Chapter-3

Chapter-3
Reconstitution of Partnership Firm-Admission of a partner
Partnership is a voluntary association of two or more persons who on the basis of an agreement
pool together their financial and managerial resources and jointly start a lawful business. Any
change in the relationship among partners may lead to reconstitution of the partnership firm. A
change in the partnership agreement brings to an end to the existing agreement. Thus in
reconstitution the existing agreement comes to an end and the firm may continue its business
with a new agreement.

Modes of Reconstitution/ Occasions when reconstitution of a firm take place

Reconstitution of a partnership firm is usually takes place in any of the following ways:

1. Change in the profit sharing ratio among the existing partners

2. Admission of a partner
3. Retirement of an existing partner
4. Death of a partner
5. Amalgamation of two partnership firms

1. Change in the profit sharing ratio among the existing partners

Sometimes partners of an existing firm may decide to change their existing profit sharing
ratio. The change in profit sharing ratio may lead to increase or decrease partner’s share in
the firm. In other words, certain partner may gain others will lose. The sacrificing partners
must be compensated by the gaining partner. The amount of compensation is calculated on
the basis of the value of goodwill of the firm (Goodwill is the value of reputation of a firm; It
is the extra earning capacity of a business compared to other business).

Example: Anna and Maria are partners, sharing profit and loss in the ratio of 3:1.Now they
decided to share profit equally (old ratio 3:1, New ratio 1:1:1).

Effects of change in profit sharing in partners capitals due to goodwill

Anna and Maria are partners, sharing profit and loss in the ratio of 3:1.They decided to share
profit equally.

Old ratio of Anna & Maria=3:1

Old share of Anna=3/4

New share of Anna=1/2

Anna’s gain/ sacrifice=New share-old share=1/2-3/4 or 2/4-3/4 = (-) 1/4 (Sacrifice or loss)

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Old share of Maria 1/4

New share of Maria=1/2

Maria’s gain/sacrifice= New share-old share=1/2-1/4 or 2/4-1/4 =1/4 (Gain or profit)

Anna’s old share was 3/4 as per new profit sharing ratio, her share is only 1/2, she sacrifice
1/4 of her share (3/4-1/2), whereas Maria whose old share was 1/4 now get 1/2 i.e, Maria has
a gain of 1/4 (1/2-1/4).It shows that Anna’s sacrifice is 1/4th share and Maria gain is
also1/4th share.

Suppose the business earned a profit of is Rs.20,000 .As per old profit sharing ratio, Anna
would get Rs.15,000 and Maria Rs.5,000.As per new profit sharing ratio, each would get
Rs.10,000 each. Here, Anna’s sacrifice is Rs.5,000 (15000 – 10000) and Maria gain is
Rs.5,000 annually. So gaining partner (Maria) should compensate the sacrificing partner
(Anna), it is just and equitable. Normally compensation is in the form of share of goodwill
(value of extra earning capacity of a business compared to other business).If the goodwill of
the firm is valued at Rs.40, 000, Maria is required to pay to Anna 1/4 of Rs.40, 000, i.e,
Rs.10, 000 (40,000 X 1/4).The following journal is required to pass to adjust it in their capital
account:

Maria’s Capital A/C Dr 10,000

To Anna’s Capital A/C 10,000

(Effects of change in profit sharing ratio is adjusted)

2. Admission of a new partner

Inclusion of a person as a partner to an existing partnership firm is called admission of a
partner. When a firm requires additional capital or managerial help or both for the expansion
of its business, a firm can admit a person as a partner to an existing firm. The new person
admitted is called as incoming partner. On admission, old partnership agreement comes to an
end and with a new agreement the business will continue. A person can be admitted as a
partner only with the consent of all partners. A minor can be admitted as a partner for the
benefit of partnership. In that case minor’s liability is limited to the capital contributed by
him.

Example: Rajan and Mohan were equal partners. They admit Sunil as a partner by giving him
an equal share. In this case agreement will change and reconstitution takes place.

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3. Retirement of a partner
Retirement means withdrawal of a partner from an existing business. Retirement may be due
to his bad health, old age or change in business interests.

Example: A, B and C are partners sharing in the ratio of 3:2:1.After C’s retirement A and B
decided to continue the business with a profit sharing ratio of 3:2.This results in
reconstitution of the firm.

4. Death of a partner
Death of a partner will also result in the change of relationship between surviving partners.
Their profit sharing ratio will change and it leads to reconstitution.

5. Amalgamation of two firms

Sometimes two firms amalgamate in order to avoid competition and reduce administrative
cost. This arrangement brings new relationship among partners of two firms. A new
agreement is signed .New profit sharing arrangements takes palce.Here also reconstitution
occurred.

As such, any change in the partnership agreement due to change in the ratio of existing
partners or admission or retirement or death of a partner or amalgamation of partnership firm
is known as Reconstitution of Partnership.

Admission of a new partner

When a firm requires additional capital or managerial help or both for the expansion of its
business, a new partner may be admitted to supplement its existing resources. According to
the partnership Act 1932, a new partner can be admitted into the firm only with the consent
of all the existing partners unless otherwise agreed upon.

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

1. Right to share the assets of the partnership firm.

2. Right to share the profit of the partnership firm.

For the right to acquire share in the assets and profit of the partnership firm, the partner
brings adequate (agreed) amount of capital either in cash or kind. For the right to share
future profit of an established firm the new partner is required to bring some additional
amount known as his share of goodwill or premium. This is necessary to compensate the
existing partners for their sacrifice a part of their share of profit in favour of the incoming
partner.

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Accounting treatment required at the time of admission of a partner

1. Recording capital contributed by the new partner

2. Calculation of new profit sharing ratio and sacrificing ratio

3. Treatment of goodwill

4. Revaluation of assets and liabilities

5. Distribution of accumulated profits and losses

6. Adjustment of partner’s capital account

1. Record the capital contributed by the new partner

When the new partner brings agreed amount or assets for capital:
Cash / Assets A/C Dr
To New Partner’s Capital A/C
(Amount brought in for capital)

2. Calculation of New profit sharing ratio and sacrificing ratio

The new profit sharing ratio is mutually decided by partners. Admission of a partner
to the existing firm means reduction in the share of old partner or partners.
New ratio = Old Share – Sacrificing Share

Sacrificing Ratio
On admission of a partner, the old partners have to give up a certain portion of their
profits in favour of the new partner. In other words, sacrificing ratio is the ratio in
which the old partners agree to sacrifice their share of profit in favour of the new
partner.
Sacrificing Ratio = Old Share – New Share
Reason for calculation of sacrificing ratio:
The new partner is required to compensate the old partners for their loss of share in
the super profits of the firm. To compensates the sacrificing partners; the incoming
partner brings in an additional amount known as premium or goodwill. This amount
is shared by the old partners in the ratio in which they sacrifice their in favour of the
new partner. Thus sacrificing ratio is calculated to share goodwill.

