     Capital Accounts are maintained under two system (methods).

♦     1. Fluctuating capital system & 2. Fixed capital system.

22.5.1  Fluctuating Capital System:

♦     In this system only one A/c is maintained for each partner.

♦     All the adjustments i.e. capital introduced, interest, salary drawings, profit/loss etc. is debited/credited in the same Account.

♦     Therefore Capital Account balance keeps on fluctuating every time.

Illustration 22.2 : Prepare capital account under fluctuating capital system taking figures of Illustration 16.1

Solution :

Capital Account

ParticularsBlackWhiteParticularsBlackWhite
To Balance c/f43,50033,600By Bank a/c30,00020,000
By Interest on loan a/c600
By Interest on Capital a/c1,5001,000
By Profit & Loss appropriation a/c12,00012,000
43,50033,60043,50033,600

22.5.2  Fixed Capital System:

♦     For each partner two accounts will be maintained namely Capital a/c and Current a/c.

♦     The capital introduced will be credited to capital a/c.

♦     All other regular adjustments like interest, Salary, drawings, share in profit/losses will be made in the current a/c and

♦     Hence capital a/c remains fixed from year to year unless their is withdrawal of capital or Addition to capital. Illustration 22.3 : Prepare capital & current account under fixed capital system taking figures of Illustration 16.1

Solution :

Capital Account

ParticularsBlackWhiteParticularsBlackWhite
To Balance c/f30,00020,000By Bank a/c30,00020,000
30,00020,00030,00020,000

Current Account

ParticularsBlackWhiteParticularsBlackWhite
To Balance c/f13,50013,600By Interest on loan a/c600
By Interest on Capital a/c1,5001,000
By Profit & Loss appropriation a/c12,00012,000
13,50013,60013,50013,600

22.6     FINAL ACCOUNTS OF PARTNERSHIP FIRM:

♦     Final Accounts of a Partnership Firm generally includes following.

  1. Trading, Profit and Loss A/c
  2. Profit & Loss Appropriation A/c
  3. Balance Sheet.

♦     Final accounts of Partnership firm are already covered in Chapter 10: Final Accounts.

i These are prepared according to the normal principles of accounting (already studied in Chapter 10).

ii The interest on capital, salary to partners, interest on drawing, interest on partners loan, transfer to reserves etc. are debited/credited to P&L Appropriation Account and not to the P&L Account. The balance of profit in P&L appropriation A/c will be then transferred to Partners capital A/cs in profit sharing ratio.

iii The goods withdrawn by the partners for personal use should be debited to their drawings A/c and credited in trading A/c as separate item or reduced from purchases and not to be clubbed with the sales.

22.7     PARTNERSHIP AND JOINT VENTURE COMPARISON:

♦     When two or more persons join together, to do business on joint account on regular basis & to share the profits or losses such relationship is known as partnership & the persons are known as partners.

♦     When two or more persons join temporarily to do a particular job or work & to share profits or losses, is known as joint venture & the persons are known as co-venturer’s.

♦     Partnership is a relationship between persons who have agreed to share profits or losses of a business carried on by all or any of them acting for all.

♦     Whereas, a joint venture is a contractual agreement whereby two or more parties undertake an economic activity which is subject to joint control.

♦     Thus joint venture is a temporary partnership formed for a particular economic activity or venture.

♦     The following additional differences exist between joint venture and other forms of partnership.

  1. Accrual basis of accounting is followed in case of partnership and a joint venture generally follows cash basis of accounting.
  2. The financial results of a partnership are obtained at regular intervals i.e. on annual basis. On the other hand, the financial results of a joint venture are obtained generally at the end of the venture.

However, there may be ventures in certain areas, which may last for a longer period, for example, joint ventures in key areas like power, petroleum, telecommunication etc. In these cases, the ventures may even last for ten/ fifteen years. For these long-term joint ventures, financial statements are prepared periodically by following accrual basis of accounting. Therefore, the line of distinction between long-term joint ventures and other forms of partnership is very thin.

PROFIT SHARING

22.8     SHARING PROFIT/LOSSES:

♦     Usually profit sharing is given by way of ratio like 5:3:2 or in % form like 20%, 40%, 40%, etc.

♦     If question is silent about profit sharing then consider them as equal partners as per the provision of partnership act.

♦     Profit should be shared in the ratio of capital only if specifically mentioned in the question, not otherwise.

♦     Partners can decide mutually any basis or mode of sharing profits and losses, there is no limit to it.

♦     You will see some illustration on profit sharing by different ways in this chapter.

♦     So whenever question contains some new basis of sharing, read and interpret it correctly and make calculations according to it.

Illustration 22.4 : A, B and C enter into partnership and agree to share profits and losses as under A – bth of the profits/losses B – 1 /4th of the profits/losses C – 1 /8th of the profits/losses

Comment on the profits/loss sharing ratio agreed to by the partners.

Solution :

The total of the ratios is 7/8 which is less than 8/8 i.e. 1. They should change the ratios so that total comes to 8/8 i.e. 1. or

they may clarify if balance 1 / 8th is to be transferred to reserves.

Illustration 22.5: The Chartered Accountants X, Y and Z form a partnership, profits being divisible in the ratio of 3:2:1 subject to the following:

  1. Z’s share of profit is guaranteed to be not less than Rs. 15,000 p.a.
  2. Y gives guarantee to the effect that gross fees earned by him for the firm shall be equal to his average gross fee of the preceding five years when he was carrying on profession alone (which average works out at Rs. 25,000).

The profit for the first year of the Partnership is Rs. 75,000. The gross fees earned by Y for the firm are Rs. 16,000. You are required to show the distribution of profits.

Solution :

Profit as given75,000
Shortfall to be contributed by Y (25,000 – 16,000)9,000
Total Profit84,000
Z’s share (1/6) Rs. 14,000
Minimum allowed to Z15,000
Balance for X and Y69,000
X’s 3/541,400
Y’s 2/527,60069,000
Nil

Illustration 22.6 : A and B were in partnership sharing profits and losses in the ratio of 3:2. In appreciation of the services of their clerk C. Who was in receipt of a salary of Rs. 2,400 p.a. and a commission of 5% on the net profit after charging such salary and commission. They took him into partnership as from 1st April, 2005, giving him one-eight share of profits.

The agreement provided that any excess over his former remuneration to which, C becomes entitled will be born by A and B in the ratio of 2:3

The profit for the year ended 31st March, 2006, amounted to Rs. 44,400.

Prepare statement showing the distribution of the profit amongst all the partners.

Solution :

(i)    Share of ‘C’ as partner 44,400 × 1/8 = 5,550

(ii)   C’s remuneration as clerk

Profit44,400
(-) Salary to clerk2,400
Profit before commission42,000
(-) Commission 42000 × 5/1052,000
Profit after Salary & comm.40,000

Total remuneration to *C’ 2,400 + 2,000 = 4,400

(iii) Excess to ‘C (i) – (ii) = 5,550 – 4,400 = 1,150 to be born by A & B as follows:

A: 2/5 × 1150 = 460

B: 3/5 × 1150 = 690

1150

Summary

PartnerShareAdjustmentTotalNote: The effect of above calculation is that extra Rs. 1,000 to Z is born by X & Y in their profit sharing ratio i.e. 3:2.
X41,40041,400
Y27,600– 9,00018,600
Z15,00015,000
84,00075,000

Summary:

PartnerShareAdjustmentTotal
A (40,000 × 3/5)24,000– 46023,540
B (40,000 × 2/5)16,000-69015,310
40,000
C4,400+ 1,1505,550
44,40044,400

Illustration 22.7 : X,Y & Z start business in partnership, X put in Rs. 20,000 for the whole year, Y Puts Rs. 30,000 at first and increases it to Rs. 40,000 at the end of four months but withdraws Rs. 20,000 at the end of six months, while Z puts Rs. 40,000 at first but withdraws Rs. 10,000 at the end of nine-months. At the end of the year how should they divide a profit of Rs. 79,000 on the basis of effective capital employed by each partner?

Solution

ParticularsCapital o/sMonthsProduct
(i) X puts in 20,00020,000122,40,000
(ii) Y puts in 30,000 at beginning30,00041,20,000
Adds 10,000 at end of 4 month40,000280,000
Withdraws 20,000 at end of 6 month20,00061,20,000
123,20,000
(iii) Z puts in 40,000 at beginning40,00093,60,000
Withdraws 10,000 at end of 9 month30,000390,000
124,50,000

Profit = Rs.79,000

To be divided in the ratio of effective capital which in monthly terms is 2,40,000 : 3,20,000:4,50,000 among X, Y & Z. i.e. 24 : 32 :45

X’s share = 79,000 × 24/301=18,772
Y’s share = 79,000 × 32/101=25,030
Z’s share = 79,000 × 45/101=35,198
79,000

CHANGE IN THE CONSTITUTION

22.9     MEANING:

22.9.1  Change in the constitution of the firm:

♦ If any of the following happens, it is said to be change in the constitution of the firm.

(1)   Admission of the new partner.

(2)   Retirement/Death of a partner.

(3)   Change in the profit sharing ratio.

Illustration 22.8 : Illustrate all the cases of change in constitution.

Whenever there is change in the constitution, the Partners & the Profit sharing Ratio: applicable till the date of change will be known as ‘Old Partners’ & Old Ratio’ & those applicable after the date of change will be known as ‘New Partners’ & ‘New Ratio’.

Solution :

(1)‘A’ & ‘B’ sharing profits in 2:3 ratio, admits ‘C & the ratio then is 2:3:1.
Then, Before Change : Old PartnersA,BOld Ratio2:3
After Change : New PartnersA,B,CNew Ratio2:3:1
(2)‘X’ ‘Y’ & ‘Z’ are Partners sharing profits in 4:5:3. ‘Y’ retires or dies.
Then, Before Change : Old PartnersX,Y,ZOld Ratio4:5:3
After Change : New PartnersX,ZNew Ratio4:3
(Note: After retirement, how X & Z will share is not given, in such cases it will be assumed that they will continue to share in their old ratio).
(3)‘L’ ‘M’ & ‘N’ sharing profits in 3:2:5, decides to change the ratio to 4:2:4.
Then, Before Change: Old PartnersL,M,NOld Ratio3:2:5
After Change : New PartnersL,M,NNew Ratio4:2:4

22.9.2  The common factor in above cases and its significance:

Old PartnersNew Partner
Old RatioDate of changeNew Ratio

The common factor in all above i.e. in Admission, Retirement, Death or change in ratio is that Profit Sharing Ratio Changes.

♦     Hence, if there is any old profit or loss unaccounted or undivided then the same should be adjusted at the time of change.

♦     Otherwise these profits/losses whenever divided in future, the same will be shared by new partners in New Ratio.

♦     To that extent some partner will be gainer and the other will be looser.

♦     This shouldn’t happen hence, we make adjustment at the time of change.

♦     The value of Building, Land or goodwill may be more than the value appearing in account books (in balance sheet) the increase in the value is an example of unaccounted profit.

♦     Sometime whole of the profit earned is not transferred to capital account, the balance appears in account like general reserve, it is an example of undivided profit.

♦     Divide old profit/loss among old partners in old ratio, or

♦     If we want to keep the unaccounted/undivided profit or loss as it is then calculate the consequent gain and loss (it is the amount of difference between the share as per old ratio and new ratio) and adjust the same either in cash or by accounting.

22.9.3  Old profits/losses referred to above may be classified under the following heads:

♦     When there is a change in the constitution basically six under mentioned adjustments (to the extent applicable) will be required.

  1. Goodwill. (Goodwill is an asset but increase in its value otherwise than by purchase will have effect of profit)
  2. Revaluation of Assets & Liabilities. (Increase in value of asset over its book value will be a profit and decrease will be a loss. For liability it will be exactly opposite)
  3. Reserves/Profit & Loss a/c balance etc. (These are undivided profits or losses)
  4. Joint Life Policy. (Increase in its value/claim amount over its book value will be a profit)
  5. Profit or loss till the date of change. (When change in constitution takes place other than exactly on year end, then profit or loss from the beginning of year to the date of change is a old profit or loss)
  6. Others: Some old rectification items. (May result into profit or loss)

All the above items have effect of unaccounted or undivided profit/loss of the period till the date of change referred here as old profit/loss.

In accounting profits or losses also means the difference between the book value (i.e. the value/balance as per account books) and the real value (market value or today’s value) of any asset or liability including goodwill, joint life policy etc.

22.9.4  The other financial items which are not adjustment of old profits/losses as described above:

♦     The Financial transactions like:

■     contributing capital in case of admission,

■     repayment of capital in case of retirement/death,

■     sale/realization of any asset,

■     settlement/payment of any liability etc. will be made as given in the question.

♦     Similarly adjustment of capitals in profit sharing ratio or in any other specified ratio will be made only if required by the question.

♦     These are not those adjustments of old unaccounted profit or loss which are necessarily required to be accounted otherwise mutual rights of partners will be disturbed.

♦     These are normal financial transactions not resulting into old profits or losses.

22.10   RATIOS:

22.10.1 Ratio of sacrifice:

+ Ratio of Sacrifice = Old ratio (-) New Ratio.

♦     Sacrifice to a partner is the reduction in his profit sharing ratio compared to old ratio.

♦     When a partner is admitted, he gets some share in profits therefore he is the gainer and one or more old partner may be sacrificer.

♦     But it is not necessary that all the old partners will be sacrificer because ratio of some old partner may also increase.

22.10.2            Ratio of gain:

♦     Ratio of gain = New Ratio – old Ratio

♦     Gain to a partner is the increase in his profit sharing ratio compared to his old ratio.

♦     When a partner retires/dies, he looses his share in profits therefore he is the sacrificer and one or more continuing partner may be gainer.

♦     But it is not necessary that all the continuing partners will be gainer because ratio of some of continuing partner may also decrease.

The term sacrifice or gain is used keeping in mind the amount of profit.

But if applied to losses it will be exactly opposite i.e. a partner whose ratio increases will bear more loss thus will be a looser and one whose ratio decreases will bear less loss thus will gain.

22.10.3 Calculation of New profit sharing ratio:

♦     Whenever change in constitution takes place, the new profit ratio may be specified in the question.

♦     Basis of calculating the new ratio may be given in the question, according to which new ratio will have to be calculated by the student.

♦     There is no limit to such alternative basis, some illustrations are given below.

♦     While solving ratios make their base i.e. denominators equal.

♦     Multiplying numerator and denominator by same number will not change the value but will convert it to the required base.

♦     In multiplication, simply multiply both the numerators and both the denominators and the result is ready.

♦     In case of addition or substraction if the base that is denominators are same, then simply add or substract the numerators as the case may be, the result will have the same base.

