1. Reconstitution and admission
Any change in the agreement among partners reconstitutes the firm: the old agreement ends and a new one begins, but the firm continues and its books are adjusted, not closed. Admission of a partner, a change in the profit-sharing ratio among existing partners, and retirement or death are all reconstitutions.
Under the Indian Partnership Act, 1932, a new partner can be admitted only with the consent of all existing partners, unless the deed provides otherwise. The newcomer acquires a share in the assets and a share in the future profits of the firm.
Matters settled on admission: new ratio; sacrificing (and any gaining) ratio; goodwill; revaluation; reserves and accumulated profits or losses; capitals and the new Balance Sheet.
Not in the ISC 2027 syllabus for this chapter: memorandum revaluation account, joint life and individual life policies, and admission of a partner during an accounting year.
Key terms
- Reconstitution
A change in the agreement among partners while the firm itself continues.
- Admission of a partner
Entry of a new partner into an existing firm with the consent of all existing partners.
2. New, sacrificing and gaining ratios
Sacrifice = old share − new share. A positive result is a sacrifice; a negative result is a gain.
| Terms of admission | How to compute |
|---|---|
| Share taken in the old ratio | New share = old share × (1 − newcomer's share); sacrificing ratio = old ratio |
| Fraction of his own share surrendered | Sacrifice = old share × fraction |
| Fraction of the firm given | Sacrifice = that fraction |
| New ratio stated | Old share − new share for each partner (an old partner may gain) |
Checks: new shares add up to 1; sacrifices minus any gains equal the newcomer's share.
| Terms of admission | Sacrifice of an old partner | New share of an old partner |
|---|---|---|
| Share taken in the old ratio | Old share × newcomer's share | Old share × (1 − newcomer's share) |
| Each surrenders a fraction of his own share | Old share × that fraction | Old share − sacrifice |
| Each gives a fraction of the firm | That fraction | Old share − that fraction |
| New ratio stated | Old share − new share (may be negative: a gain) | Read from the stated ratio |
| Partner (Pragati Pickles, imagined) | Old share | Working | New share |
|---|---|---|---|
| Sushant | 2/3 | 2/3 × 2/3 | 4/9 |
| Trupti | 1/3 | 1/3 × 2/3 | 2/9 |
| Udit | — | given | 1/3 = 3/9 |
| New ratio | 4 : 2 : 3 |
| Partner (Zoji Woollens, imagined) | Old share | New share | Old − new | Result |
|---|---|---|---|---|
| Amrita | 3/5 = 12/20 | 1/4 = 5/20 | 7/20 | Sacrifices |
| Bhuvan | 2/5 = 8/20 | 1/2 = 10/20 | −2/20 | Gains 1/10 |
| Cyrus | — | 1/4 = 5/20 | New partner |
Key terms
- Sacrificing ratio
Ratio in which the old partners give up their shares of profit.
- Gaining ratio
Ratio in which partners whose shares rise acquire their extra shares.
3. Goodwill on admission (Accounting Standard 26)
Premium for goodwill = firm's goodwill × newcomer's share, credited to the sacrificing partners in the sacrificing ratio. An old partner who gains pays for his gain in the same way. Accounting Standard 26 allows only purchased goodwill to be recorded, so no goodwill account is raised on admission.
- In cash: Bank A/c Dr. To Premium for Goodwill A/c; Premium for Goodwill A/c Dr. To sacrificing partners' Capital A/cs.
- Retained: no further entry.
- Withdrawn: sacrificing partners' Capital A/cs Dr. To Bank A/c.
- In kind: Asset A/c Dr. To Premium for Goodwill A/c and To newcomer's Capital A/c.
- Not brought (wholly or partly): newcomer's Current A/c (fixed capitals) or Capital A/c (fluctuating) Dr. To sacrificing partners' Current or Capital A/cs.