Calculation of new ratio and sacrificing ratio in different situations

Case-1 When new partner acquires his share from the old partners in their old ratio
(when the new share of the incoming partner is given without mentioning the details of
sacrifice made by the old partners)
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Case-2 When the new partner acquires his share of profit in any other agreed ratio
from the old partners (When the new share of the incoming partner and how he acquires the
share from the old partners are given)

Case-3 when old ratio of the old partners and the new ratio of all the partners are
given.

Case-4 when old partners surrendered a part of their share in favour of the new
partner.

Case-5 when new partner’s share and new profit sharing ratio between old partners are
given

Case-1 When new partner acquires his share from the old partners in their
old ratio (when the new share of the incoming partner is given without mentioning the
details of sacrifice made by the old partners)

Note: In this case sacrificing ratio is same as old ratio-the reason is that in this case, the
incoming partner acquires his share from old partners in their old ratio. So old partner’s
sacrifice for the new partner is same as their old ratio.

Calculation of New share:

Total Share of all partners (100%) = 1/1 or 1.On admission old partners admit a person as a
partner by giving a portion of share in the business.

So remaining share for old partners = Total share i.e 1 –New Partner’s Share

New Share of old partner’s = Remaining Share x Old Share

Q. Anil and Sunil are partners sharing profits and losses in the ratio of 3:2.They admits
Mahesh for ¼ shares. Calculate new ratio and sacrificing ratio.

Sacrificing ratio = Old share – New share

Old ratio of Anil and Sunil =3:2

Mahesh Share = 1/4

Remaining portion = 1 – 1/4 =3/4 (1/1 – 1/4 or 4/4 – 1/4)

This 3/4 portion is remaining for Anil and Sunil.It is to be shared by Anil and Sunil in their
old ratio.Hence there new share will be

Anil’s new share = Remaining portion X Anil’s old ratio

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= 3/4 X 3/5 =9/20

3/5 – 9/20, to deduct it,
Sunil’s new share=Remaining portion X Mohan’s old ratio we want to equalize the
denominators (here we
=3/4 X2/5 =6/20 want to change the
denominator 5 to 20).For
Mahesh share= 1/4 or 5/20 this we required to
multiply numerator and
The new ratio between Anil,Sunil and Mahesh = 9/20:6/20:5/20
denominator with 4 ie 3/5
Sacrificing Ratio = Old Share – New Share *4 or 3 * 4 and 5* 4.Then
we will get 12/20.It is the
Anil’s Sacrifice =Anil’s old share – Anil’s New Share easiest way. There are
other ways like cross
= 3/5 -9/20 or 12/20-9/20 =3/20 multiplication, calculate
L.C.M etc.
Sunil’s Sacrifice = Sunil’s Old Share – Sunil’s New Share

=2/5 – 6/20 or 8/20 – 6/20 =2/20

Sacrificing ratio of Anil and Sunil = 3/20:2/20 or 3:2

In this case sacrificing ratio is same as old ratio.

Note: When the new share of the incoming partner is given without mentioning the details of
sacrifice made by the old partners, in such a case it is assumed that the old partners make
their sacrifice in the old profit sharing ratio. In this case sacrificing ratio is same as old ratio.
So in this case, students should not waste their time in calculating sacrificing ratio.

Q. P and Q are partners sharing profit and losses in the ratio of 1:1.They admits R for a third
share. Calculate new ratio and sacrificing ratio?

Here,P & Q decided to admit R as a new partner by giving a third share.i.e,1/3 .There is no
further explanation about the new ratio of old partners.

So new profit sharing ratio will be 1:1:1

In this case, as the relative ratio between the old partners is not changed, the old ratio and
sacrificing ratio of the old partners are the same, i.e 1:1. So in this case, students should not
waste their time in calculating sacrificing ratio.

No need for calculoation, only to prove it:-

Old ratio of P & Q=1:1

New ratio of P, Q & R = 1:1:1

Sacrificing Ratio = Old Share – New Share

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P’s Sacrifice = 1/2 - 1/3 or 3/6 – 2/6 =1/6

Q’s Sacrifice =1/2 – 1/3 or 3/6 – 2/6 =1/6

Sacrificing ratio =1:1

Q. X and Y are partners sharing profits in the ratio of 3:2.They admits Z for a sixth (1/6)
share. The new ratio and sacrificing ratio are as follows. Calculate new ratio and sacrificing
ratio.

Here, we can easily calculate new ratio as-3:2:1

In this case, as the relative ratio between the old partners is not changed, the old ratio and
sacrificing ratio of the old partners are the same, i.e 3:2

Case-2 When the new partner acquires his share of profit in any other
agreed ratio from the old partners (When the new share of the incoming partner and
how he acquires the share from the old partners are given)
In this case also, there is no need to calculate sacrificing ratio, which is already mentioned
in the question itself.

Q. A & B are partners sharing profit and losses in the ratio of 4:3. They admit C into
partnership for 2/7 share, which acquires equally (2/7 * 1/2= 2/14 or 1/7) from A &
B.Calculate new ratio and sacrificing ratio.

Old ratio of A & B =4:3

C’s Share=2/7 which he acquires equally, i.e 1/7 from A and 1/7 from B.

So A’s new share = A’s old share – A’s share acquired by C

=4/7 – 1/7 =3/7

B’s new share = B’s old share – B’s share acquired by C

=3/7 – 1/7 =2/7

C’s share =2/7

So new ratio of A,B and C=3:2:2

Sacrificing ratio of A & B (In this problem C acquires his share 2/7 equally from A & B,so
there sacrifice is 1:1)

Sacrificing Ratio = Old Share – New Share

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A’s Sacrifice = A’s old share- A’s new share

=4/7 -3/7= 1/7

B’s Sacrifice = B’s old share- B’s new share

=3/7 -2/7 = 1/7

Sacrificing ratio of A & B = 1:1

Q. Arun & Varun are partners sharing profit and losses in the ratio of 7:5. They admit Tharun
into partnership for 1/6 share, which he acquires 1/24 from Arun and 1/8 from Varun.Find
out the new ratio and sacrificing ratio.

Old ratio of Arun and Tharun =7:5

Tharun’s share = 1/6 which he acquires 1/24 from Arun and 1/8 from Tharun

Arun’s new share = 7/12 – 1/24 or 14/24 -1/24 =13/24

Varun’s new share =5/12 – 1/8 or 10/24 -3/24 =7/24

Tharun’s share = 1/6 or4/24

New ratio of Arun,Varun and Tharun =13:7:4

Sacrificing ratio of Arun and Varun

Sacrificing Ratio = Old Share – New Share

Arun’s sacrifice = 7/12 – 13/24 or 14/12 -13/24 =1/24

Varun’s sacrifice =5/12 -7/24 or 10/24 – 7/24 = 3/24

Sacrificing ratio =1:3

Q.A &B are partners in a firm sharing profits and losses in the ratio of 4:1.C is admitted into
the partnership with ¼ shares in profits which he acquires wholly from A. Calculate the new
profit sharing ratio of partners and sacrificing ratio of A & B.