Illustration 22.9 : Partners A & B are sharing in the ratio of 3:2 (i.e. 3/5 & 2/5). They admit C. Calculate new ratio in the following alternative cases.

Solution;

(1)   ‘C is admitted with l/6th share.

‘C’s share is 1 /6th of the total profit.

∴ Balance profit left for A & B = 1 – 1/6 = 5/6.

Because nothing is specified we will assume that A & B will share balance in old ratio.

∴ A’s share = 5/6 × 3/5 = 15/30 = 3/6 & B’s share = 5/6 × 2/5 = 10/30 = 2/6

Thus the new ratio of A, B & C will be 3/6, 2/6 & 1/6 or 3:2:1

(2)   ‘C’ is admitted with l/6th share & ‘A’ & ‘B’ decided to share equally in future.

‘C’ share = 1/6 Balance is 5/6

which will be shared equally by A & B.

∴ A’s share =  ×  =  =  and B’s share =  ×  =  =

Thus the New Ratio of A, B & C = 5/12, 5/12, 2/12 OR 5:5:2

(3)   ‘C’ is admitted with l/6th share, which he purchased from B.

‘C’s share =1/6 which will come from B

∴ ‘B’s New share = 2/5 – 1/6 = 12/30 – 5/30 = 7/30.

∴ ‘A’s New share will remain as the old share i.e. 3/5 = 18/30.

Thus the New Ratio of A, B & C will be 3/5, 7/30 & 1/6. i.e. 18/30, 7/30, 5/30 i.e. 18:7:5

(4)   ‘C’ is admitted with I /6th share which he bought from A & B in 2:3 ratio.

‘C’s share is 1 / 6

Purchased from ‘A’ 1/6 × 2/5 = 2/30 Purchased from ‘B’ 1/6 × 3/5 = 3/30

∴ A’s share 3/5 – 2/30 = 18/30 – 2/30 = 16/30 & B’s share 2/5 – 3/30 = 12/30 – 3/30 = 9/30 Thus the New Ratio of A, B, C will be 16/30, 9/30 & 5/30 i.e. 16:9:5

(5)   ‘C’ is admitted. He purchased 1 /3rd of A’s share & 2/3rd of B’s share.

C’s share = Purchased from A + Purchased from B

Purchased from A = 3/5 × 1/3 = 1/5 i.e. 3/15

Purchased from B = 2/5 × 2/3 = 4/15

∴ A’s share = 3/5 – 1/5 = 2/5 = 6/15

B’s share = 2/5 – 4/15 = 6/15 – 4/15 = 2/15

C’s share = 1/5 4- 4/15 =3/15 + 4/15 = 7/15

Thus the New Ratio of A, B, C will be 6/15, 2/15 & 7/15 i.e. 6:2:7.

(1)   When we say new partner is purchasing share that means old partners are selling their share. Similarly in case of death/retirement, outgoing partner will sell his share and other will purchase it.

(2)   Similarly ratios will be worked out in case of Retirement/Death. In such cases wording may be like outgoing partners sells his share or other partner purchases share from the outgoing partner. When nothing is specified, it can be assumed that the remaining partner will continue to share in their old ratio.

22.11 ACCOUNTING FOR CHANGE IN CONSTITUTION:

22.11.1 The alternative modes to make adjustments for change in constitution:

The above adjustments (item 1 to 6 mentioned in para 22.9.3) can be made in any of the following ways

Alternative methods for Accounting Adjustment
Through cashThrough accounting
(1) Privately(2) Though firm
No accounting entry in the books of firmCash account will be debited by the amount received from gaining partner. This will be credited to the a/c of sacrificing partner
(3) Without changing book values/ by single journal entry Gaining partners a/c Dr.

To sacrificing partners a/c

(4) By making appropriate changes in the book values of assets/ liabilities /goodwill/reserves etc. & giving second effect to old partner in old ratio

Note: We will refer the above as method (1) to (4) in our later discussion.

  1. Any one of this method can be applied to all the above items of adjustment (namely goodwill, revaluation, reserves, profits, joint life polity, etc.) or different methods can be applied to different items. Examination questions are mostly solved by method (4) above except goodwill adjustment which is commonly solved by method (2) or (3).
  2. All these are for the old unaccounted/undivided profits or losses i.e. profits or losses upto the date of change. The profit or losses after the date of change in constitution will naturally belong to new partners in new profit sharing ratio.
  3. These are equally applicable to admission, retirement, death or change in profit sharing ratio.
  4. The amount in method (4) above will be the total old profit/loss, whereas in method (1), (2) & (3) the amount will be the net amount of gain or sacrifice to partner (it is the difference of old profit/loss divided into old ratio and new ratio).
  5. In method (1), (2) & (3) even though the mutual rights of the partners gets adjusted, but the old unaccounted/ undivided profits or losses still remains unaccounted/undivided.

22.11.2 Goodwill (Meaning, Calculation & Accounting is covered later):

22.11.3 Accounting of Revaluation of Assets/Liabilities :

♦     Revaluation a/c is prepared.

♦     All the assets and liabilities on the date of change in constitution are revalued.

♦     The revaluation difference is debited/credited to the Revaluation a/c.

(a)   If value of asset is increased: (profit)

Asset a/c         Dr.       (With the increase in the value of asset)

To Revaluation a/c

(b)   If value of asset is decreased: (loss)

Revaluation a/c           Dr.       (With the decrease in the value of asset)

To Assets a/c

(c)   If there is increase in the value of liabilities: (loss)

Revaluation a/c           Dr.       (With the amount of increase in the liability)

To Liability a/c

(d)   If there is decrease in the value of liabilities: (profit)

Liability a/c      Dr.       (With the amount of decrease in the value of liability)

To Revaluation a/c

♦     The balance in Revaluation A/c will be profit (if credit is more) or loss (if debit is more).

♦     It will be transferred to the old partners in their old profit sharing ratio (method 4).

22.11.4 Memorandum Revaluation Account: (Method 3)

♦     If the value of assets and liabilities are not to be changed in the books of Account.

♦     But at the same time the rights of the partners have to be properly adjusted on the admission/death/retirement/ change in profit sharing ratio of the partners.

♦     In such a case a Memorandum Revaluation A/c will be prepared.

(1)   It will prepared in the same way as the Revaluation a/c, only difference is that debit/credit to asset/ liability a/c’s will not be made, whatever is the balance will be the profit or loss to which the old partners are entitled in their old profit sharing ratio.

(2)   Then whatever was credited to Memorandum Revaluation a/c will be taken on debit side. And whatever was debited to the Memorandum Revaluation a/c as per above will be taken on credit side.

The balance will be the same amount as in the above, but it will be loss, if earlier there was a profit and vice versa.

This balance is to be transferred to New partners in their new profit sharing ratio.

♦     The Net difference of (1) & (2) above will be Debited/Credited to Partners a/c.

♦     Thus there will be no debit/credit to asset and liability accounts.

♦     In the same way adjustment for Reserves etc. can also be made, if the book values are not to be changed (method 3).

♦     If instead of book adjustment cash is paid or received equal to the net difference calculated above it becomes method (1) if privately settled and method (2) if cash is paid/received through firm.

♦     This amount is in the ratio of gain/sacrifice.

22.11.5 General Reserve, P&L a/c., etc.:

♦     At the time of any change in constitution the accumulated profit/Ioss balance laying in General Reserve, P&L a/c or in other a/c should be transferred to the old partners in their old profit sharing ratio (method 3).

♦     It is commonly followed, although other methods can also be followed.

General Reserve a/c Dr.         xxx

To Old Partners Capital a/c    xxx

22.11.6 Joint life policy: Meaning and purpose:

♦     A life insurance policy taken by a firm on the life of its partners is known as joint life policy.

♦     It can be either

■     one combined policy on the life of all partners or

■     separate policy on the life of each partner.

♦     Expenditure of insurance premium is borne by the firm hence this policies are the firm’s assets.

♦     Death is an uncertain and unpredictable event.

♦     In case of death of any partner, his family members may be interested to take back their dues.

♦     The purpose of joint life policy is to help financial settlement in such eventuality.

Hence, even when question is silent, the claim money received should be utilized to settle the account (dues) of deceased partner.

♦     In case of combined policy the policy amount (face value/insurance value) will be received if any partner dies.

♦     But in case of separate policy, claim will be received of the policy on deceased partner’s life only.

22.11.7 Accounting for Joint Life Policy Premium and adjustment in case of change in constitution:

♦     The firms can take joint life policy on the life of one or more partners.

♦     The premium will be paid out of the firm’s income.

♦     Accounting of such premium can be done in either of the following four ways:

(1)   Premium paid is debited in the respective years P&L a/c. No Policy (Asset) a/c is opened. It means that LIP paid & written off by debit to P&L a/c of the year..

P&L a/c Dr.     10,000

To Cash /Bank a/c      10,000

♦     In such cases whenever claim is received (on death of a partner) from the Insurance Co. the total amount received will be a profit and will be shared by all the old partners. OR

♦     Whenever constitution of the firm is changed otherwise than by death then the Policy (asset) a/c may be created at surrender value by following entry:

Joint Policy a/c Dr. (with the amount of surrender value) xxx

To Revaluation a/c (or can be directly credited to old partners) xxx

(2)   Policy a/c created: Whenever premium is paid the Policy a/c is created at surrender value and the balance is written off by passing following entry.

Policy a/c Dr. (With amount of surrender value)        6,000

P&L a/c Dr. (Premium paid (-) surrender value)        4,000

To Bank/cash a/c (With the amount of premium paid)           10,000

Note: surrender value Rs. 6000 is an assumed figure.

♦     In this case when amount is received (on death of a partner) it will be credited to Policy a/c. Balance will be profit and will be transferred to old partners in old profit sharing ratio.

♦     In case of change other than death, no adjustment will be required because policy already appears at surrender value, hence no profit on revaluation.

(3)   Joint life policy reserve account: It is only a modified version of method (1) above. Here also full amount is written off to P & L but still policy account and policy reserve account appear on the asset and liability side of balance sheet at surrender value,

When premium paid –

(a)   P&L A/c Dr.          10,000

To Bank A/c    10,000

Policy a/c created at surrender value & equal amount transferred to reserve A/c –

(b)   Policy A/c Dr.       6,000

To Joint life policy reserve A/c           6,000

♦     At the time of change in constitution JLP reserve account will be transferred to old partners account in old ratio.

♦     Alternatively it can be transferred to policy a/c. rest of the treatment will be same as in (1) above.

♦     Note: if this entry (b) is passed, with full value then policy and reserve both will appear at full value but still effect is same.

(4) Joint life policy reserve account: modified version of (2) above.

When premium paid –

(a) Policy A/c Dr.         10,000

To Bank A/c    10,000

Amount equal to premium less surrender value transferred to Joint life policy reserve A/c –

(b) P&L A/c Dr.           4,000

To Joint life policy reserve A/c           4,000

♦     As a consequence of above P&L is debited with premium in excess of surrender value and net balance of policy a/c. (-) Joint life policy reserve a/c, at any time is equal to surrender value. Thus it is same as (2) above.

♦     At the time of change in constitution

■     the balance of Joint life policy reserve can be either transferred to old partners like other reserves or

■     it can be credited to Policy a/c rest of the accounting is same as in (2) above.

22.11.8 Chart explaining treatment of Joint life policy :

When premium is paid every yearAt the time of change in constitutionNet effect
P&L a/c Dr. 10000

To Bank a/c 10000

(1)   Death → Claim received → Claim – Book value = Profit = (claim)

(2)   Other → Revalued at S.V. → R.V. (=S.V.) – B.V. (nil) = Profit = (S.V.)

Joint Life Policy
or
JLP a/c Dr. 6000 P&L a/c Dr. 4000

To Bank a/c 10000

(1)   Death → Claim received → Claim – Book value = Profit = (claim-S.V.)

(2)   Other → Revalued at S.V. → R.V.(=S.V.) – B.V.(=S.V.) = Profit = (0)

Note:

  1. Transfer above profit to old partners in old ratio.
  2. Utilize claim money to settle deceased partners dues.
  3. R.V. = Revalued value, S.V. = Surrender value, B.V. = Book value
  4. In case J.L.P. reserve is created then B.V. = Policy a/c. – J.L.P. reserve a/c. Alternatively J.L.P. reserve can be separately transferred to old partners a/c in old ratio.

Illustration 22.10 : X, Y and Z were sharing profits and losses in the ratio of 3:2:1 respectively. The firm had insured the partner’s lives severally the premium thereof is charged to Profit & Loss a/c. The surrender values of the life policies as at 31st March, 2006 were – X for Rs. 5,000, Y for Rs. 4,000 and Z for Rs. 3,000. The surrender values represents 50% of the sum assured in each case. Y and Z decide to share equally in future. Give the necessary journal entries assuming (a) If X retires on 31- 3-2006 (b) If X dies on 31-3-2006.

Solution :

DateParticularsL.F.Dr. (Rs.)Cr. (Rs.)
31-3-06Case (a)
Life policy a/cDr.12,000
To X’s Capital A/c6,000
To Y’s Capital A/c4,000
To Z’s Capital A/c2,000
(Being the creation of life policy A/c at surrender value and transfer of consequent profit)
31-3-06Case (b)
Insurance Company’s A/cDr.10,000
To Profit on Life Policy A/c10,000
(Being the claim due on X’s death recorded by crediting Profit on Life Policy A/c Policy amount = 5,000 × 100/50 = 10,000)
Life policy a/cDr.7,000
To Profit on Life Policy A/c7,000
(Being revaluation of life policy on the life of Y & Z at surrender value)
Profit on Life Policy A/cDr.17,000
To X’s Capital A/c8,500
To Y’s Capital A/c5,667
To Z’s Capital A/c2,833
(Being the transfer of balance in Profit on life policy A/c being old profit)

Illustration 22.11: X, Y and Z were sharing profits and losses in the ratio of 1 /2:1 ft: 1 /6 respectively. The firm had insured the partner’s lives severally. The surrender values of the life policies appearing in the balance sheet as at 31st March, 2006 were – X for Rs. 5,000, Y for Rs. 4,000 and Z for Rs. 3,000. The surrender values represents 50% of the sum assured in each case. Y and Z decide to share equally in future. Give the necessary journal entries assuming (a) If X retires on 31-3-2006 (b) If X dies on 31-3-2006.

Solution :       .