- Paid privately: no entry.
| Situation | Entry in the firm's books |
|---|---|
| Premium brought in cash | Bank A/c Dr. To Premium for Goodwill A/c; Premium for Goodwill A/c Dr. To sacrificing partners' Capital A/cs |
| Premium retained in the business | No further entry: it stays in the sacrificing partners' capitals |
| Premium withdrawn by the old partners | Sacrificing partners' Capital A/cs Dr. To Bank A/c |
| Premium brought in kind | Asset A/c Dr. To Premium for Goodwill A/c and To newcomer's Capital A/c |
| Premium not brought in cash | Newcomer's Current A/c (or Capital A/c) Dr. To sacrificing partners' Current (or Capital) A/cs |
| Premium paid privately | No entry |
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| (i) Bank A/c Dr. | 20,000 | |
| To Premium for Goodwill A/c | 20,000 | |
| (Being premium brought in cash by Cyrus) | ||
| (ii) Premium for Goodwill A/c Dr. | 20,000 | |
| Bhuvan's Capital A/c Dr. | 8,000 | |
| To Amrita's Capital A/c | 28,000 | |
| (Being Amrita compensated by Cyrus and by Bhuvan, who gains) |
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| Udit's Current A/c Dr. | 30,000 | |
| To Sushant's Current A/c | 20,000 | |
| To Trupti's Current A/c | 10,000 | |
| (Being Udit's share of goodwill adjusted through current accounts in the sacrificing ratio 2 : 1) |
Key terms
- Premium for goodwill
Amount the newcomer pays for his share of the firm's goodwill, to compensate the sacrificing partners.
- Purchased goodwill
Goodwill acquired for a consideration; the only goodwill that may be recorded under Accounting Standard 26.
4. Goodwill already in the books, and hidden goodwill
Goodwill already in the books belongs to the old firm: Old partners' Capital A/cs Dr. (old ratio) To Goodwill A/c.
Hidden goodwill, when no premium is stated:
- Implied total capital = newcomer's capital ÷ his share.
- Actual capital = old partners' capitals after all adjustments + newcomer's capital.
- Hidden goodwill = implied − actual.
- Newcomer's share = hidden goodwill × his share: Newcomer's Capital (or Current) A/c Dr. To sacrificing partners.
| Step (Yercaud Coffee Roasters, imagined) | Working | ₹ |
|---|---|---|
| Implied total capital | 75,000 ÷ 1/5 | 3,75,000 |
| Actual capital | 1,30,000 + 70,000 + 75,000 | 2,75,000 |
| Hidden goodwill | 3,75,000 − 2,75,000 | 1,00,000 |
| Nimisha's share | 1,00,000 × 1/5 | 20,000 |
| Credited 3 : 1 | Kartik 15,000, Malini 5,000 | 20,000 |
| Goodwill already in the books | Treatment | Entry |
|---|---|---|
| Any book balance of goodwill | Written off among the old partners in the old ratio | Old partners' Capital A/cs Dr. To Goodwill A/c |
| Then the newcomer's share | Premium or capital adjustment as usual | Sacrificing ratio |
Key terms
- Hidden goodwill
Goodwill not stated in the terms but inferred from the capital brought by the new partner.
- Write-off of goodwill
Removing a book balance of goodwill by debiting the old partners in the old ratio.
5. The Revaluation Account
The Revaluation Account (Profit and Loss Adjustment Account) records changes in values on admission.
- Debit: fall in assets, rise in liabilities, unrecorded liabilities, new provisions.
- Credit: rise in assets, fall in liabilities, unrecorded assets, provisions released.
- Balance: profit credited (or loss debited) to the old partners in the old ratio.
Typical entries: Revaluation A/c Dr. To Machinery A/c (fall); Building A/c Dr. To Revaluation A/c (rise); Revaluation A/c Dr. To old partners' Capital A/cs (profit).
| Debit side (losses) | Credit side (gains) |
|---|---|
| Fall in the value of an asset | Rise in the value of an asset |
| Rise in a liability | Fall in a liability |
| Unrecorded liability brought in | Unrecorded asset brought in |
| New or higher provision | Provision no longer needed |
| Balance: profit to old partners (old ratio) | Balance: loss to old partners (old ratio) |
| Dr. Particulars | ₹ | Cr. Particulars | ₹ |
|---|---|---|---|
| To Machinery A/c (depreciation) | 8,000 | By Building A/c (increase) | 25,000 |
| To Provision for Doubtful Debts A/c | 2,500 | ||
| To Outstanding Electricity Bill A/c | 1,500 | ||
| To Prabhat's Capital A/c (profit) | 7,800 | ||
| To Rohini's Capital A/c (profit) | 5,200 | ||
| Total | 25,000 | Total | 25,000 |
Key terms
- Revaluation Account
Nominal account recording gains and losses from revaluing assets and liabilities on reconstitution.