Old ratio of A & B =4:1

C’s share = ¼ which he acquires wholly from A

So A’s new share = A’s old share – A’s share acquired by C

=4/5 – 1/4 or 16/20 – 5/20 = 11/20

B,s new share =1/5 or 4/20 (No change)

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C’s share =1/4 or 5/20

New ratio of A,B and C = 11:4:5

Sacrificing Ratio = Old Share – New Share

A’s sacrifice =4/5 – 11/20 or 16/20 -11/20 =5/20

B’s sacrifice = 1/5 -4/20 or 4/20-4/20 = 0

In this case A made the complete sacrifice. Ratio is 5/20:0/20 or 5:0

Case-3 When old ratio of the old partners and the new ratio of all the
partners are given.
Sacrificing Ratio = Old Share – New Share

Q. P and Q are partners in a firm sharing profits in the ratio of 5:3.They admits R as a new
partner for 1/7 share in profit. The new profit sharing ratio will be 4:2:1.Calculate the
sacrificing ratio of P and Q.

Old ratio of P and Q = 5:3

New ratio of P, Q and R =4:2:1

Sacrificing Ratio = Old Share – New Share

Sacrificing ratio of P = 5/8 -4/7 or 35/56 -32/56 =3/56

Sacrificing ratio of Q = 3/8 – 2/7 or 21/56 – 16/56 =5/56

Sacrificing ratio of P and Q = 3:5

Q.Arjun and Karnan are partners in a firm sharing profits in the ratio of 4:3.They admitted
Soman as a new partner.The profit sharing ratio of Arjun,Karnan and Mohan will be 2:3:1.
Calculate sacrificing ratio.

Old ratio of Arjun and Karnan = 4:3

New ratio of Arjun,Karnan and Soman = 2:3:1

Sacrificing Ratio = Old Share – New Share

Arjun’s sacrifice = 4/7 – 2/6 or 24/42 – 14/42 = 10/42

Karnan’s sacrifice = 3/7 – 3/6 or 18/42 – 21/42 = (-) 3/42 (Gain)

Mahesh share = 1/6 or 7/42

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Arjun’s sacrifice = Karnan’s gain + Mahesh’s gain

= 3/42 + 7/42 =10/42

In this case all sacrifice is made by Arjun.

Case -4 when old partners surrender a part of their share in favour of the
new partner.
In this case, it is necessary to find out new ratio and sacrificing ratio. Here old partners
surrender a portion of their share in favour of the new partner. Surrendered portion of each
partner is ascertained by multiplying their old share with ratio of their sacrifice. The new
profit sharing ratio of existing partner’s is determined by deducting sacrificed portion from
old share.

Surrendered portion = Old Share x Ratio of sacrifice

Old Partner’s new share = Old Share - Surrendered portion

Sacrificing Ratio = Old Share – New Share

Q. A and B are partners sharing profits equally. They took C into partnership. A surrendered
1/3 of his share and B surrendered ¼ of his share in favour of C.Calculate new profit sharing
ratio and sacrificing ratio.

Old ratio of A & B = 1:1

A surrendered 1/3 of his share in favour of C,i.e, 1/2 X 1/3 =1/6

So A’s new share = Old share – Surrendered portion

=1/2 - 1/6 or 3/6 – 1/6 = 2/6

B surrendered 1/4 of his share in favour of C,i.e, 1/2 X 1/4 = 1/8

So, B’s new share = 1/2 -1/8 or 4/8 -1/8 = 3/8

C’s share = Surrendered portion of A + surrendered portion of B

= 1/6 + 1/8 or 8/48 +6/48 = 14/48

A’s new share=2/6 or 16/48, B’s new share=3/8 or 18/48, C’s share =14/48

New ratio of A,B and C =16:18:14 or 8:9:7

Sacrificing Ratio = Old Share – New Share

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A’s sacrifice = 1/2 – 8/24 or 12/24 -8/24 = 4/24

B’s sacrifice = 1/2 -9/24 or 12/24 -9/24 =3/24

Sacrificing ratio = 4:3

Case-5 when new partner’s share and new profit sharing ratio between old
partners are given
In this case also, it is necessary to find out new ratio and sacrificing ratio. In this case incoming
partners share directly given. Old partner’s old ratio and their proportionate new ratio are
referred here.

1. Find out remaining portion (1 – New partner’s share)

2. Calculate new ratio of old partners = Remaining portion x New proportionate ratio between
old partners.

3. Find out the new ratio of all partners

4. Calculate Sacrificing Ratio = New Share – Old Share

Q.Veeran and Velu are partners in a firm sharing profits and losses in the ratio of 3:2.They
admitted Vijay as a new partner for 1/4 share. The new profit sharing ratio between Veeran
and Velu will be 2:1.Calculate new profit sharing ratio and sacrificing ratio.

Old ratio of Veeran and Velu = 3:2

Whole (full) share for all partners = 1/1 i.e 100%

Vijay’s share =1/4

Remaining portion =1-1/4 =3/4

New profit sharing ratio between Veeran and Velu = 2:1

New ratio of Veeran = Remaing portion X new ratio of Veeran

= 3/4 X 2/3 = 6/12

New ratio of Velu = 3/4 X 1/3 = 3/12

Vijay’s share = 1/4 or 3/12

So New ratio of Veeran,Velu and Vijay =6:3:3 or 2:1:1

Sacrificing Ratio = Old Share – New Share

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Veeran’s sacrifice = 3/5 – 2/4 or 12/20 – 10/20 = 2/20

Velu’s sacrifice = 2/5 – 1/4 or 8/20 – 5/20 =3/20

Sacrificing ratio of Veeran and Velu =2:3

Goodwill
Goodwill the value of reputation of a firm in respect of the profits expected in future over
and above the normal profits earned by other similar firms belonging to the same industry.
Such excess of future profit over the normal profit is known as super profit.Thus, goodwill
exists only when the firm earns super profit. Goodwill is shown as fixed asset of the business
because it increases profit earning capacity of the business.

In simple words, goodwill can be defined as” the present value of a firm’s anticipated excess
earnings”.

Nature of Goodwill
 It is an intangible asset
 A firm that earns only normal profit or is incurring lossess has no goodwill
 Sometimes Goodwill has more value than the tangible asset

Factors affecting the value of goodwill

The main factors that affect the value of goodwill of a firm are the following:

1. Favorable location – If the business is centrally located, it will attract more

customers. It increases the profitability and also the value of goodwill.
2. Nature of business – A firm that produces high value added products or dealing
goods having stable demand is able to earn more profits and therefore has more
goodwill.
3. Efficiency of management – A well managed concern enjoys the advantages of high
productivity and profitability. Hence; its goodwill will be more.
4. Market situation – The monopoly condition or limited competition enables the
business to earn more profits and so the value of goodwill will be high.
5. Special advantages – A firm which enjoys special advantages like import licencing,
low rate and assured supply of electricity, trade mark, well known collaborations,
patents etc. enjoy higher value of goodwill.
6. Time Factor – A business concern running profitably for a long period will have
more goodwill.