DateParticularsL.F.Dr. (Rs.)Cr. (Rs.)
31-3-06Case (a)
No entry is to be passed since policies appear at surrender value and its real value is also surrender value, hence no unaccounted/ undivided profit.
31-3-06Case (b)
Insurance Company’s A/cDr.10,000
To X’s Life Policy A/c10,000
(Being the claim due on X’s death recorded by crediting X’s Life Policy A/c)
X’s Life Policy A/cDr.5,000
To X’s Capital A/c2,500
To Y’s Capital A/c1,667
To Z’s Capital A/c833
(Being the transfer of balance in X’s life policy A/c being profit)

22.12 PROFIT/LOSS TILL THE DATE OF CHANGE IN CONSTITUTION:

♦     In case change in constitution takes place in between a Financial year, then

■     profit/loss till the date of change belongs to old partners in old ratio and

■     profit/loss after the date of change belongs to new partners in new ratio.

♦     Such profit/loss can be ascertained by preparing an Interim P&L a/c for that period otherwise average profit of the earlier years may be taken as basis for calculating profit/loss for the period.

♦     Generally this adjustment is given in case of death, although it can be applicable in the same way in any other type of change in constitution.

♦     In case of death/retirement the outgoing partner is also entitled to share profits/losses from the closure of last accounting year till the date of retirement/death.

♦     The outgoing partners share in the profit is accounted by way of the following entry. It should be proportionate to the No. of days/months he was partner in relation to whole year.

P&L Adjustment a/c Dr.          (With the amount of his share in the profit)

To Outgoing Partners a/c

♦     Alternatively share of all old partners can be accounted.

When the profit sharing ratio in between remaining partners has changed then we must transfer total profit to all old partners a/c and not the outgoing partners share only.

While preparing balance sheet, 2nd effect of such profit must be taken either on 1) cash or 2) working capital or 3) P&L adjustment a/c as it is can be shown in balance sheet.

22.13   OTHER ADJUSTMENTS:

♦     In addition to the adjustments discussed above some other adjustments/entries may come if given in the question.

♦     For Example entry for rectification of some old errors, which gives rise to profit/loss.

22.14   IF DECEASED OR RETIRED PARTNER’S DUES ARE NOT SETTLED IMMEDIATELY:

♦     As per provisions of section 37 of the Partnership Act if full or part amount of outgoing partner is still balance then

(a)   He will be entitled to Interest or profit share or nothing as may be mutually agreed among them.

(b)   If nothing is agreed then outgoing partner or his representatives have choice to get either of the following until final settlement

(i) Interest @6% p.a. on the balance amount

(ii) Share in the profit earned proportionate to their amount outstanding to total capital.

Share in profit = Total profit earned ×

♦     Normally he will select the better of (i) or (ii).

♦     Hence, if required student should calculate both and give higher one.

♦     If concern incurs losses then he will opt for interest.

Illustration 22.12 t A, B and C were partners sharing profits, and losses in the ratio of 2:2:1. C retired on 1st July, 2005 on which date the capitals of A, B and C after all necessary adjustments stood at Rs. 74,000, Rs. 63,750 and 42,250 respectively. A an d B continued to carry on the business for six months without settling the accounts of C. During the period of six months from 1-7-2005, a profit of Rs. 20,500 is earned by the use of the firm’s property. State which of the two options available u/s 37 of the Indian Partnership Act, 1932 should be exercised by C.

Solution :

(i) Share in the subsequent profits attributable to the use of his balance.

× Rs.20,500 – Rs.4,812

(ii) Interest @ 6% p.a. on the use of his balance = Rs. 42,250 × 6/12 × 6/100 = Rs. 1,267.50

C should exercise option (i) since the amount payable to him under this option is more as compared to the amount payable to him under option (ii).

GOODWILL: MEANING, CALCULATION & ACCOUNTING

22.15   MEANING OF GOODWILL:

♦     Goodwill is the value of reputation of the firm.

♦     It is the total of those unidentified benefits which firm enjoys, which help it to earn profit higher than normal profit.

♦     It is an intangible asset, hence difficult to value when it is self generated.

♦     But following are the methods which can be used for valuation.

♦     a. Average profit method b. Super profit method c. Capitalization method d. Annuity method

♦     The firm’s goodwill may have value, but in the books of account it may be nil, hence it represents an unaccounted profit.

♦     Therefore at the time of change in constitution it needs to be valued and adjusted by any of the four methods discussed later.

♦     The Accounting Standard No. 26 on Intangible Assets issued by the ICAI does not allow recognition of self generated goodwill in the books of account.

22.16   METHODS OF GOODWILL CALCULATION:

22.16.1 Average Profit Method:

♦     Goodwill is calculated as a certain number of years purchase of the average profit of last few years.

♦     Number of year of purchase means that many times.

♦     Average profit is basically a future maintainable profit.

♦     Goodwill = Average Profit × number of year’s purchase.

Illustration 22.13 : Goodwill of M/s. AB & Co. is to be valued as 3 years purchase of last four years average profit. Profit for 2005 is Rs.12,000 for 2004 Rs.10,000 for 2003 Rs. 15,000 and for 2002 Rs.13,000.

Average Profit per year =  = 12,500

Firm’s Goodwill = 12,500 ×3= Rs.37,500

Alternatively weighted average can be taken giving highest weightage to the latest year & lowest weightage to the oldest year. Ex: 2002 – 01, 2003 – 02,2004 – 03 & 2005 – 04.

YearProfitWeightWeighted amount
200213,000113,000
200315,000230,000
200410,000330,000
200512,000448,000
101,21,000

Weighted average = 1,21,000/10 = Rs. 12,100

Goodwill = 12,100 × 3 = Rs. 36,300

22.16.2 Super profit method:

♦     Super profit is the excess of average profit (profit earned/future maintainable profit) over the normal profit (re. normally expected in the business).

♦     Goodwill is calculated as certain number of years purchase of super profit.

Illustration 22.14 : M/s AB & Co. Wants to value the goodwill as 4 years purchase of the super profit. Their capital employed is Rs. 1,00,000. The normal rate of return by the similar concerns is 15% p.a. Average profit of the firm is Rs. 20,000. (Future maintainable profit)

Solution : Normal Profit = 1,00,000 ×  = 15,000

Super profit = 20,000 – 15,000 = Rs. 5,000. ∴ Goodwill = 5,000 × 4 = 20,000

Goodwill have a positive value, hence when profit earned is less than normal profit, we will not calculate negative super profit and consequently negative goodwill, rather in such cases super profit and goodwill both will be considered as nil.

22.16.3 Capitalization method:

♦     Capitalised value of the business =  × 100

♦    From this capitalized value the amount of the net assets or capital employed (ie. fixed assets + current asset – Current liabilities) are subtracted the balance is the value of the goodwill.

Illustration 22.15 : Taking the same figure as in above Illustration. 16.

Solution : Capitalised value of the business =  × 100 = 1,33,333

Goodwill = 133333 – 100000 = Rs. 33,333 OR Goodwill =  =  × 100 = 33,333

In the capitalization method: Number of year’s purchase = 100/Normal rate = 100/15 = 6.6667 Therefore Goodwill = 5,000 × 6.6667 = Rs.33,333

22.16.4 Annuity method:

♦     In the annuity method the effect of interest on the extra profit to be earned due to goodwill in the future years, is considered.

♦     Goodwill = Super Profit × Cumulative Present value annuity factor

Illustration 22.16 : For example in the case of illustration. 16. above goodwill will be calculated as below. The present value of annuity of Rs. 1 for 4 years @ 10% is 3.169.

Solution : Goodwill = Super Profit × Cumulative Present value annuity factor = 5,000 × 3.169 = 15,845

If in any of the above methods the figure of profit earned includes the effect of abnormal/extra-ordinary/non- reoccurring profits/losses the same should be eliminated. In fact the profit should be future maintainable profit which can be earned in normal course of business. The past average normal profit is taken as equal to future maintainable profit.

The concept of present value is not covered in any of the chapters of your syllabus hence it is not being elaborated here. It is a very important & common concept of financial management which is covered in Intermediate syllabus.

22.17   ALTERNATIVE TREATMENT OF GOODWILL ACCOUNTING:

Following are the different ways in which goodwill may be accounted in case of Admission.

1st Alternative goodwill settled by the Partners privately, (method 1)

2nd Alternative the new partner bring in his share in goodwill in the form of cash, (method 2)

3rd Alternative (a) Total goodwill of the firm is raised & then written off. (method 3) or

(b)   Goodwill a/c is not to be raised/direct adjustment to be made in capital a/c (method 3)

Net effect of (a) and (b) will be same.

4th Alternative goodwill to be adjusted without bringing cash. Total goodwill of the firm is to be raised, (method 4)

Notes:

(1)   AO the above alternatives can be applicable in case of retirement/death or change in profit sharing ratio also.

(2)   Detailed accounting entries for all this alternatives is explained in illustration below.

(3)   Alternatives 4 is not in compliance with AS-26 which permits raising of goodwill a/c only when it is purchased. Hence, student should follow it only when specifically required by the question.

Illustration 22.17:XandY are in partnership sharing profits and losses as 3:2. They admit Z into the firm, Z paying a premium (share in goodwill) of Rs. 36,000 for 1/6th share of the profits. As between themselves, X and Y agree to share future profits and tosses equally. Draft journal entry showing the appropriation of premium (goodwill) money.

Solution :

PartnersXYZ
Old Ratio3 or (3/5)2 or (2/5) –
Z is given 1 /6th ie, 2/ 12th share therefore balance for X & Y is 10/12 which is shared by them equally i.e. 5/ 12th, 5/ 12th hence:
New Ratio5 or (5/12)5 or (5/12)2 or (2/12)
Ratio of SacrificeX = 3/5 – 5/12= 11/60
(Old Ratio-New Ratio)Y = 2/5 – 5/12= -1/60
Z = 0 – 1/6= -10/60

This means that ‘X’ has sacrificed 11/60, whereas ‘Y’ has gained 1/60 & ‘Z’ has gained 10/60. ‘Z’ is bringing Rs. 36,000 as Goodwill for 10/60 share.

∴ Total goodwill of the firm =  = 2,16,000

Y is also gaining (means his new ratio is higher)

∴ He will also have to contribute towards goodwill to the extent of his gain.

∴ His contribution = 2,16,000 × 1/60 = 3,600

X has scarified in favour of Y and Z

∴ he should get the credit for it.

Goodwill Accounting Alternatives:

1st method: Cash settlement privately: Z &Y both should pay Rs. 36,000/- and Rs. 3,600/- respectively to X in lieu of goodwill. As this is done privately, no entry in the books of firm will be passed.

2nd method: Cash settlement through firm

The new partner brings in cash as his share of goodwill.

(1)   Cash a/c  Dr. 36,000

To Goodwill a/c           36,000

(Cash brought by new Partner ‘Z’ equal to his share in goodwill)

(2)   Goodwill a/c         Dr. 36,000

To X’s a/c        36,000

(Goodwill is transferred to the old partners, who are making sacrifice)

Note: Y has also gained Rs.3,600 (1/60) but he is not bringing cash being an existing partner.

∴We will adjust from his account.

(3)   ‘Y’s A/c     Dr. 3,600

To ‘X’ a/c         3,600

Or in place of above three entries, we can pass following entry:

Cash a/c          Dr. 36,000

‘Y’ a/c              Dr. 3,600

To X’s a/c                                39,600

3rd Method: Adjustment through, accounting but without changing book value: It can be done in either of the following two ways:

(A)  Goodwill a/cis raised and after the admission of new partner it is written off.

(1)   Goodwill a/c Dr. 2,16,000

To X’s a/c        1,29,600

To Y’s a/c        86,400

(Goodwill raised & credited to old partners in old ratio)

(2)   X’s a/c. Dr. (5/12) 90,000

Y’s a/c, Dr. (5/12)        90,000

Z’s a/c. Dr. (2/12)        36,000

To Goodwill a/c                       2,16,000

(Goodwill written off by debiting to new partners in new ratio).

(B)  Goodwill a/c is not to be raised in Books at all.

‘Z’ a/c Dr.        36,000

‘Y’ a/c Dr.        3,600

To X’s a/c             39,600

(Goodwill adjusted by crediting the partner who has sacrificed & debiting the gaining partner)

Goodwill can be adjusted by passing a single entry in this way, without raising goodwill account in the books.

4th Method: Adjustment through accounting by changing book values :

If Z doesn’t bring his share of Goodwill in cash then accounting can be done as follows – Goodwill a/c is raised and left as it is.

Goodwill a/c Dr. 2,16,000

To ‘X’s a/c       1,29,600

To ‘Y’ s a/c      86,400

(Goodwill account is raised & credited to old partners in old ratio)

[This method is not in compliance with AS-26, hence students should follow it only when required by the question.]

Note (1) Instead of calculating Ratio of sacrifice or Ratio of Gain, we can directly calculate the amount of goodwill in the ratio of sacrifice or ratio of gain, as follows:

Table of Calculation

XYZExplanation
Cr.1,29,60086,400Goodwill is credited to old partners in old ratio (what they should get)
Dr.90,00090,00036,000It is debited to new (all) partners in new ratio (what they will get in future)
Cr. 39,600Dr. 3,600Dr. 36,000This difference amt. will be in the ratio of gain or ratio of sacrifice.

Note (2) Suppose in the given question New Ratio is 6:4:2 instead of 5:5:2. Then Z has gained 10/60, which has come from X 6/60 and from Y 4/60, hence ratio of sacrifice of X & Y will be 6:4 & Goodwill Rs.36,000 brought by Z will be credited to X as Rs. 21,600 & Y Rs.14,400.

Note (3) In the same way goodwill accounting will be done in case of Retirement/death or change in Profit Sharing Ratio.

22.18   SPECIAL POINTS RELATED TO GOODWILL:

22.18.1 Inference of Goodwill:

♦     ‘Inference of Goodwill’ is calculation of goodwill when apparently it is not given in the question.

♦     This is done only when Capitals are said to be in Profit Sharing ratio and the New Partner brings in cash more than the proportionate Capital.

♦     Then the extra amount contributed is inferred as his contribution towards goodwill.

Illustration 22.18 : A & B are partners sharing equally with capital of Rs. 50,000 each. C is admitted with l/3rd share, and contributes Rs. 65,000. Capitals were in profit sharing ratio and they are intended to be kept in profit sharing ratio in future also.

Calculate goodwill if (i) A & B are to withdraw their share in goodwill immediately (ii) They will not withdraw.

Solution:

(i) When A&B will withdraw their share in goodwill

Hence, their capital will remain at Rs. 1,00,000 for 2/3rd share together

∴ Total capital should be = 1,00,000 × 3/2 = 1,50,000 &

C’s capital should be = 1,50,000 × 1/3 = 50,000

∴ Goodwill is the excess amount contributed = 65,000 – 50,000 = 15,000/-

This will be equally credited to A&B and withdrawn by them. Hence, capital now will be 50,000/- of each of A,B,C.