- Unrecorded asset or liability
An item missing from the books and brought in at the time of admission.
6. Reserves and accumulated profits or losses
If closed (the usual case), in the old ratio:
- General reserve, credit balance of profit and loss: Reserve A/c Dr. To old partners' Capital A/cs.
- Debit balance of profit and loss, deferred revenue expenditure (e.g. advertisement suspense): old partners' Capital A/cs Dr. To the account.
- Workmen compensation reserve: meets the claim first; the balance is credited; an excess claim is a revaluation loss.
- Investment fluctuation reserve: meets the fall in investments first; the balance is credited; an excess fall is a revaluation loss.
If kept in the books (single adjustment entry): net = reserves + credit balances − accumulated losses; Newcomer's Capital A/c Dr. (net × his share) To sacrificing partners' Capital A/cs (sacrificing ratio).
| Item in the old balance sheet | If closed (old partners, old ratio) | If kept in the books |
|---|---|---|
| General reserve, credit balance of profit and loss | Credited to old partners' capitals | Single entry: newcomer's Capital A/c Dr. (his share of the net) To sacrificing partners |
| Debit balance of profit and loss, deferred revenue expenditure | Debited to old partners' capitals | Reduces the net figure in the same single entry |
| Workmen compensation reserve | Claim first; balance credited (excess claim: revaluation loss) | — |
| Investment fluctuation reserve | Fall first; balance credited (excess fall: revaluation loss) | — |
| Dhauli Agarbatti Works (imagined) | Particulars | Dr (₹) | Cr (₹) |
|---|---|---|---|
| (a) Closed | General Reserve A/c Dr. | 36,000 | |
| To Tapan's Capital A/c / Usha's Capital A/c | 24,000 / 12,000 | ||
| Tapan's Capital A/c / Usha's Capital A/c Dr. | 4,000 / 2,000 | ||
| To Profit and Loss A/c | 6,000 | ||
| (b) Kept | Vikas's Capital A/c Dr. | 7,500 | |
| To Tapan's Capital A/c / Usha's Capital A/c | 5,000 / 2,500 |
Key terms
- Accumulated profits
Profits earned before admission and kept in the business as reserves or credit balances.
- Deferred revenue expenditure
Revenue expenditure carried forward on the assets side, such as advertisement suspense; a past loss of the old partners.
- Single adjustment entry
One entry charging the newcomer with his share of reserves kept in the books, in favour of the sacrificing partners.
7. Capitals and the new Balance Sheet (horizontal form)
Capital accounts are prepared in columnar form for all partners; closing balances go to the new Balance Sheet.
Old capitals on the basis of the newcomer's capital
- Total capital = newcomer's capital ÷ his share; required capital = total × each old partner's new share.
- Surplus: withdrawn (Capital A/c Dr. To Bank A/c) or credited to the current account; shortfall: brought in (Bank A/c Dr. To Capital A/c) or debited to the current account.
Newcomer's capital on the basis of the old capitals
- Total = old partners' adjusted capitals ÷ their combined new share; newcomer's capital = total × his share.
New Balance Sheet: horizontal form, liabilities and capitals on the left, assets on the right; revised values; reserves removed if closed; closing capitals and any current-account balances shown.