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Need for valuation of Goodwill

Normally, the need for valuation of goodwill arises at the time of sale of a business. But in
case of partnership need for valuation of goodwill may arise when there is reconstitution
takes place. Thus, in partnership, the need for valuation of goodwill arises in the following
circumstances:

1. When there is a change in profit sharing ratio (Some partners may gain and others
may sacrifice)
2. At the time of admission of a partner
3. At the time of retirement or death of a partner
4. When two or more firms amalgamate

Classification of goodwill
Goodwill can be classified as (1) Purchased Goodwill (2) Self Generated Goodwill

1. Purchased Goodwill
Purchased goodwill is that goodwill which is acquired from others through made
payment. For Example, when a business is purchased, the excess of purchased
consideration of it net assets (Assets – Liabilities) is the purchased goodwill.

Features of Purchased Goodwill

1. It arises on purchase of a business or for purchase of a brand

2. Since the purchase consideration is paid for, it should be recorded in the books of
accounts
3. It is shown in the balance sheet as an asset.
2. Self -Generated Goodwill
It is an internally generated goodwill which arises from a number of attributes like
efficiency of management, location, special advantages like patents etc.

Features of self generated goodwill

1. It is generated internally generally over the years.

2. It is not recorded in the books of accounts if AS-10 is followed
3. Valuation depends on the subjective judgment of the valuer

Methods of Valuation of Goodwill

Since goodwill is an intangible asset it is very difficult accurately calculate its value. Various
methods have been advocated for the valuation of goodwill of a partnership firm. The
important methods for valuation of goodwill are as follows:

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A. Average Profit Method

B. Super Profit Method
C. Capitalisation Method

I. Average profit method

Under this method, the goodwill is valued at agreed number of year’s purchase of the average
profit of the past few years.
Steps to be followed:

Step -1 Calculate normal past business profits for each year by deducting abnormal gain and
adding abnormal losses.

Step -2 Sums up the normal profit calculated above

Step-3 Calculate Average profit = Total Profit / Number of Years

Step-4 Calculate Goodwill

Goodwill = Average profit X Agreed number of years purchase

Q. Calculate the value of goodwill on the basis of three year’s purchase of the average profits
based on the last 5 years. The profits of the last five years were as follows:

2014 40000

2015 60000
If any loss, it should be
2016 30000 deducted

2017 50000

2018 28000

Ans:

Total Normal Profit = 40000+60000+30000+50000+28000 =2,08,000

Average Profit = Total normal profit / Number of years

=2,08,000 / 5 =41,600

Goodwill = Three year’s purchase of average profit of last 5 years

=41,600 X 3 =1,24,800

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Q.The following were the profits/loss of a firm for the last six years

Year Profit (Rs.)

2012 250000 (Including abnormal gain Rs.30000)

2013 200000 (After charging abnormal loss of Rs.40000)

2014 325000 (Excluding Rs.20000 payable on the insurance of Plant)

2015 100000 (Including profit on sale of land Rs.70000)

2016 80000

2017 (- )60000 (Loss)

Calculate the value of firm’s goodwill on the basis of two years purchase of average profit
for the last 6 years.

Ans:Calculate average maintainable profit

Year Profit

2012(2, 50,000 – 30,000) 2, 20,000

2013 (2,00,000 + 40,000) 2,40,000

2014 (3,25,000 – 20,000) 3,05,000

2015 (1,00,000 – 70,000) 30,000

2016 80,000

2017 (-) 60,000

Total 8, 15,000

Average Profit = Total normal profit / Number of years

= 8,15,000 / 6 =135833

Goodwill = Two year’s purchase of average profit of last 6 years

= 135833 X 2 =271666

Average profit method-important assumptions

a) This method is based on the assumption that a new business will not be able to earn
any profit during the first few years of its operations. Hence, a person who purchases

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the share of a running business must pay in the form of goodwill a sum which is equal
to the profits he is likely to receive for the first few years.
b) In this method calculation of goodwill is based on the assumption that no change in
the overall situation of profit is expected in the future.

II. Weighted average profit method

Calculation of goodwill in the case of average profit method is based on the
assumption that there is no change in the profit expected in the future. If we expect a
decreasing or increasing trend, it is better to give a higher weight age to the profits in
the recent years and less waightage to profits of earlier years. Hence we calculate
goodwill based on specific weights like 1,2,3,4 and so on for respective year’s profit.

Steps to be followed

Step-1 Write up the profits of the last years and assigning weights

Step-2 Multiply each year’s profit by its weight to find out product

Step-3 Find out some of products and weights

Step-4 Divide the total of products by total of weights to find out the weighted average
profit

Step-5 Calculate goodwill by multiplying the weighted average profits with agreed
number of years purchase.

Q.The profits of a firm for the last 4 years ending 31st March were as follows

Year 2014 2015 2016 2017 2018

Profit 14000 18000 22000 38000 50000

Calculate the value of goodwill on the basis of two years purchase of weighted average
profits. The appropriate weights for the last 5years were 1,2,3,4 and5 respectively.

Ans:

Year Profit Weight Product

2014 14000 1 14000
2015 18000 2 36000
2016 22000 3 66000
2017 38000 4 152000
2018 50000 5 250000
15 518000

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Weighted average profit = Sum of product / sum of weights

= 518000 / 15 =34533.33

Value of goodwill = Weighted average profit X agreed number of years

= 34533.33 X 2 = 69066.66

Goodwill = 69067

III. Super profit Method

This method is based on the concept of superprofit.Super profit is the excess of actual
profit over normal profit. Normally every business firm earns profit; because earning
profit is the ultimate aim of every business. But due to favourable conditions some
business earned superprofit.Under this method goodwill is valued multiplying the
super profit with the decided number of years.

Steps to be followed:

Step-1 Calculate the actual average profit

Step -2 Ascertain the Normal Profit
Normal profit = Capital employed X Normal Rate of Return / 100
Step -3 Ascertain super profits
Super Profit = Actual Average Profit – Normal Profit
Step -4 Calculate Goodwill
Goodwill = Super profit X Agreed number of years purchase

Q.Calculate goodwill if it is to be calculated at three year’s purchase of the super profit.The

firm started business with capital of Rs.2,00,000.The normal rate of earning in this class of
business is 15%.The firm earned Rs.37000 as profit during the year.

Ans:

Actual Profit = 37000

Normal Profit = Capital employed X Normal Rate of Return / 100

= 200000 X 15/100 = 30,000

Super profit = 37000 – 30000 = 7000

Goodwill = Super profit X Agreed number of year’s

= 7000 X 3 = 21000

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Q. The books of a firm showed that the capital employed on 31/12/2018 ,Rs.6,00,000 and
the profit for the last 5 years were:2014- Rs.50,000, 2015 – Rs.70,000, 2016 – Rs. 88,000,
2017 – Rs.95,000, 2018 – Rs.1,00,000. You are required to find out the value of goodwill
based on 4 years purchase of the super profits of the business, the normal rate of return is
10%.