(ii) If goodwill is to be retained

Capital after admission will-be = 50000 + 50000 + 65000 = 1,65,000

∴ Capital of C should be = 165000 × 1/3 = 55,000

∴ Goodwill contributed by C = 65000 – 55000 = 10,000

This will be credited to A&B Rs. 5000 each. Thus making capital of the three partners as Rs. 55,000 each.

22.18.2 Calculation of partners share from firms goodwill and vice-a-versa:

(1)   Calculation of partners share from total goodwill of the firm:

♦     Total goodwill is Rs. 1,00,000.

♦     There are three partners A, B, & C Sharing profit/losses in the ratio of 2:3:5.

♦     Then Share in goodwill of each partner will be calculated as follows.

♦     A’s Share = 1,00,000 × 2/10 = 20,000, B= 1,00,000 × 3/10 – 30,000, C = 1,00,000 × 5/10 = 50,000

(2)   Calculation of total goodwill from a partners share:

♦     Mr. A is admitted as partner with 1/5 share and has brought Rs. 10,000 towards his share in goodwill.

♦     Total goodwill of the firm = 10,000 × 5/1 = Rs. 50,000

22.18.3 Withdrawal of Goodwill by Partners:

♦     Sometimes it will be given in the question that old partners withdraws full or part of the goodwill.

♦     It simply means that they are withdrawing Cash equal to either full or part of their share in goodwill.

♦     In such cases also the above accounting of goodwill will remain same and

♦     one additional entry for drawings will come as follows:

Partners a/c Dr.          xxx

To Cash/Bank a/c            xxx

Thus withdrawal of goodwill has no effect on the goodwill a / c. It is so bee ause goodwill is not a tangible asset which someone can withdraw, in reality partners have withdrawn money equal to share in goodwill.

Illustration 22.19 : Hari and Ram were in partnership, sharing profits and losses in 4:2 ratio. On 1st January, 2006, Suraj was admitted into partnership on the following terms:

Suraj is to have one-sixth share in the profits/losses, which he has got from Hari & Ram equally, paying Rs. 40,000 for share in goodwill. Hari & Ram withdraws 50% of their share in goodwill.

Journalise the entries related to goodwill on Suraj’s admission.

Solution

Journal Entries

ParticularsRs.Rs.
1.1.06Cash/Bank a/cDr.40,000
To Hari20,000
To Ram20,000
(Suraj pays to the firm for the share of goodwill which he get from Hari & Ram equally i.e. their sacrifice is equal)
1.1.06HariDr.10,000
RamDr.10,000
To Cash/Bank a/c20,000
(Hari & Ram withdraws cash equal to 50% of their share in goodwill)

22.18.4 Goodwill in books which is worthless:

♦     Suppose goodwill appearing in the balance sheet is stated to be worthless.

♦     Then it will be written off by debiting to old partners in old ratio because it is an old loss.

Illustration 22.20: Hari and Ram were in partnership, sharing profits and losses in 4:2 ratio. On 1st January, 2006, Suraj was admitted into partnership on the following terms:

Suraj is to have one-sixth share in the profits/losses, which he has got from Hari & Ram equally. The Goodwill appears in the books at Rs.30,000/- but the present valuation is agreed as nil

Journalise the entries related to goodwill on Suraj’s admission.

Solution :       Journal Entries

ParticularsRs.Rs.
1.1.06HariDr,20,000
RamDr.10,000
To Goodwill a/c30,000
(Goodwill appearing in the books is worthless hence is an old loss to be born by old partners in old ratio)

22.18.5 Goodwill of Incoming partner:

♦     If incoming partner has experience and name in that field then he can also have goodwill.

♦     He will get credit for his goodwill like partners of existing firm get credit for their goodwill.

♦     The debit of it can be kept in goodwill a/c (i.e. goodwill is raised or it can be written off to new partners in new ratio).

Illustration 22.21: X and Y are partners in a firm sharing profits and losses in the ratio of 3:2. They admit Z as a partner for 1 /4th share. Z acquires his share from X and Y in the ratio of 2:1. Z brings in his personal goodwill worth Rs. 6,000 in the firm. Pass the necessary journal entries under each of the following alternative cases:

Case (a) When adjustments is to be made through Goodwill Account and Goodwill Account is to be written off immediately, Case (b) When adjustment is to be made through capital Accounts.

Solution :

New Ratio:      Z’s share purchased from X = U × 2/3 = 2/12 X’s Share = 3/5 – 2/12 = 26/60

Z’s share purchased from Y = 14 × 1/3 = 1/12 Y’s Share = 2/5 – 1/12 = 19/60

Z’s Share = ¼ = 15/60

Journal

ParticularsL.F.Dr. (Rs.)Cr. (Rs.)
Case (a)
(i)Goodwill A/cDr.6,000
To Z’s Capital A/c ’6,000
(Being personal goodwill brought in by Z)
(ii)X’s Capital A/cDr.2,600
Y’s Capital A/cDr.1,900
Z’s Capital A/cDr.1,500
To Goodwill A/c6,000
(Being Goodwill Account written off in new’ ratio)
Case (b)
X’s Capital A/cDr.2,600
Y’s Capital A/cDr.1,900
To Z’s Capital A/c4,500
[Being old partners contributed towards their share (gain) in personal goodwill brought in by Z (ue. 3/4th of Rs. 6,000)]

ILLUSTRATIONS

ADMISSION OF PARTNER

Illustration 22.22 : A, B and C are partners, sharing profit and loss in the ratio of 3:2:1. They decide to admit D for 14 share on 1-1-2006. For this purpose goodwill is valued at 4 years purchase of annual super profits. Profit of previous three years were as under:

2003 – Rs. 68,000;      2004 – Rs. 75,000;      2005 – Rs. 73,000.

Capital Employed on 1-1-2006 is Rs. 3,00,000.

Normal rate of return is 2046. New profit sharing ratio is 5:3:1:3.

(;) Calculate value of goodwill as per super profit method.

(ii) Find out D’s share in goodwill.

(iii) Calculate ratio of sacrifice by A, B and C.

(tv) Pass necessary journal entries, when D brings amount of goodwill in cash.

(v) Pass necessary journal entries, when goodwill is raised and written off in the books.

Solution

(i) Annual Average Profit

= Rs.72,000

Less Normal Profit

= Rs. 60,000

Annual Super Profit = Rs. 12,000

Value of Goodwill = Rs. 12,000 × 4 = 48,000

(ii) D’s Share in Goodwill = 48,000 ×  = Rs. 12,000

(iii) Ratio of Sacrifice: Old ratio – New Ratio

A =  –  = ; B  –  = ; C =  –  =

A, B and C each has sacrifice 1/12 from his old share, therefore ratio of sacrifice is 1:1:1.

(iv) When new partner (D) brings cash for his share in goodwill:

ParticularsL.F.Dr. (Rs.)Cr. (Rs.
(A) Cash A/c Dr.12,000
To Goodwill A/c12,000
(Being cash brought by D for his share in Goodwill.)
(B) Goodwill A/c Dr.12,000
To A’s Capital A/c4,000
To B’s Capital A/c4,000
To C’s Capital A/c4,000
(Being amount of goodwill brought by D, credited to old partners Capital accounts
in the ratio of sacrifice)
The above entry can be passed in any other combination giving same net effect.

(v) When Goodwill A/c is raised and written off:

ParticularsL.F.Rs.Rs.
(A)Goodwill A/cDr.48,000
To A’s Capital A/c24,000
To B’s Capital A/c16,000
To C’s Capital A/c8,000
(Being Goodwill Account raised by crediting capital accounts of old
partners in old ratio)
(B)A’s Capital A/cDr.20,000
B’s Capital A/cDr.12,000
C’s Capital A/cDr.4,000
D’s Capita] A/cDr.12,000
To Goodwill A/c48,000
(Being goodwill account is written off in new profit sharing ratio)

Illustration 22.23 : Messrs Dalai, Banerji and Malick is a firm sharing profits and losses in the ratio of 2:2:1. Their Balance Sheet as on 31st March, 2006, is shown as below:

LiabilitiesRs.AssetsRs.
Sundry Creditors12,850Land and Building25,000
Outstanding Liabilities1,500Furniture6,500
General Reserve6,500Stock of Goods11,750
Capital Account:Sundry Debtors5,500
Mr. Dalai12,000Cash-in-hand140
Mr. Banerji12,000Cash-at-Bank960
Mr. Malick5,00029,000
49,85049,850

The partners have agreed to take Mr. Mistri as a partner with effect from 1st April, 2006 on the following terms:

(a)   Mr. Mistri shall bring Rs. 5,000 towards his capital.

(b)   The value of stock should be increased by Rs. 2,500.   .

(c)   Provision for bad and doubtful debts should be provided at 10% of the debtors.

(d) Furniture should be depreciated by 10%.

(e) The value of land and buildings should be enhanced by 20%.

(f) The value of the goodwill be fixed at Rs.15,000.

(g)   General Reserve will be transferred to the Partners’ Capital Accounts.

(h)   The new profit sharing ratio of Dalai, Banerji, Malick and Mistri shall be 5:5:3:2.

(i)    The goodwill account shall be written back to the Partners’ Accounts in accordance with the new profit sharing proportion.

(j) The Outstanding liabilities include Rs.1,000 due to Mr. Sen which has been paid by Mr. Dalai. Necessary entries were not made in the books.

Prepare (i) Revaluation Account, (ii) The Capital Accounts of the partners, and (iii) The Balance Sheet of the firm as newly constituted.

Solution :

Dr.Revaluation AccountCr.
ParticularsRs.ParticularsRs.
To Provision for bad & doubtful debts550By Stock in trade2,500
To Furniture and fittings650By Land and Building5,000
To Profit on Revaluation transferred to
Dalai2,520
Banerji2,520
Malick1,2606,300
7,5007,500

Capital Accounts of Partners

ParticularsDalai

Rs.

Banerji

Rs.

Malick

Rs.

Mistri

Rs.

ParticularsDalai

Rs.

Banerji

Rs.

Malick

Rs.

Mistri

Rs.

To Goodwill5000500030002000By Bal. b/d.12000120005000
By General Reserve260026001300
By Cash5000
By Goodwill600060003000
By Outstadg. Liab.1000
To Balance c/d191201812075603000By Revaluation252025201260
24120231201056050002412023120105605000

Balance Sheet of M/s. Dalai, Malick and Mistri as on 1-4-2006

LiabilitiesRs.AssetsRs.
Sundry Creditors12,850Land and Building30,000
Outstanding Liabilities500Furniture5,850
Capital Accounts of PartnersStock of Goods14,250
Mr. Dalai19,120Sundry Debtors5,500
Mr. Banerji18,120Less: Provision5504,950
Mr. Malick7,560Cash-in-hand140
Mr. Mistri3,00047,800Cash-at-Bank5,960
61,15061,150

Illustration 22.24 : Gopal and Govind are partners sharing profits and losses in the ratio 60:40. The firms Balance Sheet as on 31-3-2006 was as follows:

LiabilitiesRs.AssetsRs.
Capital AccountsFixed Assets3,00,000
Gopal1,20,000Investments50,000
Govind80,0002,00,000Current Assets2,00,000
Long Term Loan2,00,000Loans and Advances1,00,000
Current Liabilities2,50,000
6,50,0006,50,000

Due to financial difficulties, they have decided to admit Guru as a Partner in the firm from 1-4-2006 on the following terms:

Guru will be paid 4016 of the profits. Guru will bring in cash Rs.1,00,000 as capital. It is agreed that goodwill of the firm will be valued at 2 years purchase of 3 years normal average profits of the firm and Guru will bring in cash for his share of Goodwill. It was also decided that the partners will not withdraw their share of goodwill nor will the goodwill appear in the books of account.

The profits of the previous three years were as follows:

♦     For the year ended 31-3-2004 Profit Rs. 20,000 (includes insurance claim received of Rs.40,000).

♦     For the year ended 31.3.2005 Loss Rs. 80,000 (includes voluntary retirement compensation paid Rs. 1,10,000).

♦     For the year ended 31.3.2006 Profit of Rs. 1,05,000 (includes a profit of Rs.25,000 on the sale of assets).

It was decided to revalue the assets on 31.3.2006 as follows:

Fixed Assets4,00,000
InvestmentsNil
Current Assets1,80,000
Loans and Advances1,00,000

The new profit sharing ratio after the admission of Guru was 35:25:40.

Pass Journal Entries on admission, show goodwill calculation and prepare Revaluation Account, Partners Capital Accounts and Balance Sheet as on 1.4.2006 after the admission of Guru.

Solution :       Calculation & Adjustment for Goodwill

Year31.3.0431.3.0531.3.06
Profit as givenCr. 20,000Dr. 80,000Cr. 1,05,000
Reversal of abnormal/non recurring items:
Insurance claim receivedDr. 40,000
Retirement compensation paidCr. 1,10,000
Profit on sale of assetsDr. 25,000
Normal profitDr. 20,000Cr. 30,000Cr. 80,000
Average future maintainable profit = -20,000+30,000 + 80,000 =>90,000 + 3 = 30,000
Goodwill = 30,000 × 2 = 60,000
Adjustment of Goodwill
Profit on account of goodwillGopalGovindGuru
Credit in Old ratio (Raise the goodwill)Cr. 36,000Cr. 24,000
Debit in New ratio (Reverse the goodwill)Dr. 21,000Dr. 15,000Dr. 24,000
Difference (Cr.: Sacrifice and Dr.: Gain)Cr. 15,000Cr. 9,000Dr. 24,000

Entry: Cash Dr.          24,000

To Gopal         15,000

To Govind       9,000

Capital Account

ParticularsGopalGovindGuruParticularsGopalGovindGum
By Balance c/f1,53,0001,01,0001,00,000By Balance b/f1,20,00080,000
By Cash a/c1,00,000
By Cash (Goodwill adjustment) a/c ‘15,0009,000
By Revaluation a/c18,00012,000
1,53,0001,01,0001,00,0001,53,0001,01,0001,00,000

Revaluation Account

ParticularsRs.ParticularsRs.
To Investment a/c50,000By Fixed asset a/c1,00,000
To Current assets a/c20,000
To Profit a/cGopal18,000
Govind12,00030,000
1,00,0001,00,000

Balance Sheet as on 1st April 2006

LiabilitiesRs.AssetsRs.
CapitalFixed assets4,00,000
Gopal1,53,000Current assets1,80,000
Govind1,01,000Cash/Bank1,24,0003,04,000
Guru1,00,0003,54,000Loans and advances1,00,000
Long term loan2,00,000
Liabilities2,50,000
8,04,0008,04,000

Illustration 22.25 : The Balance Sheet of A & B, a partnership firm, as at 31st March, 2006 is as follows:

LiabilitiesRs.AssetsRs.
Capital Account:Goodwill14,000
A26,400Land and Building14,400
B33,60060,000Furniture2,200
Contingency Reserve6,000Stock26,000
Sundry Creditors9,000Sundry Debtors6,400
Cash at Bank12,000
75,00075,000

A (St B share profits and losses as 1:2. They agree to admit C (who is also in business on his own) as a third partner from 1-4-2006.

