The admission of a new partner into an existing firm is a significant event that changes the ownership and profit sharing arrangement of the business. A new partner is admitted when the firm needs additional capital, more managerial talent, or wider market access. Under the Indian Partnership Act, 1932, a new partner can be admitted only with the consent of all the existing partners, unless the partnership deed provides otherwise.
When a new partner is admitted, the old partnership is reconstituted and a new agreement comes into existence. The old partners sacrifice a part of their share of profit in favour of the new partner. Since the incoming partner acquires a right to a share of the firm's future profits, the goodwill, accumulated reserves, and revalued assets must be adjusted so that the old partners are not disadvantaged. The new partner is required to bring in capital and, usually, a premium for goodwill.
The accounting treatment on admission involves the calculation of the new profit sharing ratio and sacrificing ratio, the valuation and treatment of goodwill, the revaluation of assets and liabilities, the distribution of reserves and accumulated profits, and the adjustment of the new partner's capital. This chapter builds directly on the concepts of goodwill valuation and change in profit sharing ratio studied earlier.
When a new partner is admitted, the old ratio is reduced by the share sacrificed by each old partner. The new profit sharing ratio is computed as:
$$\text{New Share of an Old Partner} = \text{Old Share} - \text{Sacrificed Share}$$
The new partner's share is the total sacrifice made by the old partners. If the new partner's share is given directly, the sacrificing ratio must be determined from the new ratio:
$$\text{Sacrificing Ratio} = \text{Old Ratio} - \text{New Ratio}$$
The incoming partner compensates the old partners for the share of goodwill he acquires. The amount of goodwill premium brought in by the new partner is distributed among the old partners in their sacrificing ratio. If the new partner does not bring cash for goodwill, or brings only partly, his current account is debited for the shortfall.
$$\text{Premium for Goodwill} = \text{New Partner's Share} \times \text{Value of Goodwill}$$
When the new partner brings in goodwill in cash:
Cash/Bank A/c Dr.
To Premium for Goodwill A/c
Premium for Goodwill A/c Dr.
To Sacrificing Partners' Capital/Current A/cs (in sacrificing ratio)
If goodwill already appears in the books, it is first written off among the old partners in the old ratio.
The assets and liabilities of the firm are revalued on the admission of a new partner so that the new partner does not share in any profits or losses arising from the change in the value of assets that were created before his admission. A Revaluation Account is prepared and its profit or loss is transferred to the old partners in their old ratio.
All reserves and accumulated profits belong to the old partners and are credited to their capital accounts in the old ratio. Accumulated losses, if any, are debited to the old partners' capital accounts in the old ratio. The new partner is not entitled to any share of these items since they relate to the period before his admission.
After admission, the capital of the firm may be adjusted in proportion to the new profit sharing ratio. The total capital of the firm is determined and each partner's share is computed:
$$\text{New Partner's Capital} = \text{Total Capital of Firm} \times \text{His Share}$$
$$\text{Each Old Partner's Capital} = \text{Total Capital of Firm} \times \text{His New Share}$$
The partner whose capital is short brings in the difference; the partner whose capital exceeds the required share withdraws it or transfers it to his current account.
Sometimes the new partner brings capital in excess of his proportionate capital, and the excess is treated as his share of goodwill. If the total capital of the firm is not specified but the new partner's capital is given as a proportion of the total, goodwill can be computed by capitalizing the new partner's capital:
$$\text{Total Capital of Firm} = \frac{\text{New Partner's Capital}}{\text{New Partner's Share}}$$
$$\text{Hidden Goodwill} = \text{Total Capital of Firm (computed)} - \text{Net Assets of the Firm}$$
| Item | Formula |
|---|---|
| New share of old partner | Old share - Sacrificed share |
| Sacrificing ratio | Old ratio - New ratio |
| Premium for goodwill | New partner's share x Value of goodwill |
| Hidden goodwill | Capitalized capital - Net assets |
| Item | Treatment |
|---|---|
| Goodwill premium in cash | Distributed to old partners in sacrificing ratio |
| Existing goodwill | Written off in old ratio |
| Revaluation profit/loss | Old partners in old ratio |
| Reserves & accumulated profits | Old partners in old ratio |
| New partner's capital | Proportionate to his new share |
| Accumulated losses | Old partners in old ratio |
| Situation | Assumption |
|---|---|
| New partner's share given only | Old partners sacrifice in their old ratio |
| New partner takes share from specific partners | Sacrifice in the specified ratio |
| New ratio of all partners given | Derive sacrificing ratio as old - new |
The admission of a partner reconstitutes the firm and redistributes the ownership of its profits and wealth. The new partner acquires a share in future profits, and in return compensates the old partners through the premium for goodwill. The accurate computation of the new profit sharing ratio and sacrificing ratio, the careful treatment of goodwill, revaluation of assets, and distribution of reserves are the pillars of this chapter. Since these techniques are extended in the chapters on retirement, death, and dissolution, mastering the admission chapter ensures confidence across the entire partnership accounting syllabus.