Actual Average Profit = 50000+70000+88000+95000+100000 / 5

=4,03,000 / 5 =80,600

Normal Profit = Capital employed X Normal Rate of Return/ 100

= 6,00,000 X 10/100 = 60,000

Super profit = 80,600 – 60,000 = 20,600

Goodwill = Super profit X Agreed number of year’s

= 20,600 X 4 = 82,400

IV. Capitalisation Methods

Under this method the goodwill can be calculated in two ways: (a) Capitalisation of
average profit method (b) Capitalisation of super profits

IV (A). Capitalisation of average profit method

Under this method the value of goodwill is ascertained by deducting net tangible
assets (capital employed) from the capitalized value of average profits. This method involves
the following steps.
Steps to be followed- Capitalisation of average profit method

Step-1 Ascertain average profits based on the past few years

Step-2 Ascertain the capitalized value of average profit

Average profit X100 / Normal rate of return

Step-3 Ascertain Net Assets by deducting outside liabilities from the total value of assets
(excluding goodwill)

Step-4 Compute the value of goodwill by subtracting Net Assets from the capitalized value of
average profits

Goodwill = Capitalised value of average profit – Net Assets

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Q. A business has earned average profits of Rs.1, 00,000 during the last few years and the
normal rate of return in a similar business is 10%. Ascertain the value of goodwill by
capitalization of average profits method, given that the value of net assets of the business is
Rs.8,00,000.

Average profit = 100000

Normal Rate of Return (NRR) =10%

Capitalised value of average profit = 100000 X 100 /10 =10,00,000

Net Assets = 800000

Goodwill = Capitalised value of average profit – Net Assets

=10,00,000 – 8,00,000 = 2,00,000

Q.A business has earned an average profit of Rs.90, 000 during the last few years and the
Normal Rate of Return in similar type of business is 9 %.Find out the value of goodwill by
capitalization method assuming that the firm owns total assets worth Rs.8,30,000 including
therein a goodwill of Rs.40,000 and outside liabilities worth Rs.1,00,000.

Average profit = 90,000

Normal Rate of Return (NRR) =9%

Capitalised value of average profit = 90,000 X 100 /9 =10, 00,000

Net Assets = (Total Assets – Goodwill) – Outside Liabilities

= (8, 30,000 – 40,000) – 1, 00,000 = 6, 90,000

Goodwill = Capitalised value of average profit – Net Assets

=10, 00,000 - 6, 90,000 = 3, 10,000

IV (B). Capitalisation of super profit method

In this method goodwill is ascertained by capitalizing the super profit directly. Under this
method there is no need to work out the capitalized value of average profits. This method
involves the following steps.

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Steps to be followed- capitalization of super profit method

Step-1 Calculate the total capital employed

Capital employed = Total assets expect goodwill – outside liabilities

Step-2 Calculate normal profit on capital employed

Normal Profit = Capital employed X Normal Rate of Return / 100

Step -3 Calculate the actual average profit ( as specified)

Step-4 Calculate super profit

Super profit = Actual profit – Normal Profit

Step-5 Calculate Goodwill (Goodwill is the capitalized value of superprofit)

Q.A business has earned an average profit of Rs.90, 000 during the last few years and the
Normal
Goodwill Rate of Return
= Super in Xsimilar
profit type of business
100 / Normal is 9 %.Find out the value of goodwill by
Rate of Return
capitalization of super profit method assuming that the firm owns total assets worth Rs.8,
30,000 including therein a goodwill of Rs.40, 000 and outside liabilities worth Rs.1, 00,000.

Capital employed = Total Assets except goodwill – Outside Liabilities

= (8, 30,000 – 40,000) – 1, 00,000 = 6, 90,000

Normal Profit = Capital employed X Normal Rate of Return / 100

= 6, 90,000 X 9/100 = 62,100

Actual profit = 90,000

Super profit = Actual profit – Normal Profit

=90,000 – 62,100 = 27,900

Goodwill = Super profit X 100 / Normal Rate of Return

=27,900 X100/9 = 3,10,000

Q. The following relate to the profit made by a firm for last 4 years

Year 2014 2015 2016 2017

Profit 30000 50000 70000 80000

The capital employed by the firm is Rs.6, 00,000 and the normal rate of return is 8 %.
Calculate the goodwill of firm under capitalization of super profit method.

Capital employed = 6, 00,000

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Normal Profit = Capital employed X Normal Rate of Return / 100

= 6, 00,000 X 8/100 = 48,000

Actual average profit = (30000 +50000+70000+80000) / 4 =2, 30,000 / 4 =57500

Super profit = Actual profit – Normal Profit

=57,500 – 48,000 = 9,500

Goodwill = Super profit X 100 / Normal Rate of Return

=9,500 X100 / 8 = 1,18,750

Treatment of Goodwill
On admission, the incoming partner who acquires his share of profit from the existing
partners has to bring in some additional amount to compensate them for the loss of their
share in super profits. It is termed as his share of goodwill or premium.This premium amount
is shared by old partners in the ratio in which they make their sacrifice. From the accounting
point of view, there may be different situations related to treatment of goodwill and these are:

Treatment of goodwill-Various cases

Case-1 When the goodwill (premium) is paid privately (i.e., outside the business) by the
new partner to the old partners, no entry is recorded in the books of account.

Case-2 When the new partner brings in his share of goodwill in cash and the same
retained in the business

Case-3 When the new partner brings in his share of goodwill in cash and the same fully
or partly withdrawn by old partners.

Case -4 when the new partner brings his share of goodwill in kind (in the form of assets)

Case-5 When the new partner is unable to bring in his share of goodwill in cash or kind

Case-6 When new partner brings in only a portion of the goodwill in cash

Case-7 Goodwill appearing in the book at the time of admission

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Treatment of Goodwill
Case-1 When the goodwill (premium) is paid privately (i.e., outside the business) by the
new partner to the old partners

Sometimes, the new partner brings in his share of goodwill in cash and the same is paid to
the old partners privately,i.e.,outside the business. In such a case no entry is made in the
books of account of the firm.

Case-2 When the new partner brings in his share of goodwill in cash and the same
retained in the business

Journal Entry -1 When cash brought in as goodwill

Cash A/C Dr

To Premium

(Cash brought in by the new partner as goodwill)

Journal entry -2 when goodwill distributed among old partners

Premium A/C Dr

To Old partner’s capital A/C (sacrificing ratio)

(Goodwill distributed among old partners)

Note: Alternatively, the cash premium brought in by the new partner may be directly credited
to old partner’s capital account. If so, instead of two journal entries (1) and (2) in the above
two cases, a single journal entry would sufficient (Cancel premium debit and credit balance)

Single Journal entry when the new partner brings in his share of goodwill in cash and the
same retained in the business

Cash A/C Dr

To old partners capital A/C (Sacrificing ratio)

(Cash brought in by the new partner as goodwill)

Q.A and B are partners sharing profits and losses in the ratio of 5:3.They admitted C as a
new partner 1/4 share in the profits. C brought in Rs.30, 000 for 1/4 share in the profits as
premium for goodwill. Record necessary journal entries in the book of the firm on C’s
admission.

Note: In this case sacrificing ratio will be same as old ratio, i.e, 5:3
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C’s share of goodwill for 1/4 share = 30,000

Single journal entry:

Cash A/C Dr 30000

To A’s Capital A/C 18750

To B’s Capital A/C 11250

(Cash brought in by C as goodwill and the transferred to old partners capital account

In their sacrificing ratio)

Case-3 When the new partner brings in his share of goodwill in cash and the same fully
or partly withdrawn by the old partners.