The Assets are revalued as under:

Goodwill – Rs. 18,000, Land and Building Rs. 30,000, Furniture Rs. 6,000.

C brings the following assets into the partnership Goodwill Rs. 6,000, Furniture Rs. 2,800, Stock Rs. 13,600.

Profits in the new firm are to be shared equally by the three partners and the Capital Accounts are to be so adjusted as to be equal. For this purpose, additional cash should be brought in by the partner or partners concerned.

Prepare the necessary accounts and the opening Balance Sheet of new’ firm, showing the amounts of cash, if any, which each partner may have to provide.

Solution :

Capital Account

ParticularsABCParticularsABC
To Balance c/f.36,20053,20022,400By Balance b/d26,40033,600
By Contingency res. a/c2,0004,000
By Goodwill a/c1,3332,667
By Revaluation a/c6,46712,933
By Goodwill a/c6,000
By Furniture,
stock a/c16,400
To Balance c/d.53,20053,20053,200By Balance b/f36,20053,20022,400
By Cash/Bank a/c17,00030,800
53,20053,20053,20053,20053,20053,200

Revaluation Account

ParticularsRs.ParticularsRs.
To Profit a/cBy Building a/c15,600
A6,467By Furniture a/c3,800
C12,93319,400
19,40019,400

Cash/Bank Account

ParticularsRs.ParticularsRs.
To Balance b/f12,000By Balance c/d59,800
To Capital a/c
A17,000
B30,800
59,80059,800

Balance sheet

LiabilityRs.AssetsRs.
CapitalGoodwill24,000
A53,200Land and building30,000
B53,200Furniture8,800
C53,2001,59,600Stock39,600
Creditor9,000Debtors6,400
Cash/Bank59,800
1,68,6001,68,600

♦     Goodwill of the old firm is valued at Rs. 1 8,000 whereas book value is Rs. 1 4,000, thus there is profit due to Goodwill appreciation Rs. 4,000 which is credited to old partners in old ratio.

♦     New partner also has goodwill value of which Rs.6,000 is credited to him. Thus the value of the goodwill of new firm is Rs. 24,000 which is appearing in books, if they decide to write it off the same will be debited to new partners in new ratio.

Adjustment of Capital:

♦     Capital can be adjusted if required by the question.

♦     It can be adjusted in any ratio and taking anybody’s capital as base.

♦     But if not clarified in the question then adjust in profit sharing ratio.

♦     If not clarified take total capital as base, in this case partner whose capital is short will bring cash and cash will be repaid to the partner whose capital is excess. Total capital will remain unchanged.

♦     If highest capital (highest capital per share of profit) is taken as base then other partners capital will fell short and they will contribute the required cash, (in this question it was hinted that partner or partners shall bring cash). Total capital will increase.

♦     If smallest capital (smallest capital per share of profit) is taken as base then other partners capital will show’ excess capital and the same will be repaid to them.

♦     Adjustment of capital can be done through cash or through current account.

Illustration 22.26 : The following is the balance sheet of A and B who share profits and losses as 4/7 and 3/7:

LiabilitiesRs.AssetsRs.
Creditors15,000Land and Buildings36,000
Bills payable5,000Machinery20,000
Capital AccountsFurniture2,000
A : 45,000Stock25,000
B : 35,00080,000Sundry Debtors16,000
Cash1,000
1,00,0001,00,000

They agree to take C into partnership and give him a share of 20 paise in the rupee subject to the following terms and conditions:

L C is to contribute capital @ Rs. 12000 for each 10 paise share in the rupee. ii Land and Buildings are to be increased to Rs. 40000.

iii Machinery is to be depreciated by 10% and Furniture by Rs. 500.

  1. Stock is to be appreciated by Rs. 1000.

v,   Goodwill of the firm is to be valued at 2 years’ purchase of average profits of the last three years. (Profits for the last three years were Rs. 14500, Rs. 20000 and Rs. 22500.)

vi         A provision of 2½% is to be made for bad debts and another of Rs. 2500 for outstanding expenses.

vii         A trade creditor for Rs. 1600 is not traceable for a number of years and the amount is to be written back.

Show Journal entries and c apital accounts of the partners assuming no goodwill account is to be opened and the book values of assets and liabilities are not to be disturbed.

Also prepare the Balance Sheet of the new firm.

Solution :

Question requires that Goodwill should not appear in the books and value of the asset and liability should not change i.e. application of method 4. Ascertain profit/loss on revaluation of asset & liability and on goodwill and adjust.

Workings notes

(1) New profit sharing ratio :

C comes for 20 paise share in the rupee, i.e., for  share, the share left for A and B is (1- ) or 4

5

So, A’s share is  of  or

And, B’s share is  of  or

Hence, new ratio is  :  :

Value of Goodwill:

Average profit of the last three years :  = Rs. 19,000

Value of Goodwill on the basis of 2 years’ purchase Rs. 19,000 × 2 = Rs. 38,000

(2) Profit/Loss on revaluationRs.Rs.
Value of assets to be increased :
Land and Buildings4,000
Stock1,000
Goodwill38,000+ 43,000
Value of assets to be reduced:
Machinery2,000
Furniture500-2,500
Provision to be made for :
Bad Debts400
Outstanding Expenses2,500– 2,900
Liabilities to be written back :
Trade Creditors+1,600
Profit on Revaluation+ 39,200

(3) Adjustment required

ABC
Profit credited in the old ratio of 4 : 3+22,400+ 16,800
Profit written back in the new ratio of 16 : 12 : 7-17,920-13,440– 7,840
Net adjustment+ 4,480+ 3,360-7,840

Alternatively, Profit/Loss on revaluation may be ascertained by preparing a Memorandum Revaluation Account as under:

Memorandum Revaluation Account

ParticularsRs.ParticularsRs.
To Machinery2,000By Land & Buildings4,000
To Furniture500By Stock1,000
To Provision for Bad Debts400By Goodwill38,000
To Provision for Outstanding Expenses2,500By Trade Creditors1,600
To Profit on Revaluation39,200
44,60044,600

Journal Entry

Rs.Rs.
Cash A/c (12,000 × 2)Dr.24,000
To C’s Capital A/c24,000
(Capital introduced by C’s on his admission @ Rs. 12,000 for each 10 paise share in the rupee)
C’s Capital A/cDr.7,840
To A’s Capital A/c4,480
To B’s Capital A/c3,360
(Adjustment for Goodwill & Revaluation of assets and liabilities without altering the book values on admission of C)

 

Dr.Capital AccountsCr.
A

Rs.

B

Rs.

C

Rs.

A

Rs.

B

Rs.

C

Rs.

To Capital of A&B7,840By Balance b/f45,00035,000
To Balance c/d49,48038,36016,160By Cash24,000
By Capital of C49,48038,360
49,48038,36024,00049,48038,36024,000
By Balance b/d49,48038,36016,160

Balance Sheet as at

LiabilitiesRs.AssetsRs.
Creditors15,000Land & Buildings36,000
Bills Payable5,000Machinery20,000
Capital Accounts:Furniture2,000
A49,480Stock25,000
B38,360Sundry Debtors16,000
C16,1601,04,000Cash : 1,000 + 24,00025,000
1,24,0001,24,000

RETIREMENT OF A PARTNER

Illustration 22.27 : On 31st March 2006, the Balance Sheet of M/s. Ram, Rahul and Rohit sharing profits and losses in proportion to their capitals, stood as follows:

LiabilitiesRs.AssetsRs.
Capital Accounts:Land & Buildings2,00,000
Ram3,00,000Machinery2,00,000
Rahul2,00,000Closing Stock1,00,000
Rohit1,00,0006,00,000Sundry Debtors2,00,000
Sundry Creditors2,00,000Cash and Bank Balances1,00,000
8,00,0008,00,000

On 31st March, 2006, Ram desired to retire from the firm and the remaining partners decided to carry on. It was agreed to revalue the Assets and Liabilities on that date on the following basis:

  1. Land and Buildings be appreciated by 3096.
  2. Machinery be depreciated by 2096.
  3. Closing stock to be valued at Rs. 80,000.
  4. Provision for bad debts be made at 5%.
  5. Old credit balances of Sundry Creditors Rs. 10,000 be WTitten back.
  6. Joint Life Policy of the partners surrendered and cash obtained Rs. 60,000.
  7. Goodwill of the entire firm be valued at Rs. 1,80,000 and Ram’s share of the Goodwill be adjusted in the Accounts of Rahul and Rohit who share the future profits equally. No Goodwill account being raised.
  8. Total capital of the firm is to be the same as before retirement. Individual capital be in their profit sharing ratio.
  9. Amount due to Ram is to be settled on the following basis: 50% on retirement & the balance 50% within 1 year. Prepare Revaluation Account, Capital Account of Partners, Rahul & Rohit. Loan Account of Ram, Cash Account and Balance Sheet as on 1.4,06 of M/s. Rahul and Rohit.

Solution :

Capital Account

ParticularsRamRahulRohitParticularsRamRahulRohit
To Ram (Goodwill) a/c30,00060,000By Balance a/c3,00,0002,00,0001,00,000
To Cash/Bank a/c2,10,000By J. L. Policy a/c30,00020,00010,000
To Ram’s loan a/c2,10,000By Sundry a/c (goodwill90,000
To Balance c/d1,90,00050,000adj.)
4,20,0002,20,0001,10,0004,20,0002,20,0001,10,000
By Balance b/d1,90,00050,000
To Balance c/f (Adj usted)3,00,0003,00,000By Cash/Bank a/c1,10,0002,50,000
3,00,0003,00,0003,00,0003,00,000

Revaluation Account

ParticularsRs.ParticularsRs.
To Machinery a/c40,000By Land & Building a/c60,000
To Stock a/c20,000By Creditors a/c10,000
To Provision for bad debt a/c10,000
70,00070,000

Cash/Bank Account

ParticularsRs.ParticularsRs.
To Balance b/f1,00,000By Ram a/c2,10,000
To Joint life policy a/c60,000By Balance c/f3,10,000
To Rahula/c1,10,000
To Rohit a/c2,50,000
5,20,0005,20,000

Table of Goodwill

ParticularsRamRahulRohit
Credit in old ratio90,00060,00030,000
Debit in new ratio .90,00090,000
Difference (Cr. Indicates sacrifice & Dr. gain)Cr. 90,000Dr. 30,000Dr. 60,000

Adjustment of Goodwill without raising it in the books: Rahul Dr.     30,000

Rohit Dr.          60,000

To Ram a/c     90,000

Joint Life Policy Account

ParticularsRs.ParticularsRs.
To Profit transferred:By Cash a/c (Policy surrendered as60,000
Ram a/c30,000specified in the question. Otherwise it
Rohul a/c20,000Can be revalued at surrender value &
Rohit a/c10,000Credit to old partner in old ratio)
60,00060,000

Balance Sheet as on 1st April 2006

LiabilitiesRs.AssetsRs.
Capital a/cLand and building2,60,000
Rahul3,00,000Machinery1,60,000
Rohit3,00,0006,00,000Closing stock80,000
Creditors1,90,000Debtors 2,00,000
Ram loan2,10,000(-) Provision for bad debt 10,0001,90,000
Cash balance3,10,000
10,00,00010,00,000

Illustration 22.28 : A, B, C were in partnership sharing profits and losses in the ratio of 3:2:1. The Balance Sheet of the firm as on 31-3-2006 was as under:

LiabilitiesRs.AssetsRs.
Capital Accounts:Goodwill40,000
A1,50,000Fixtures30,000
B1,00,000Stock1,70,000
C50,0003,00,000Sundry Debtors90,000
Sundry Creditors40,000Cash10,000
3,40,0003,40,000

A on account of ill health, gave notice that he wished to retire from the firm. A retirement agreement was, therefore, entered into as on 31.3.2006, the terms of which were as follows:

(a)   The Profit and Loss Account for the year ended 31.3.2006, which showed a net profit of Rs. 42,000 was to be re-opened. B was to be credited with Rs. 6,000 as bonus, in consideration of the extra work, which had devolved upon him during the year. The profit sharing basis was to be revised and the revised ratio to be 2:3:1 as and from 1st April, 2005.

(b)   Goodwill was to be valued at two year’s purchase of the average profits of five years. Profits for these five years ending on 31st March were as under:

Rs.
31.3.200215,000
31.3.200323,000
31.3.200425,000
31.3.200535,000
31.3.200642,000

(c)   Fixtures are to be valued at Rs. 39,800 and a provision of 2% was to be made for doubtful debts and the remaining assets were to be taken at their book value.

(d)   That the amount payable to A shall be paid by B.

B and C agreed, as between themselves, to continue the business, sharing profits and losses in the ratio of 3:1 and decided to eliminate goodwill from Balance Sheet, to retain fixtures in the books at the revised value and increase the provision for doubtful debts to 6%. Total capital of the firm will be Rs. 3 lakhs as before to be maintained in the new ratio as between B and C.

You are required to give the necessary entries to give effect to the above arrangements. Prepare Capital Account of Partners, Cash Account and Balance Sheet of B and C after giving effect to the above arrangements on the retirement of A.

Solution :

Journal Entries

ParticularsDr.

Rs.

Cr.

Rs.