| Ooty Varkey Bakers (imagined) | Ajit | Bharati |
|---|---|---|
| New share | 1/3 | 1/3 |
| Required (2,40,000 × share) | 80,000 | 80,000 |
| Adjusted capital | 95,000 | 72,000 |
| Current account | Cr. 15,000 (surplus) | Dr. 8,000 (shortfall) |
| Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Creditors | 50,000 | Bank | 30,000 |
| General Reserve | 20,000 | Debtors | 50,000 |
| Prabhat's Capital | 1,50,000 | Stock | 60,000 |
| Rohini's Capital | 1,00,000 | Machinery | 80,000 |
| Building | 1,00,000 | ||
| Total | 3,20,000 | Total | 3,20,000 |
| Dr. Particulars | Prabhat (₹) | Rohini (₹) | Sanjana (₹) | Cr. Particulars | Prabhat (₹) | Rohini (₹) | Sanjana (₹) |
|---|---|---|---|---|---|---|---|
| By Balance b/d | 1,50,000 | 1,00,000 | |||||
| By Revaluation A/c (profit) | 7,800 | 5,200 | |||||
| By General Reserve A/c | 12,000 | 8,000 | |||||
| By Premium for Goodwill A/c | 18,000 | 12,000 | |||||
| To Balance c/d | 1,87,800 | 1,25,200 | 1,10,000 | By Bank A/c | 1,10,000 | ||
| Total | 1,87,800 | 1,25,200 | 1,10,000 | Total | 1,87,800 | 1,25,200 | 1,10,000 |
| Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Creditors | 50,000 | Bank | 1,70,000 |
| Outstanding Electricity Bill | 1,500 | Debtors 50,000 less provision 2,500 | 47,500 |
| Prabhat's Capital | 1,87,800 | Stock | 60,000 |
| Rohini's Capital | 1,25,200 | Machinery | 72,000 |
| Sanjana's Capital | 1,10,000 | Building | 1,25,000 |
| Total | 4,74,500 | Total | 4,74,500 |
Key terms
- Current account
A partner's account for adjustments other than fixed capital; used to settle surpluses and shortfalls without cash.
- Proportionate capital
Capital in the same proportion as the profit-sharing ratio.
8. Change in profit-sharing ratio among existing partners
No partner joins or leaves, but the firm is still reconstituted.
- Sacrifice or gain = old share − new share; gaining ratio = ratio of the gains.
- Goodwill: Gaining partner's Capital A/c Dr. To sacrificing partner's Capital A/c, with (old − new) × goodwill.
- Revaluation: profit or loss shared in the old ratio.
- Reserves closed: shared in the old ratio.
- Reserves kept: Gaining partner Dr. To sacrificing partner, with (old − new) × net reserves.
| Item | On a change in ratio (no partner joins) |
|---|---|
| Sacrifice / gain | Old share − new share: positive = sacrifice, negative = gain |
| Goodwill | Gaining partner's Capital A/c Dr. To sacrificing partner's Capital A/c |
| Revaluation | Profit or loss shared in the old ratio |
| Reserves closed | Shared in the old ratio |
| Reserves kept | Gainer Dr. To sacrificer, with (old − new) × net reserves |
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| (i) Gulnar's Capital A/c Dr. | 10,000 | |
| To Feroz's Capital A/c | 10,000 | |
| (Being goodwill adjusted: Gulnar, who gains 1/5, compensates Feroz) | ||
| (ii) Gulnar's Capital A/c Dr. | 3,000 | |
| To Feroz's Capital A/c | 3,000 | |
| (Being adjustment for the general reserve left in the books) | ||
| (iii) Revaluation A/c Dr. | 5,000 | |
| To Feroz's Capital A/c | 3,000 | |
| To Gulnar's Capital A/c | 2,000 | |
| (Being revaluation profit shared in the old ratio 3 : 2) |
Key terms
- Gaining partner
A partner whose share of profit increases on reconstitution; he compensates the sacrificing partner.
- Adjustment entry
An entry between partners' capital accounts that settles goodwill or reserves without opening new accounts.
Exam tips
Common mistakes
- Crediting the premium in the old ratio when the sacrificing ratio is different.
- Ignoring an old partner who gains under a stated new ratio.
- Multiplying when a partner gives a fraction of the firm, or subtracting when he surrenders a fraction of his own share.
- Giving the newcomer a share of revaluation profit or of reserves earned before he joined.
- Posting goodwill adjustments to fixed capital accounts instead of current accounts.
- Comparing capitals before all adjustments (revaluation, reserves, premium) are made.
- Drawing the Balance Sheet in vertical form; partnership reconstitution uses the horizontal form.
How marks are usually awarded (SOYL chapter tests on the ISC default pattern)
- 1 mark: objective items.
- 2 marks: a ratio calculation, or two or three entries with narrations.
- 3 marks: a Revaluation Account, a hidden-goodwill working with its entry, or a set of reserve entries.
- 5 marks in parts, e.g. (a) 2 + (b) 3: ratios and goodwill entries, or a Revaluation Account with capital accounts.
- Full practical (practice, 8 marks): Revaluation Account about 2, capital accounts about 3, Balance Sheet about 3; working notes earn step marks.
Figures in SOYL practice are imagined; your board paper will give its own.