The following journal entries are passed in the books:

(a) When cash brought in as goodwill

Cash A/C Dr

To old partners capital A/C

(Cash brought in by the new partner as goodwill)

(b) When goodwill amount withdrawn by old partners from business

Old partners’ capital A/C Dr

To Cash

(The amount of goodwill withdrawn by old partners)

Q.Santhosh and Antony are partners in a firm.They sharing profit and losses in the ratio of
5:3.They admits Biju into partnership who pays Rs.50, 000 for his capital and 18,000 as his
share of goodwill. Half of the goodwill is withdrawn by the partners. They agree to share
profit and losses in the ratio of 4:2:1.

Ans:New partner’s share of goodwill should be shared by old partners in their sacrificing
ratio. So here,we want to calculate sacrificing ratio (S.R)

Sacrificing ratio = Old ratio - New ratio

Old ratio of Santhosh and Antony =5 :3

New ratio of Santhosh, Antony and Biju = 4:2:1

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Santhosh’s Sacrifice = 5/8 - 4/7 or 35/56 – 32/56 =3/56

Antony’s Sacrifice = 3/8 - 2/7 or 21/56 -16/56 =5/56 .Sacrificing Ratio = 3:5

Biju’s share of goodwill =18,000

Journal entry to record capital :

Cash A/C Dr 50000

To Biju’s Capital 50000

(Being cash brought in as capital)

Journal entry when cash brought in as goodwill

Cash A/C Dr 18000

To Santhosh’s capital A/C 6750

To Antony’s capital A/C 11250

(Being goodwill brought in by Biju credited to old partner’s capital account in their S.R)

Journal entry when goodwill (here half) withdrawn by old partners

Snathsh’s capital A/C Dr(9000 X3/8) 3375

Anton’s capital A/C Dr(9000 X 5/8) 5625

To Cash A/C 9000

(Being half of the goodwill withdrawn by old partners in their S.R)

Case -4 when the new partner brings his share of goodwill in kind (in the form of assets)

In this case, the new partner brings his share of goodwill and capital in the form of assets,
instead of cash.The assets brought in by the new partner will be debited. Credit is given for
his share of goodwill and his capital account. Afterwards, premium is transferred to the
capital accounts of the old partners in the sacrificing ratio.

Journal entry-1 when capital and goodwill are brought in the form of assets.

Assets (Individually) A/C Dr.

To new partner’s capital account (new partner’s capital portion)

To Premium A/C (New partner’s share of goodwill)

(Being assets brought in by the new partner towards his capital and goodwill)
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Journal Entry-2 When share of premium distributed among old partners

Premium A/C Dr.

To Old partner’s capital A/C (Individually, in sacrificing ratio)

(Being premium amount transferred to old partner’s capital A/C in their S.R)

Q. A and B are partners in a firm sharing profits in the ratio of 3:2.On April 1, 2018, they
admit C as a new partner for 1/6 share. The new ratio will be 3:2:1.C contributed the
following assets to his capital and his share of goodwill. Stock Rs.90,000,Debtors
Rs.1,10,000, Land Rs.2,00,000,P & M Rs.1,40,000.On the date of admission of C ,goodwill
of the firm was valued at Rs.3,36,000.Record necessary journal entries in the books of the
firm on C’s admission and prepare C’s capital account.

Ans: Old ratio of A and B =3:2

New ratio of A, B and C = 3:2:1

In this problem, the relative ratio between A and B do not change(i.e 3:2).So sacrificing ratio
of A and B will be same as their old share i.e 3:2.

A’s Sacrifice =3/5 – 3/6 or 18/30 – 15/30 = 3/30

B’s Sacrifice 2/5 - 2/6 or 12/30 - 10/30 = 2/30

Sacrificing ratio = 3:2

Goodwill of the firm = 3, 36,000

C’s share of goodwill = 3, 36,000 X 1/6 = 56,000

Journal entry-1 when capital and goodwill are brought in the form of assets.

Stock A/C Dr. 90,000

Debtors A/C Dr. 1,10,000

Land A/C Dr. 2,00,000

P & M A/C Dr. 1,40,000

To C’s capital 4,84,000 (5,40,000-56000)

(Total assets – share of goodwill)

To Premium 56,000

(Assets contributed by C as his share of capital and share of premium)

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Journal Entry-2 When share of premium distributed among old partners

Premium A/C Dr. 56,000

To A’s Capital A/C (56000 * 3/5) 33,600

To B’s Capital A/C (56000 *2/5) 22400

(Being premium amount transferred to old partner’s capital account in their S.R)

C’s Capital Account

Particulars Amount Particulars Amount

To balance c/d 4,84,000 By Sundry Assets 4,84,000

4,84,000 4,84,000
Case-5 When the new partner is unable to bring in his share of goodwill in cash or kind

If a new partner does not bring his share of goodwill in cash, the new partner’s capital
account is debited for his share of goodwill and the old partners / sacrificing partner’s Capital
Accounts are credited in their sacrificing ratio.Journal Entry:

New Partner’s Capital A/C Dr. (new partner’s share of goodwill)

To Sacrificing Partner’s Capital A/C (Sacrificing ratio)

(Being new partner’s share of goodwill adjusted by crediting old/ sacrificing artner’s
capital account in their S.R)

Q.P and Q are partners who share profits and losses in the ratio of 3:2.Their capitals were
Rs.4,00,000 and Rs.3,00,000 respectively.They agree to admit R into partnership from 1 st
January 2018,on the following terms in return for one third share in the future profits:

1. That R should bring in Rs.4, 00,000 as capital

2. That R is unable to bring in his share of goodwill in cash, the goodwill of the firm be
valued at Rs.1, 50,000.

Record necessary journal entries in the books of the firm.

Journal entry: When capital brought in

Cash A/C Dr. 4, 00,000

To R’s Capital Account 4,00,000

(Being capital brought in by C)

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Journal entry to adjust R’s share of goodwill

R’s Capital Account Dr. 50,000

To P’s Capital Account (50000 *3/5) 30,000

To Q’s Capital Account (50000 * 2/5) 20,000

(Being R’s share of goowill adjusted by crediting old partner’s capital account in their
S.R)

Note:

C’s share = 1/3

Goodwill of the firm = 1, 50,000

C’s share of goodwill = 1, 50,000 X 1/3 =50,000

In this problem sacrificing ratio is same as old ratio, i.e 3:2

Case-6 When new partner brings in only a portion of the goodwill in cash

Sometimes, the new partner may not be in a position to bring in full amount of his share of
goodwill in cash,new partner brings only a portion his share in cash.In such a case, premium
account will be credited for the amount of premium brought in cash by him.Then for the
remaining amount,new partner’s capital account will be debited.The effect is that his capital
account will get reduced.

Journal entry-1 For the amount of premium brought in cash

Cash A/C Dr.

To Premium A/C (Actual amount of goodwill brought in as cash)

Journal entry -2 For transferring the premium to old partner’s capital account.