(i)A’s capital A/cDr.21,000
B’s capital A/cDr.14,000
C’s capital A/cDr.7,000
To Profit and loss adjustment A/c42,000
(Profit of last year written back for making adjustment)
(ii)Profit and loss adjustment accountDr.6,000
To B’s capital A/c6,000
(Bonus credited to B’s capital account)
(iii)Profit and loss adjustment a/cDr.36,000
To A’s capital A/c12,000
To B’s capital A/c18,000
To C’s capital A/c6,000
(Distribution of profits in the new ratio)
(iv)Goodwill a/c (56,000 – 40,000)Dr.16,000
Fixtures a/cDr.9,800
To Provision for bad debts A/c1,800
To A’s capital A/c8,000
To B’s capital A/c12,000
To C’s capital A/c4,000
(Revaluation of assets on A’s retirement)
(v)B’s capital A/cDr.44,700
C’s capital A/cDr.14,900
To Goodwill A/c56,000
To Provision for bad debts A/c3,600
(Written off goodwill and raising provision for bad debts)
(vi)A’s capital A/cDr.1,49,000
To B’s capital A/c1,49,000
(Amount payable to A paid by B)

Partners’ Capital Accounts

ParticularsABCParticularsABC
Rs.Rs.Rs.Rs.Rs.Rs.
To P&L AdjustmentBy Balance b/d1,50,0001,00,00050,000
A/c (Profit reversed)21,00014,0007,000By P&L Adjustment A/c6,000
To Goodwill & Provision44,70014,900(Bonus)
for bad debtsBy P&L Adjustment A/c12,00018,0006,000
To B’s Capital A/c1,49,000By Goodwill and Fixtures8,00012,0004,000
To Cash A/c (excessBy A’s Capital A/c1,49,000
repaid)1,300By Cash A/c
To Balance c/d (adjusted capital)2,25,00075,000(short fall recovered)36,900
1,70,0002,85,00096,9001,70,0002,85,00096,900

Cash Account

Rs.Rs.
To Balance b/d10,000By B’s Capital A/c1,300
To C’s Capital A/c36,900By Balance c/d45,600
46,90046,900

Balance Sheet of B and C

As on 31st March, 2006 (after retirement of A)

LiabilitiesAmount

Rs.

AssetsAmount

Rs.

Capital Accounts:Fixtures39,800
B2,25,000Stock1,70,000
C75,0003,00,000Sundry debtors90,000
Sundry Creditors40,000Less: Provision for bad debts5,40084,600
Cash45,600
3,40,0003,40,000

Working note: Calculation of goodwill

Average of last five year’s profits

Year ended onProfit (Rs.)
31.3.200215,000
31.3.200323,000
31.3.200425,000
31.3.200535,000
31.3.200642,000
1,40,000

Average profit = Rs.  = Rs. 28,000

Goodwill at two years purchase: Rs. 28,000 × 2 = Rs. 56,000

♦     Goodwill already appears in the books at Rs.40,000 hence now increased by Rs. 1 6,000 and included together with revaluation of other assets and liabilities. Alternatively it can be accounted separately.

♦     Capital is required to be Rs.3,00,000 in new ratio, the balance is accordingly written in capital account and the difference then is repaid or recovered as the case may be.

RETIREMENT CUM ADMISSION

Illustration 22.29 : Dowell & Co. is a partnership firm with partners Mr. A, Mr. B and Mr. C, sharing profits and losses in the ratio of 10:6:4. The Balance Sheet of the firm as at 31st March, 2006 is as under:

LiabilitiesRs.AssetsRs.
Capital:Land10,000
Mr. A80,000Buildings2,00,000
Mr. B20,000Plant and Machineryi ,30,000
Mr. C30,0001,30,000Furniture43,000
Reserves (Un-appropriated Profit)20,000Investments12,000
Long Term Debt3,00,000Stock1,30,000
Bank Overdraft44,000Debtors1,39,000
Trade Creditors1,70,000
Total6,64,000Total6,64,000

It was mutually agreed that Mr. B will retire from partnership and in his place Mr. D will be admitted as a partner with effect from 1st April, 2006. For this purpose, the following adjustments are to be made:

  1. Goodwill is to be valued at Rs. 1 lakh but the same will not appear as an asset in the books of the reconstituted firm.
  2. Buildings and Plant & Machinery are to be depreciated by 5 per cent and 20 per cent respectively. Investments are to be taken over by the retiring partner at Rs. 1 5,000. Provision of 20 per cent is to be made on debtors to cover doubtful debts.

iii.    In the reconstituted firm, the total capital will be Rs.2 lakhs which will be contributed by Mr. A, Mr. C and Mr. D in their new profit sharing ratio, which is 2:2:1.

  1. The surplus funds, if any, will be used for repaying the Bank Overdraft.
  2. The amount due to the retiring partner shall be transferred to his loan account.

You are to prepare:

(a)   Revaluation A/c;

(b)   Partner’s Capital Accounts;

(c)   Bank Account; and

(d)   Balance Sheet of the reconstituted firm as on 1st April, 2006.

Solution

Capital Account

ParticularsABCDParticularsABCD
To A&B a/c (Goodwill
adjustment)20,00020,000By Balance b/£80,00020,00030,000
To Investment a/c15,000By Reserve a/c10,0006,0004,000
To Revaluation a/c30,40018,24012,160By C&D a/c (Good-
To B’s loan a/c.22,760will adjustment)10,00030,000
To Balance c/d69,6001,840By Balance c/d20,000
1,00,00056,00034,00020,0001,00,00056,00034,00020,000
To Balance b/d20,000By Balance b/f69,6001,840
To Closing balanceBy Cash/Bank a/c10,40078,16060,000
c/d (Adjusted capita))80,00080,00040,000
Total80,00080,00060,000Total80,00080,00060,000

Rs.2,00,000 capital balance is written in new ratio 2:2:1 and the shortfall in capital account then is contributed by the new partners A, C & D.

Revaluation Account

ParticularsRs.ParticularsRs.
To Building a/c10,000By Investment a/c (profit)3,000
To Plant and Machinery a/c26,000By Loss a/c A30,400
To Provision for bad debt a/c27,800B18,240
C12,16060,800
63,80063,800

Cash/Bank Account

ParticularsRs.ParticularsRs.
To A a/c10,400By Bank over draft a/c44,000
To C a/c78,160By Balance c/f1,04,560
To D a/c60,000
1,48,5601,48,560

Table of Goodwill Adjustment

ABCD
Credit in old ratio50,00030,00020,000
Debit in new ratio40,00040,00020,000
Difference (ie. sacrifice/gain)Cr. 10,000Cr. 30,000Dr. 20,000Dr. 20,000

C’s a/c Dr.       20,000

D’s a/c Dr.       20,000

To A’s a/c        10,000

To B’s a/c        30,000

Balance Sheet as on 1st April 2006

LiabilitiesRs.AssetsRs.
CapitalLand10,000
A80,000Building1,90,000
C80,000Plant and machinery1,04,000
D40,0002,00,000Furniture43,000
Long term debt3,00,000Stock
Creditors1,70,000Debtors1,39,000
B’s loan22,760(-) Provision27,8001,11,200
Cash/Bank1,04,560
6,92,7606,92,760

Illustration 22.30: X, Y and Z are partners sharing profits and losses in the proportion of 3:2:2 respectively. The Balance Sheet of the firm as on 1-1-2006 was as follows:

LiabilitiesRs.AssetsRs.
Capital Accounts:Plant and Machinery36,000
Furniture14,000
X50,000Stock56,000
Y40,000Sundry Debtors48,000
Z35,0001,25,000Cash-at-Bank9,000
Bank overdraft10,000
Sundry Creditors28,000
1,63,0001,63,000

X retired on 1-1-2006, on which date R is admitted as a new partner. For the purpose of adjusting the rights as between old partners, goodwill to be valued at Rs.42,000 and Sundry Debtors and stock to be reduced by Rs.8,000 and toRs.50,000 respectively. X is to receive Rs.22,000 in cash on the date of retirement and the balance due to him is to remain as loan at 89s p.a. Repayment of loan to be made at the end of each year by annual instalments representing 25% of the future profit before charging interest on loan.

R is to bring in Rs. 50,000 in cash as his capital on the date of admission. The new partners are to share profits and losses equally after paying the interest on X’s loan.

The net profit for the year ended 31st Dec.2006, is Rs. 32,000 before taking into account the instalment payable to X.

You are required to show :

(α) Profit and Loss Appropriation Account for the year ended 31st Dec., 2006.

(b)   Capital Accounts of tire new partners; and

(c)   X’s Loan Account as on 31st Dec., 2006.

Solution

Capital Account

ParticularsXYZRParticularsXYZR
To Goodwill a/c (written off)14,00014,00014,000By Balance b/f50,00040,00035,000
To Revaluation a/c (loss)6,0004,0004,000By Goodwill a/c (raised)18,00012,00012,000
To Cash/Bank a/c22,000By Cash/Bank a/c50,000
To X’s loan a/c40,000
To Balance c/d34,00029,00036,000
68,00052,00047,00050,00068,00052,00047,00050,000
To Balance c/f43,60038,60045,600By Balance b/d34,00029,00036,000
By P & L a/c9,6009,6009,600
43,60038,60045,60043,60038,60045,600

Revaluation Account

ParticularsRs.ParticularsRs.
To Debtors a/c8,000By Loss transf.X6,000
To Stock a/c6,000Y4,000
Z4,00014,000
14,00014,000

X’s Loan Account

ParticularsRs.ParticularsRs.
To Bank a/c (loan + interest) (8000+3200)11,200By Capital a/c40,000
To Balance c/d32,000By Interest a/c3,200
43,20043,200

Repayment of loan is 25% of profit before interest i.e. 32,000 × 25% = Rs.8,000/- paid together with the interest accrued for the year Rs.3,200/-

P&L appropriation A/c For the year ended 31.12.2006

ParticularsRs.ParticularsRs.
To Interest on loan3,200By Profit as per P&L32,000
To Profit transferredX9600
Y9600
Z960028,800
32,00032,000

DEATH OF A PARTNER

Illustration 22.31 : A, B and C were in partnership sharing profit and losses in the proportion of 4:3:3. The balances in the books of the firm as on 31-12-2006, subject to final adjustment, were as under:

Trial Balance

Dr. Rs.Cr. Rs.
Capital and Drawings Accounts:A24,0001,50,000
B36,00075,000
C36,00090,000
Land and Buildings1,20,000
Furniture and Fixtures22,500
Stock1,87,500
Debtors30,000
Bank60,000
Creditors45,000
Profit for the year before interest1,56,000
TOTAL5,16,0005,16,000

Adjustment: C died on 30-6-06. The partnership deed provided that:

  1. Interest was to be credited on capital accounts of partners at 10% p.a. on the opening balance.
  2. On the death of a partner, (i) Goodwill to be valued at 3 years’ purchase of average annual profits of 3 years up to the date of death, after deducting interest on capital employed at 8% p.a. & a fair remuneration for each partners; (ii) Fixed assets were to be valued by a valuer & all other assets-liabilities to be taken at book value.
  3. Wherever necessary, profit or loss should be apportioned on a time basis.
  4. The amount due to the deceased partner’s estate was to receive interest @ 12% p.a. from the date of the death until paid.

You ascertain that:

(a)   Profits for three years, before charging partner’s interest were: 2003- Rs.1,68,000; 2004 – Rs.1,89,000; 2005 – Rs.1,80,000;

(b)   The independent valuation at the date of death revealed: Land and Building Rs. 1,50,000; Furniture & Fixtures Rs. 15,000;

(c)   A fair remuneration for each of the partners would be Rs.37,500 p.a. & that capital employed in the business to be taken as Rs. 3,90,000 throughout.

It was agreed among the partners that:

(i) Goodwill was not to be shown as an asset of the firm as on 31 -12-06. Therefore adjustment for goodwill was to be made in Capital A/c;

(ii)  A & B would share equally from the date of death of C;

(iii)   Depreciation on revised value of assets would be ignored.

You are required to prepare: (a) Partner’s Capital Accounts and (b) Balance Sheet of the firm as on 31-12-06.

Solution :

Dr.Partners’ Capital AccountCr.
ParticularsABCParticularsABC
To Drawings a/c24,00036,00036,000By Balance b/d1,50,00075,00090,000
To C Capital A/c9,99019,980By Revaluation A/c9,0006,7506,750
(Goodwill adj.)By A A/c (goodwill adj.)9,990
To C’s Executors A/c1,13,895By B A/c (goodwill adj.)19,980
By Interest on Capital15,0007,5004,500
To Balance c/d1,94,86881,903By P & L Appropriation a/c54,85848,63318,675
2,28,858137,8831,49,8952,28,858137,8831,49,895

Balance Sheet as on 31-12-2006

LiabilitiesRs.AssetsRs.
Capital Account-A1,94,868Land and Building1,50,000
– B81,9032,76,771Furniture and Fittings15,000
Stock1,87,500
C’s Executors A/c1,20,729Debtors30,000
Creditors45,000Bank60,000
4,42,5004,42,500

Dr.                                           (1) Revaluation Account                                                      Cr.

To Furniture and Fixtures A/c7,500By Land and Building A/c30,000
To Partners’ Capital A/cA-9,000
B-6,750
C-6,75022,500
30,00030,000

(2) Adjustment in regard to Goodwill

Aggregate profits for three years upto the date of death (30-6-2006) are as follows:Rs.
Profit for 2003-04 : 1/2 of Rs. 1,68,000 + X/2 of Rs. 1,89,0001,78,500
Profit for 2004-05 : 1/2 of Rs. 1,89,000 4-1/2 of Rs. 1,80,0001,84,500
Profit for 2005-06 : 1/2 of Rs. 1,80,000 + 1/2 of Rs. 1,56,0001,68,000
Total profits for three years5,31,000
Average profit (Rs. 5,31,000/3)1,77,000
Less. Interest on capital employed (8% on Rs. 3,90,000)31,200
Fair remuneration to partners (Rs. 37,500 × 3)1,12,5001,43,700
Adjusted average profit for goodwill33,300
Goodwill is the purchase of 3 years’ profit = 3 × Rs. 33,30099,900

 

PartnersABC
Right of goodwill before death (4:3:3)(Rs.) Cr.39,96029,97029,970
Right of goodwill after death (1:1)(Rs.) Dr.49,95049,950
Gain (-l-)/Sacrifice (-)(Rs.)Dr. (+) 9,990Dr. (+) 19,980Cr.(-)2 9,970

 

Dr.(3) Profit & Loss Appropriation AccountCr.
Particulars1-1-06 to 30-6-061-7-06 to 31-12-06Particulars1-1-06 to 30-6-061-7-06 to 31-12-06
To Interest on Capita! A/cBy Profit & Loss A/c78,00078,000
-A7,5007,500
-B3,7503,750
– C4,500
To Interest on C’s Executors6,834
Loan A/c – 12%
To Profit transferred
-A24,90029,958
-B18,67529,958
-C18,675
78,00078,00078,00078,000

 

Dr.(4) C’s Executor Loan AccountCr.
To Balance c/f1,20,729By C’s Capital A/c1,13,895
By P & L Appropriation A/c6,834
1,20,7291,20,729

Illustration 22.32 : Firm ABC consist of 3 partners A, B and C, sharing profits and losses in the ratio 5:3:2 respectively. The partner A died on February 20,2006, Profit and Loss Account for the period upto date of death and Balance sheet as on that date were prepared. The Balance sheet as on that date was as given by the side.