Premium A/C Dr.(Goodwill brought in cash)

New Partner’s Capital A/C Dr.(New partners share of goodwill – Goodwill brought
in cash)

To Old Partner’s Capital A/C (new partners share of goodwill)

New partners share of goodwill shared by old partners in their S.R)

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Q. A and B are partners in a firm sharing profits in the ratio of 3:2.They admitted C as a new
partner for 1/5 share in the profits. C brought in Rs.2, 00,000 as his capital. His share of
goodwill was Rs.18,000.But he was in a position to bring only Rs.12,000.Record necessary
journal entries in the books of the firm.

Ans: Journal entry –1 For capital

Cash A/C Dr 2,00,000

To C’s Capital A/C 2,00,000

(Capital brought in by C)

Journal entry-2 when part of goodwill brought in as cash

Cash A/C Dr 12,000

To Premium A/C 12,000

(C brought a portion of his share of goodwill in cash)

Journal entry-3 when new partners share of premium transferred to old partner’s capital
account

Premium A/C Dr 12,000

C’s Capital A/C Dr 6,000

To A’s capital a/c 10,800

To B’s Capital a/c 7,200

(C’s share of goodwill transferred to old partner’s capital a/c in their S.R 3:2)

Case-7 Goodwill appearing in the book at the time of admission

There are two types of goodwill (1) Purchased Goodwill (2) Self generated goodwill.
Purchased goodwill is the goodwill that is acquired by making a payment. Self -generated
goodwill is internally generated goodwill which arises from a number of attributes like
efficiency of management, location, special advantages like patents etc.According to
Accounting Standard 10 (AS-10) goodwill should not be brought into books unless it is paid
for (purchased goodwill), and whenever it is recorded it should be written off over a period.

If goodwill appears in the Balance Sheet of a firm before the new partner is admitted,it would
be desirable to close the goodwill account by debiting the existing partner’s capital account
and crediting the goodwill account in their old profit sharing ratio.

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Journal Entry: To write off existing goodwill

Old Partners Capital A/C (old ratio)

To Goodwill Account (Value of goodwill recorded in the balance sheet)

(Being existing goodwill written off)

Q.P and Q are partners sharing profits and losses in the ratio of 5:3. On 1-1-2018 they admit
R as a new partner.The new profit sharing ratio will be 4:3:2. R brought Rs.1,00,000 as his
share of capital but could not bring any share of goodwill.The firm’s goodwill on R’s
admission was valued at Rs.2,80,000.At the time of R’s admission goodwill existed in the
books of the firm at Rs.1,80,000.Record necessary journal entries on R’s admission.

Ans:

Old ratio of P and Q = 5:3

New ratio of P, Q and R = 4:3:2

P’s sacrifice = 5/8 – 4/9 or 45/72 - 32/72 = 13/72

Q’s sacrifice =3/8 - 3/9 or 27/72 - 24/72 = 3/72

S.R = 13:3

R’s share of goodwill =goodwill of the firm X R’s share

=2,80,000 X 2/9 =62,222

Notes to remember:-

a. Existing goodwill should be written off

b. R is not able to bring his share of goodwill cash or kind.

c. Need to calculate S.R

Journal entry to record New partner’s capital

Cash A/C Dr. 1, 00,000

To R’s capital A/C 1, 00,000

(Capital brought in by R)

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Journal Entry: To write off existing goodwill

P’s capital A/C Dr 1, 12,500

Q’s Capital A/C Dr 67,500

To Goodwill 1,80,000

(Being existing goodwill written off)

Journal entry: Journal entry to adjust R’s share of goodwill

R’s capital A/C Dr 62222

To p’s capital (62222 *13/16) 50,555

To Q’s capital (62222 * 3/16) 11667

(R’s share of goodwill adjusted )

Hidden goodwill

Sometimes, the value of the goodwill is not mentioned in the question. This hidden goodwill
is calculated on the basis of net worth of the firm:

Step-(1) Calculate Net Worth (including goodwill) on the basis of capital contributed by the
new partner

Net worth (Total Capital) = New partner’s Capital x Reciprocal of new partner’s share

Step-(2) Calculate Net worth (excluding goodwill).It comprises capital balances of old partners
(adjusted) or old partners capital balances + Reserves + P & L A/C credit balance – P &l A/c
debit balance – deffered revenue expenditure + New partner’s Capital

Value of Goodwill Goodwill = (1) – (2)

Note:

Net worth = Sundry Assets – Outside Liabilities

OR

Net worth = Capitals of all partners + Accumulated profits and reserves – Accumulated losses

Q.P an Q are partners with capitals of Rs.5000 each.They admit R as a partner with ¼
th share in the profits of the firm.R brings Rs.8000 as his share of capital.The profit

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and loss Account showed a credit balance of Rs.4000 as on the date of admission of
R.Give necessary journal entry to record goodwill.

Ans:

Calculate net worth on the basis of R’s Capital = 8000 x 4/1 =32000

Calculate net worth on the basis of all partners’ capitals and accumulated
profits/losses =5000 + 5000 +8000 +4000

=22000

Value of goodwill = 32000 – 22000

= 10000(Goodwill of the firm)

R’s share ¼ and R’s share of goodwill = 10000 x ¼ =2500

Sacrificing ratio is same as old ratio, i.e, 1:1

Journal entry for goodwill:

R’s Capital A/C Dr 2500

To P’s Capital A/C 1250

To Q’s Capital A/C 1250

(Share of hidden goodwill of R adjusted among the capital accounts of P and Q

in their S.R)

4. Revaluation of assets and liabilities

At the time of admission of a partner, assets and liabilities of a firm must be
revalued. It is necessary because actual realizable value of assets and actual liabilities may
be different from their book values. The outcome of revaluation may be revaluation profit
or loss. Profit or loss arising on account of such revaluation up to the date of admission of a
new partner may be ascertained and adjusted in the old partners’ capital accounts in their
old profit sharing ratio since it belongs to the old partners and not to the new partner.
Effect of revaluation can be ascertained by preparing a revaluation account.

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Revaluation Account

Revaluation account is a nominal account prepared to bring the assets and liabilities of the
firm to their true (market) values and to find out profit or loss on revaluation of assets and
reassessment of liabilities. Revaluation account is credited with increase in the value of
assets, decrease in the amount of liabilities and unrecorded assets. Revaluation account is
debited with decrease in the value of assets, increase in the value of liabilities and
unrecorded liabilities. The balance of Revaluation account represents the profit or loss on
revaluation and is transferred to the old partners’ capital accounts in their old profit sharing
ratio.

Note: Revaluation account records only changes in values of assets and liabilities, not book
value or real value.

Revaluation Account

Particulars Amount Particulars Amount

To Assets Decrease (-) XXXX By Assets Increase (+) XXXX
To Liability Increase (+) XXXX By Liabilities Decrease (-) XXXX
To Unrecorded Liability (+) XXXX By Unrecorded Assets (+) XXXX
To Old partners ‘Capital Accounts XXXX By Old partners ‘Capital Accounts XXXX
(Profit, old ratio) (Loss, old ratio)

XXXX XXXX
Journal Entry –Revaluation of Assets and Liabilities

Particulars Journal Entry

Increase in the value of Assets Assets A/c Dr
To Revaluation A/C
Decrease in the value of Assets Revaluation A/C Dr
To Assets
Increase in the value of Liability Revaluation A/C Dr
To Liabilities
Decrease in the value of Liability Liabilities A/C Dr
Revaluation A/C
Un Recorded Assets Assets A/C Dr
To Revaluation

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Unrecorded Liabilities Revaluation A/C Dr

To Liabilities
For Distribution of Revaluation Profits Revaluation A/C Dr
To Old Partners’ Capital A/c
For Distribution of Revaluation Loss Old Partner’s Capital A/C Dr
To Revaluation

5. (A) Distribution of accumulated profits and losses

If, at the time of admission of a partner, any reserve or accumulated profits/losses

exists in the books of the firm, these should be transferred to old partners’ Capital accounts
(if capitals are fluctuating) or Current Accounts (If capitals are fixed) in their old profit
sharing ratio since the reserves, accumulated profits/losses up to the date of admission of a
new partner belong to the old partners and not to the new partner.

General Reserve A/C Dr

Profit & Loss A/C Dr

To Old Partners Capital A/C (Old ratio, individually)

(Accumulated profit transferred to old partners capital A/C in their old ratio)

5. (B) Distribution of Accumulated Losses

Old Partners’ Capital A/C Dr

To Profit & Loss A/C

(Accumulated Loss transferred to old partner’s capital A/C in their old ratio)

Adjustments of capitals
The capitals of the partners may be adjusted in any one of the following ways.

1. Adjusting the capitals of Old Partners on the on the basis of the Capitals of Incoming
Partner when the Total Capital of New Firm is not given

2. Determining the new partner’s capital on the basis of combined capital of Old
Partners’

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1. Adjusting the capitals of Old Partners on the on the basis of the Capitals of Incoming
Partner when the Total Capital of New Firm is not given

Adjusting the capitals of Old Partners ,when the Total Capital of New Firm is not given

Step-1 Calculate Total capital of the new firm on the basis of new partner’s capital

Total Capital = New partner’s Capital X Reciprocal of proportion of share of new partner

Step-2 Calculate new profit sharing ratio

Step-3 Calculate new capital of old partners on the basis of total capital and new profit sharing
ratio

New capital of all partners = Total Capital x New profit sharing ratio of each partner

Step-4 Calculate surplus/deficit of old partners’ capital account by comparing the new capital
with adjusted old capital

Step-5 Adjust the surplus by paying off or by transfer to the credit of his current account and
adjust the deficiency by asking the concerned partner to bring in the required amount or by
transfer to the debit of his current account.

Journal Entry (1) when adjusted old capital is less than the new capital

Cash/ Particular Partner’s Current A/C Dr

To Particular partner’s Capital A/C

(Being shortage brought in /adjusted by……)

Journal Entry (2) When Adjusted old capital is more than the new capital

Particular Partner’s Capital A/C Dr.

To Cash / Particular Partner’s Current A/C Dr

(Being excess amount withdrawn by……)

Note: In the absence of any contract, suplus/deficit should be adjusted in cash and not by
transfer to current account

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Example: Adjusting the capitals of Old Partners on the on the basis of the Capitals of
Incoming Partner when the Total Capital of New Firm is not given

P and Q are in partnership sharing profits and losses in the ratio of 3:2.The capitals of P and
Q remaining after adjustments are Rs.80,000 and Rs.60,000 respectively. They admit R as a
partner who contribute Rs.35,000 as capital for 1/5 share of profits to be acquired equally
from both P and Q.The capital accounts of old partners are to be adjusted on the basis of the
proportion R’s capital to his share in the business. Calculate the amount of actual cash to
be paid off or brought in by the old partners for the purpose and pass the necessary journal
entries.

Ans:

Calculation of new ratio

Old ratio of P and Q =3:2

R’s Share=1/5 which he acquires equally, i.e 1/10 from P and 1/10 from Q.

So P’s new share = P’s old share – P’s share acquired by R

=3/5 – 1/10 or 6/10 – 1/10 =5/10

Q’s new share = Q’s old share – Q’s share acquired by R

=2/5 – 1/10 or 4/10 – 1/10 =3/10

R’s share =1/5 or 2/10

So new ratio of P,Q and R=5/10: 3/10: 2/10 or 5:3:2

Total capital of the new firm on the basis of R’s capital = 35000 x 5/1 =1,75,000

New profit sharing ratio of P,Q and R =5:3:2

New capital of all partners’ = (175000) 5:3:2

P’s new capital = 175000 x 5/10 = 87500

Q’s new capital = 175000 x 3/10 =52500

R’s capital = 175000 x 2/10 =35000

Adjusted capital of P and Q = 80000 and 60000

Shortage of P’s capital = 87500 – 80000 = 7500

Surplus of Q = 60000 – 52500 = 7500

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Journal entry to record shortage brought in by P

Cash A/C Dr 7500

To P’s Capital A/C 7500

(Being shortage brought in by P)

Journal entry to surplus withdrawn by Q

Q’s Capital A/C Dr 7500

To Cash 7500

(Being the surplus capital withdrawn by Q)

2. Determining the new partner’s capital on the basis of combined capital of Old
Partners’

The various steps involved in the determination of capital of Old Partners are:

Step-1 Calculate the adjusted (after all adjustments have been made) old capital of old partners

Step-2 Calculate the total capital of the new firm on the basis of combined capital of old
partners

Total Capital = Combined adjusted old capital of old partners x Reciprocal proportion of share
of old partners in new firm

Step-3 Calculate new partner’s capital

New partners capital = Total capital x new partner’s share

Example : Determining the new partner’s capital on the basis of combined capital of Old
Partners’

Q.

P and Q are in partnership sharing profits and losses in the ratio of 3:2.The capitals of P and
Q remaining after adjustments are Rs.80,000 and Rs.60,000 respectively. They admit R as a
partner who has to contribute sufficient capital to acquire a 1/5th share of total capital of the
new firm equally from both the partners P and Q.Calculate the capital to be brought in by R.

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Ans:

Calculation of new ratio

Old ratio of P and Q =3:2

R’s Share=1/5 which he acquires equally, i.e 1/10 from P and 1/10 from Q.

So P’s new share = P’s old share – P’s share acquired by R

=3/5 – 1/10 or 6/10 – 1/10 =5/10

Q’s new share = Q’s old share – Q’s share acquired by R

=2/5 – 1/10 or 4/10 – 1/10 =3/10

R’s share =1/5 or 2/10

So new ratio of P, Q and R =5/10: 3/10: 2/10 or 5:3:2

Combined share of old partners P and Q = 5/10 +3/10 = 8/10

Total adjusted capital of P and Q = 80000 + 60000 = 140000 i.e,8/10 share of total capital

So total capital = 140000 x 10/8 = 175000

R’s capital = 175000 x 2/10 =35000

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Prepared By, BINOY GEORGE, HSST, MKNM HSS, Kumaramangalam, Thodupuzha, Idukki Dt.

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