LiabilitiesRs.AssetsRs.
CapitalGoodwill6,000
A12,000Machinery35,000
B16,000Furniture6,000
C12,00040,000Stock9,000
Debtors15,000
Loan from A5,000Cash in hand3,000
General Reserve7,000
Creditors22,000
74,00074,000

In addition to the assets shown above, the firm had 3 life policies in the name of each partner, for insured value of 20,000 each, the premium of which were charged to Profit & Loss Account.

According to the partnership deed, on death of partner, the asset and liabilities are to be revalued by a valuer. The re-valued figures were:

(1)   Goodwill 21,000, Machinery 45,000, Debtors are subject and to a provision for doubtful debts at 10% and Furniture at 7,000.

(2)   Provision for taxation to be created for Rs. 1,500.

(3)   Death-claim for policy in the name of A will be realised in full & the surrender values of the other 2 policies were Rs. 7500 each.

The business will be continued by B & C, henceforth sharing profits and losses equally. The net balance due to A is transferred to a Loan account which will be paid off later.

Show Capital Account, Revaluation Account and the new Balance Sheet of the firm.

Solution :

Journal Entries

Sr. No.ParticularsDebit Rs.Credit Rs.
1.Reserve A/cDr.7,000
To A A/c3,500
To B A/c2,100
To C A/c1,400
(Reserves transferred in old ratio)
2.Goodwill A/cDr.15,000
To A A/c7,500
To B A/c4,500
To C A/c3,000
(Goodwill raised and credited to partners in old ratio)
3.Machinery A/cDr.10,000
Furniture A/cDr.1,000
To Revaluation A/c11,000
(Asset value appreciated)
4.Revaluation A/cDr.3,000
To Provision for BDD1,500
To Tax provision A/c1,500
(Provision increased)
5.Revaluation A/cDr.8,000
To A A/c4,000
To B A/c2,400
To C A/c1,600
(Profit on revaluation transferred in old ratio)
6.A A/cDr.20,000
To Cash/Bank A/c20,000
(Claim money utilised to settle A’s A/c)
7.Cash A/cDr.20,000
To profit on JLP A/c20,000
(Claim received due to ‘A’s death)
8.Joint Life Policy A/cDr.15,000
To profit on JLP A/c15,000
(Two policies revalued)
9.Profit on Joint Life Policy A/cDr.35,000
To A A/c17,500
To B A/c10,500
To C A/c7,000
(Profit transferred in old ratio)

Capital Account

ParticularsABCParticularsABC
To Cash/Bank A/c20,000By Balance b/d12,00016,00012,000
(Claim moneyBy Reserve A/c3,5002,1001,400
utilised)By Goodwill A/c7,5004,5003,000
To A’s Loan A/c24,500By Revaluation A/c (profit)4,0002,4001,600
To Balance c/d35,50025,000By Joint Life Policy (profit)17,50010,5007,000
44,50035,50025,00044,50035,50025,000

Revaluation Account

ParticularsRs.ParticularsRs.
To Provision for doubtful debts1,500By Machinery A/c10,000
To Provision for taxation A/c1,500By Furniture A/c1,000
To Profit trf. to Capital A/c
A4,000
B2,400
C1,6008,000
11,00011,000

A’s (Legal heirs/representatives) Loan Account

ParticularsRs.ParticularsRs.
To Balance c/d29,500By Balance b/d5,000
By A’s Capital A/c24,500
29,50029,500

Profit on Joint Life Policy Account

To profit trf. to capital A/cBy Cash/Bank A/c20,000
A17,500(Claim on A’s policy)
B10,500By Joint Life Policy A/c (Revaluation)
C7,00035,000(2 Joint life policy of B & C) (7500 × 2)15,000
35,00035,000

Balance Sheet

LiabilitiesRs.AssetsRs.
Capital A/cGoodwill (6,000 + 15,000)21,000
B35,500Machinery A/c45,000
C25,00065,500Furniture A/c7,000
Stock A/c9,000
Loan from A A/c29,500Debtors A/c15,000
Provision for tax1,500(-) Provision for BDD1,50013,500
Creditors22,000Cash in hand3,000
Joint Life Policy A/c15,000
1,13,5001,13,500

CHANGE IN PROFIT SHARING RATIO

Illustration 22.33: Raju Shashtri and Tank are partners in a firm, Sharing profits and losses in the ratio of 5:3:2. Their Balance Sheet as on 31st March, 2005, stood as follows:

LiabilitiesRs.AssetsRs.
Sundry Creditors25,000Cash at Bank10,000
General Reserve20,000Sundry Debtors22,000
Shashtri’s Loan A/c15,000Less: Reserve for bad debts2,00020,000
Capital Accounts:
Raju25,000Furniture10,000
Shashtri10,000Plant and Machinery35,000
Tank5,00040,000Stock25,000
Total1,00,000Total1,00,000

From 1st April, 2005, the partners decided to change their profit sharing ratio as 2:1:2 instead of their former ratio of 5:3:2 and for that purpose the following adjustments were agreed upon:

(i) The reserve for bad debt was to be raised to 10%.

(ii) The furniture was to be appreciated by Rs. 5,200.

They did not, however want to alter, the book value of the assets and reserves but record the change by passing single journal entry.

The Profit and Loss Account of the firm for the year ended 31st March, 2006, showed a net profit of Rs, 22,900.

(a)   Show the single journal entry adjusting the partners capital as on 1st April, 2005 and

(b)   Prepare the Profit and Loss Appropriation Account for the year ended 31 st March, 2006, after taking into consideration the following adjustments:

(i)    Interest on Capital at 5% p.a.

(ii)   Transfer 25% of the divisible profit, to Reserve Fund, after charging such Reserve.

Solution :

Memorandum Revaluation Account

ParticularsRs.ParticularsRs.
To Provision for bad debt200By Furniture A/c5,200
(2,200 – 2,000)By General reserve A/c20,000
To Profit on Revaluation trf. (old ratio)
R’s Capital12,500
S’s Capital7,500
T’s Capital5,00025,000
25,20025,200
To Furniture A/c5,200By Provision for Bad debt200
To General reserve A/c20,000(reversal of above debts)
(Reversal of above credits)By Loss transfer to: (new ratio)
R’s Capital10,000
S’s Capital5,000
T’s Capital10,00025,200
25,00025,200

Alternatively above revaluation profit & reserves can be worked out as a working note.

On 1.4.05 Net Difference on revaluation profit including reserves

RST
Profit credited in old Ratio (Cr.)12,5007,5005,000
Reversed it in new ratio (Dr.)10,0005,00010,000
DifferenceCr. 2,500Cr. 2,500Dr. 5,000

 

Single Entry on 1.4,05 Adjusting Partners Capital for Revaluation & Reserves:
Tank A/cDr.5,000
To Raju A/c2,500
To Shastri A/c2,500
Capital Account on 1.4.05 of
Tank = 5,000 – 5,000 = 0Raju = 25,000 + 2,500 = 27,500Shastri = 10,000 + 2,500 = 12,500

Profit & loss Appropriation Account (Year ended 31.3.06)

ParticularsRs.ParticularsRs.
To Interest on Shastri’s loan (15000 × 6%)900By Net profit as per P&L b/d22,900
To Interest on capital
R’s Capital1,375
S’s Capital625
T’s Capital2,000
To Trf to Reserve A/c4,000
(20,000X25/125)
To Net profit trf. to
R6,400
S3,200
T6,40016,000
22,90022,900

If nothing is specified then partners loan is entitled for 6% interest as per partnership law.

Illustration 22.34: A, B and C are partners in a firm sharing profits and losses as 8:5:3. The Balance Sheet as at 31st December, 2005 was as follows:

LiabilitiesRs.AssetsRs.
Sundry Creditors1,50,000Cash
General Reserve80,000Bills Receivable50,000
Partner’s Loan Accounts:Sundry Debtors60,000
A40,000Stock1,20,000
B30,000Fixed Assets2,80,000
Partner’s Capital Accounts:
A1,00,000
B80,000
C70,000
5,50,0005,50,000

From 1st January, 2006 they agreed to alter their profit-sharing ratio as 5:6:5. It is also decided that:

(a)   The fixed assets should be valued at Rs. 3,31,000;

(b)   A provision of 596 on sundry debtors be made for doubtful debts;

(c)   The goodwill of the firm at this date be valued at three year’s purchase of the average net profit of the last five years before charging insurance premium; and

(d)   The stock be reduced to Rs. 1,12,000.

There is a joint life insurance policy for Rs. 2,00,000 for which an annual premium of Rs. 10,000 is paid, the premium being charged to Profit and Loss Account. The surrender value of the policy on 31st December, 2005 was Rs. 78,000.

The net profits of the firm for the last five years were Rs. 14,000, Rs. 17,000, Rs. 20,000, Rs. 22,000 and Rs. 27,000.

Goodwill and the surrender value of the joint life policy was not to appear in the books.

Draft Journal Entries necessary to adjust the capital accounts of the partners and prepare the revised Balance Sheet.

Solution :

M/s A, B and C Journal Entries

DateParticularsRs.Rs.
1.1.06Fixed Assets A/cDr.51,000
To Revaluation A/c51,000
(Being increase in the value of fixed assets)
Revaluation A/cDr.11,000
To Stock A/c8,000
To Provision for Doubtful Debts A/c3,000
(Being reduction in the value of stock and provision for doubtful debts @ 596 created on sundry debtors)
Revaluation A/cDr.40,000
To A’s Capital A/c20,000
To B’s Capital A/c12,500
To C’s Capital A/c7,500
(Being transfer of profit on revaluation to partners in their old profit sharing ratio of 8:5:3)
General Reserve A/cDr.80,000
To A’s capital A/c40,000
To B’s capital A/c25,000
To C’s capital A/c15,000
(Being transfer of general reserve in old ratio of 8:5:3)
B’s capital A/cDr.10,500
C’s capital A/cDr.21,000
To A’s Capital A/c31,500
(Being adjustment for goodwill and joint life policy without raising the same in the books. For calculation refer working note)

Balance sheet (revised)

As on 1st January, 2006

LiabilitiesRs.AssetsRs.
Sundry Creditors1,50,000Cash40,000
Partner’s Loan Accounts:Bills Receivable50,000
A40,000Sundry Debtors60,000
B30,00070,000Less-. Provision3,00057,000
Partner’s Capital Accounts:Stock1,12,000
A1,91,500Fixed Assets3,31,000
B1,07,000
C71,5003,70,000
5,90,0005,90,000

Working Note:

Adjustment for Goodwill and joint Life PolicyRs.
Profit for 5 years (14,000+ 17,000+20,000+22,000+27,000)1,00,000
Average profit per year (1,00,000 + 5)20,000
Add. Insurance premium per annum10,000
Average profit before charging premium30,000
Value of goodwill at three year’s purchase (3X30,000)90,000
Add: Surrender value of joint life policy78,000
Total amount of unaccounted profit requiring adjustment without changing book value1,68,000

 

Adjustment for Goodwill & Joint-life PolicyA

Rs.

B

Rs.

C

Rs.

Raised goodwill & joint Life Policy in old profit sharing ratio 8:5:384,000 (Cr.)52,500(Cr.)31,500(Cr.)
Less. Written off in new profit sharing ratio of 5:6:552,500 (Dr.)63,000(Dr.)52,500(Dr.)
Net effect in Capital Accounts31,500(Cr.)10,500(Dr.)21,000(Dr.)

PRACTICE PROBLEMS

(Answers & Hints given at the end of the Chapter)

SHARING OF PROFIT

P.1 : Black and white are partners with capital Rs. 30,000 and Rs. 20,000. .

Profits for the year ended 31st March, 2011 amounts to Rs. 27,100.

It is agreed that 5% interest on capital as such shall be allowable.

There is no agreement regarding sharing of profits or partnership salary.

Black is a whole time partner whereas white does not attend business regularly.

Black claims Rs. 600 salary p.m. and 60% of balance profit.

White advanced Rs. 10,000 loan and he now claims 10% interest.

Show distribution of profit by a statement.

P.2 : A, B, C and D are partners in a garage comprising (i) petrol sales, (ii) repairs and servicing, and (iii) second-hand car dealing. A is responsible for petrol sales, B for repairs and servicing, and C for second-hand car dealing, while D acts purely in an advisory capacity,

The partnership agreement provides for the following:

(a)   Each partner is to receive commission of the net profit of the partner’s own department as under – A – 10%; B – 15% and C-20%.

(b)   A total salary of Rs. 11,000 is payable to D which is to be allocated among the above three departments in the ratio of 3:4:4 respectively.

(c)   50% of the net profit of each department after charging commission and salary will be distributed to A, B, and C as under –

Petrol sales                 Repairs and Servicing             Second-hand Car Dealing

A, B and C- Equally    A : B : C = 2:2:1                      A : B : C = 3:2:1

(d)   The balance of the profit of the firm will be shared equally by all partners.

The net profits of the departments for the year ended 31.12.2010 were as under:

Petrol sales: Rs. 20,000; Repairs and Servicing – Rs. 40,000; Second hand-car dealing – Rs. 50,000.

You are required to prepare the Profit and Loss Appropriation Account for the year ended 31.12.2010.

P.3 : The Chartered Accountants X, Y and Z form a partnership, profits being divisible in the ratio of 3:2:1 subject to the following:

(i) Z’s share of profit is guaranteed to be not less than Rs. 15,000 p.a.

(ii) Y gives guarantee to the effect that gross fees earned by him for the firm shall be equal to his average gross fee of the preceding five years when he was carrying on profession alone (which average works out at Rs. 25,000).

The profit for the first year of the Partnership is Rs. 75,000. The gross fees earned by Y for the firm are Rs. 16,000. You are required to show the distribution of profits.

P.4 : Calculate interest on drawings @12%, under following situation for the year ended 31.12.2011:

(1)   Partner A withdrew Rs. 12,000 during the year, Rs. 5,000 on 31.3.2011, Rs. 4,000 on 30.6.2011 & Rs. 3,000 on 30.9.2011.

(2)   Partner B withdrew Rs. 12,000 during the year.

(3)   Partner C withdrew Rs. 12,000 during the year, Rs. 1,000 at the beginning of each month.

(4)   Partner D withdrew Rs. 12,000 during the year, Rs. 1,000 at the end of each month.

CALCULATION OF NEW RATIO

P.5 : Partners A & B are sharing in the ratio of 3:2 (i.e. 3/5 & 2/5). They admit C. Calculate new ratio in the following alternative cases :

(1)   ‘C’ is admitted with 1 /6th share.

(2)   ‘C’ is admitted with 1 /6th share & ‘A’ & ‘B’ decided to share equally in future.

(3)   ‘C is admitted with l/6th share, which he purchased from B.

(4)   ‘C’ is admitted with 1 /6th share which he bought from A & B in 2:3 ratio.

(5)   ‘C’ is admitted. He purchased 1 /3rd of A’s share & 2/3rd of B’s share.

CALCULATION OF GOODWILL

P.6 : Goodwill of M/s. AB & Co. is to be valued as 3 years purchase of last four years average profit. Profit for 2013 is Rs. 12,000 for 2012 Rs. 10,000 for 2011 Rs. 15,000 and for 2010 Rs. 13,000.

P.7 : M/s AB & Co. Wants to value the goodwill as 4 years purchase of the super profit. Their capital employed is Rs. 1,00,000. The normal rate of return by the similar concerns is 15% p.a. Average profit of the firm -is Rs. 20,000. (Future maintainable profit)

P.8 : In the case of P.7 : above goodwill to be calculated as 4 years purchase of the super profit by Annuity method. The present value of annuity of Rs. 1 for 4 years @10% is 3.169.

P.9 : In the case of P.7 : above calculate goodwill by capitalization method.

P.10 : A & B are partners sharing equally with capital of Rs. 50,000 each. C is admitted with l/3rd share, and contributes Rs. 65,000. Capitals were in profit sharing ratio and they are intended to be kept in profit sharing ratio in future also.

Calculate goodwill if (i) A & B are to withdraw their share in goodwill immediately or (ii) They will not withdraw.

ACCOUNTING OF GOODWILL

P.11 : X and Y are in partnership sharing profits and losses as 3:2. They admit Z into the firm, Z paying a premium (share in goodwill) of Rs. 36,000 for 1 /6th share of the profits. As between themselves, X and Y agree to share future profits and losses equally. Draft journal entry showing the appropriation of premium (goodwill) money.

P.12 : Hari and Ram were in partnership, sharing profits and losses in 4:2 ratio. On 1st January, 2006, Suraj was admitted into partnership on the following terms:

Suraj is to have one-sixth share in the profits/ losses, which he has got from Hari & Ram equally. The Goodwill appears in the books at Rs. 30,000 but the present valuation is agreed as nil.

Journalise the entries related to goodwill on Suraj’s admission.

ADMISSION OF A PARTNER

P.13 : P and Q are partners in a firm sharing profits and losses in the ratio of 2:1 respectively. They admit R into partnership on the terms that R will bring such an amount that his capital will be one-third of the total capital of the new firm.

R is given one-third share in future profits. At the time of admission of R, the balance sheet of P and Q was as under :

LiabilitiesRs.AssetsRs.
Capital account:Machinery60,000
P60,000Furniture5,000
Q55,000Stock40,000
General Reserve15,000Sundry debtors15,000
Sundry creditors25,000Cash at bank35,000
1,55,0001,55,000

On an independent valuation, it is found that the stock was overvalued by Rs. 2,500.

It is decided to depreciate furniture and machinery at 10% and 5% respectively and to make a provision of Rs. 1,500 on sundry debtors for doubtful debts.

Goodwill of the firm is valued at Rs. 45,000 and partners decided that no goodwill account be opened in the books.

Pass the journal entries for all the abovementioned transactions and prepare the initial balance sheet of the new firm.

P.14 : The balance sheet of a partnership firm of X and Y, who were sharing profits in the ratio of 5:3 respectively, as on 31st March, 2011 was as follows:

LiabilitiesRs.AssetsRs.
Creditors25,000Cash at bank11,200
Reserve20,000Other current asset53,800
Capitals:Stock35,000
X75,000Machinery30,000
Y60,0001,35,000Building50,000
1,80,0001,80,000

On the above date, Z was admitted on the following terms :

  1. Z was to get 17 5th share in the profits which he bought equally from X & Y.
  2. Z was to pay Rs. 50,000 as capital and Rs. 16,000 for his share of goodwill.
  3. Machinery was to be depreciated by 10% and building w’as to be appreciated by 20%.
  4. Stock was valued at 25% above cost. It was to be brought into the books of the new firm at      cost price.
  5. There was a liability for repairs to furniture amounting to Rs. 600; the same was to be recorded in the books.
  6. Capital accounts of the old partners were to be adjusted in the new profit sharing ratio by opening the necessary current accounts.

Prepare revaluation account, capital accounts and the initial balance sheet of the new firm.

P.15 : A and B sharing profits in the ratio of 3:2 respectively, showed the following as their balance sheet on 31st March, 2011:

LiabilitiesRs.AssetsRs.
Creditors25,000Cash at bank5,000
General reserve60,000Debtors40,000
Capital accountsStock1,00,000
A1,70,000Furniture20,000
B80,0002,50,000Land and building1,70,000
3,35,0003,35,000

They admit C into partnership on 1st April, 2011 on the following terms:

  1. That C pays Rs. 1,00,000 as his capital.
  2. New profit sharing is 3:2:1.
  3. That goodwill of the new firm is valued at Rs. 1,00,000.
  4. That the value of stock and furniture is lower by 10% and 5% of debtors are doubtful.
  5. That the value of land and building has appreciated by 20%.
  6. That the adjustment should be made without changing book value of asset, liability & reserves. Pass the entry for the adjustment and draw the opening balance sheet of the new firm.

RETIREMENT OF A PARTNER

P.16 : X, Y and Z were sharing profits and losses in the ratio of 3:2:1 respectively. The firm had insured the partner’s lives severally the premium thereof is charged to Profit & Loss a/c. The surrender values of the life policies as at 31st March, 2014 were – X for Rs. 5,000, Y for Rs. 4,000 and Z for Rs. 3,000. The surrender values represents 50% of the sum assured in each ease. Y and Z decide to share equally in future. Give the necessary journal entries assuming (a) If X retires on 31.03.2014 (assume policy surrendered) (b) If X dies on 31.03.2014.

P.17 : The balance sheet of A, B and C who were sharing profits in proportion to their capitals stood as follows on 31st March, 2011:

LiabilitiesRs.AssetsRs.
Sundry creditors69,000Cash at bank55,000
General reserve1,80,000Sundry debtors50,000
Capital accounts:Less: Provision for Bad debts1,00049,000
A2,00,000Stock2,60,000
B1,50,000Machinery1,35,000
C1,00,000Land and buildings2,00,000
6,99,0006,99,000

B retired on the above date and the following was agreed upon:

  1. that the provision for bad debts be brought upto 5% on debtors;
  2. that land and buildings be appreciated by 25%;
  3. that a provision of Rs. 3,500 be made in respect of outstanding legal charges;
  4. that the goodwill of the firm be fixed at Rs. 1,08,000 and B’s share of it be adjusted into the accounts of A and C who are going to share future profits in the ratio of 5:3; and
  5. that the entire capital of the firm as newly constituted be fixed at Rs. 4,80,000 and the capitals of A and C be made proportionate to their new profit sharing ratio of 5:3 (actual cash to be brought in or paid off, as the case may be).

Pass journal entries. Also show profit and loss adjustment account and capital accounts.

P.18 : The following is the balance sheet as on 31st March, 2011 of Alex, Best and Cooper who share profits in the ratio of 4:2:1 respectively:

Rs.
Liabilities;
Capital accounts:
AlexRs. 30,000
BestRs. 20,000
CooperRs. 15,00065,000
General reserve10,500
Sundry creditors15,000
Bills payable3,000
93,500
Assets :
Goodwill10,000
Land and buildings20,000
Plant and machinery26,500
Motor vehicle10,000
Stock15,000
Sundry debtors11,000
Cash1,000
93,500

On the above date, Alex retired, his share was equally purchased by Best and Cooper and the following arrangements were agreed upon:

  1. Goodwill of the firm be valued at Rs. 24,000.
  2. The assets and liabilities be re-valued as under:

Stock – Rs. 12,000; Sundry debtors – Rs. 10,500; land and buildings – Rs. 22,600; Plant and machinery – Rs. 25,000; and sundry creditors-? 14,000.

  1. Best and Cooper to introduce Rs. 20,000 and Rs. 5,000 respectively into the business. A sum of Rs. 16,200 be paid to Alex immediately and the balance be kept as loan.
  2. Best and Cooper agreed not to retain goodwill in the books.

Give journal entries to record the above transactions and prepare the balance sheet of the firm after Alex’s retirement. Also show Alex’s loan account until it is paid off.

RETIREMENT CUM ADMISSION

P.19 : Alpha and Beta were carrying on the business styled Gamma & Co. as equal partners. It was agreed that Alpha should retire from the firm on 31 st March, 2011 and that his son Haren should join Beta from 1st April, 2011, and should be entitled to one-third of the profits of the partnership.

The balances in the firm’s books on 31st March, 2011, were as follows:

LiabilitiesRs.AssetsRs.
Alpha’s Capital Account34,000Cash at Bank11,000
Beta’s Capital Account28,200Sundry Debtors14,100
Sundry Liabilities7,800Furniture14,200
Building20,700
Goodwill10,000
70,00070,000

On 31st March, 2011, Goodwill was valued at Rs. 22,000 and Building at Rs. 24,000.

It was also agreed that enough money should be introduced to enable Alpha to be paid out and leave Rs. 10,000 cash by way of working capital. Beta and Haren were to provide such sum as would make their capital proportionate to their shares of profits. Alpha agreed to make a friendly personal loan of Rs. 10,000 to Haren, by transfer from his Capital Account.

Beta and Haren paid in the cash due from them on 7th April, 2011, and the amount due to Alpha was paid out on the same day.

Set out journal entries with full narration to record the above transactions in the books of the partnership.

DEATH OF A PARTNER

P.20 : A, B and C were in partnership sharing profits and losses in the ratio of 5:4:3 respectively. A died on 31.12.2010, on which date the balance sheet of the firm was as under:

LiabilitiesRs.AssetsRs.
Capital accountsPremises40,000
A42,500Less: Provision for depreciation4,00036,000
B30,000Plant46,000
C22,50095,000Less: Provision for depreciation13,50032,500
Current accounts:Stock27,000
A4,250Debtors21,000
B6,500Less: Provision for doubtful debts3,75017,250
C5,75016,500Bank40,000
Loan: A20,000
Creditors21,250
1,52,7501,52,750

B and C decided to carry on the business sharing profits and losses in the ratio of 7:5 respectively. The following adjustments were made on 31.12.2010:

(i) Plant, stock and debtors were valued at Rs. 34,500, Rs. 24,300 and Rs. 16,850 respectively.

(π) Valuer’s charge of Rs. 700 was to be provided for.

(iii) Goodwill was to be valued as equal to 3 years purchase of super profits.

The required return was to be calculated as 25% on partners’ capital, current and loan accounts, and was to be set against weighted average profits of the last three years. Profits were: 2010 = Rs. 52,000; 2009 = Rs. 46,000:2008 = Rs. 45,250. Adjustment for goodwill were to be made in and out of the capital accounts.

(iv)  Rs. 25,000 was repaid to A’s executors on 1.1.2011, the balance owing to be a loan to the partnership.

Prepare necessary ledger accounts and the balance sheet on 1.1.2011.

P.21 : A, B and C are partners sharing profits and losses in the ratio of 2:1:1 respectively. On 31st March, 2011, their balance sheet was as follows:

LiabilitiesRs.AssetsRs.
A’s capital10,000Goodwill3,000
B’s capital6,000Freehold property9,000
C’s capital4,000Furniture1,000
Creditors4,000Joint life policy2,000
Bills payable2,000Stock5,500
Debtors4,500
Cash at bank1,000
26,00026,000

A died on 1st April, 2011. The firm had taken a joint life policy for Rs. 15,000, the payment for which was received by the firm. According to the partnership deed, on retirement or death of a partner, the goodwill was to be valued at 1 & ½ times of the average profit for the last four years. The profits for the last four years were Rs. 6,000, Rs. 7,500, Rs. 9,000 and Rs. 9,500 respectively. For paying the amount due to A’s legal representative, B and C brought required cash in their profit sharing ratio and the firm would have a cash balance of Rs. 3,000.

Pass journal entries to record the abovementioned transactions and prepare partners’ capital accounts.

ANSWERS AND HINTS FOR

Practice Problems

P. No.Answers & Hints
1.Interest on loan- Rs. 600; Interest on capital- Rs. 2,500; Balance profit 12,000+12,000 = Rs. 24,000
2.Final shares A- 29,625; B- 30,625; C- 28,625; D- 21,125
3.Final Shares X- 41,400; Y- 27,600 – 9000 = 18,600 ; Z- 15,000
4.Interest on drawing: 1) Rs. 780 ; 2) Rs. 720 ; 3) Rs. 780 ; 4) Rs. 660
5.New Ratio after admission: 1) 3:2:1; 2) 5:5:2 ; 3) 18:7:5 ; 4) 16:9:5 ; 5) 6:2:7
6.Goodwill Rs. 37,500
7.Goodwill Rs. 20,000
8.Goodwill Rs. 15,845
9.Goodwill Rs. 33,333
10.Total Goodwill (i) Rs. 45,000 ; (ii) Rs. 30,000
11.Total Goodwill Rs. 2,16,000
12.Goodwill w/off Rs. 30,000
13.Revaluation loss Rs. 7,500, Cash brought by R Rs. 83,750; New Ratio 4:2:3 & Balance sheet total Rs. 2,31,250
14.Revaluation Loss Rs. 600; X’s current A/c- Dr. 36,125 ; Y’s current A/c- Cr. 6,525; Balance sheet total Rs. 2,75,600
15.Adjustment entry:
 C A/c – Dr. Rs. 30,000 ,
 To A Rs. 18,000
 To B Rs. 12,000
 Balance sheet total Rs. 4,35,000 ; Memorandum revaluation A/c – Rs. 20,000 profit
16.Refer solved illustration in book.
17.Revaluation Profit – Rs. 45,000 ; B’s Loan A/c – Rs. 2,61,000 ; Balance sheet total – Rs. 8,13,500
18.Revaluation Loss- Rs. 1,400 ; A’s Loan A/c- Rs. 27,000 ; Balance sheet total- Rs. 89,900
19.Balance sheet total – Rs. 84,300 ; Cash brought bv B- Rs. 15,150 ; H- Rs. 15,500 ; Paid to A – Rs. 31,650 ‘
20.Revaluation Loss- Rs. 1,800 ; A’s executors balance- Rs. 61,000 ; Goodwill- Rs. 48,000 ; Balance sheet total – Rs. 1,26,650
21.Goodwill- Rs. 12,000 (simple average) ; Paid to A – Rs. 21,000 ; Cash brought by- B: Rs. 4,000, C: Rs. 4,000 ; Balance sheet total – Rs. 35,000

*This article contains all topics about Partnership Accounting.

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