Admission of a Partner – Partnership Accounting – New Profit-Sharing Ratio

 Partnership

A partnership is an agreement between two or more persons called partners to share the profits of a business carried on by all or any of them acting on behalf of all. Any change in the existing agreement results in a reconstitution of the partnership firm. This brings the current agreement to an end and leads to the creation of a new agreement, altering the relationship among the partners and/or the composition of the firm.

When an existing partnership firm plans to expand or diversify its business, it may require additional capital or managerial support. One of the available options is to admit a new partner. When a new person is admitted into an existing partnership, the process is known as the admission of a partner.

According to the Indian Partnership Act, 1932, a person can be admitted into a partnership only with the consent of all existing partners, unless the partnership agreement specifies otherwise.

Modes of Reconstitution of a Partnership Firm

1. Admission of a New Partner - A new partner may be admitted when the firm requires additional capital or managerial support. Admission is possible only with the unanimous consent of all existing partners, unless otherwise provided in the partnership agreement.
2. Change in the Profit-Sharing Ratio Among Existing Partners - The partners may decide to change their profit-sharing ratio due to changes in their roles, responsibilities, or contributions to the firm. This adjustment leads to a reconstitution of the partnership.
3. Retirement of an Existing Partner - A partner may retire due to reasons such as ill health, old age, or shifting business interests. Retirement of a partner results in the reconstitution of the firm with a new agreement among the remaining partners.
4. Death of a Partner - The death of a partner automatically leads to the dissolution of the existing partnership agreement and results in the reconstitution of the firm if the remaining partners decide to continue the business.

Admission of a New Partner

When a new partner is admitted into a partnership firm, he or she obtains a share of profits from the existing partners. Consequently, the new profit-sharing ratio is mutually decided between the existing partners and the incoming partner. Since the new partner acquires a portion of future profits from one or more existing partners, those partners must sacrifice a part of their share, making the calculation of the new ratio essential.

A new partner may be admitted when the firm requires additional capital, managerial expertise, or both, usually for business expansion. The admission of a partner results in the reconstitution of the partnership firm, and a new partnership agreement comes into effect to continue the business.

A newly admitted partner gets two fundamental rights:

1. Right to share in the assets of the firm
2. Right to share in the profits of the firm

At the same time, the new partner becomes liable for any business obligations incurred after admission, as well as for future losses of the firm.

The incoming partner typically brings an agreed amount of capital, either in cash or in kind. Additionally, in the case of an established firm earning more than the normal rate of return, the new partner may be required to bring an extra amount known as premium or goodwill. This amount compensates the existing partners for the reduction in their share of the firm’s super profits. Apart from goodwill, the new partner contributes capital to obtain rights in the firm’s assets.

Adjustments Required on the Admission of a Partner

1. Determination of the New Profit-Sharing Ratio - The new ratio is decided among the existing partners and the incoming partner based on the share acquired by the new partner.
2. Calculation of the Sacrificing Ratio - Existing partners determine the proportion of their profit share that they sacrifice in favour of the new partner.
3. Valuation and Adjustment of Goodwill - Goodwill is valued and adjusted through partners’ capital accounts to compensate the sacrificing partners.
4. Adjustment of Profit or Loss on Revaluation of Assets and Reassessment of Liabilities - Any increase or decrease in the value of assets and liabilities is adjusted through a revaluation account and transferred to the existing partners’ capital accounts.
5. Adjustment of Accumulated Profits, Reserves, and Losses - Existing reserves, undistributed profits, and accumulated losses are distributed among existing partners before admitting the new partner.
6. Adjustment of Capitals - Partners’ capital accounts may be adjusted either by bringing in additional capital or by withdrawing excess capital to maintain the agreed capital structure.

New Profit-Sharing Ratio

Upon the admission of a new partner, the existing partners surrender a portion of their profit share in favour of the incoming partner. The new profit-sharing ratio is mutually decided between the old partners and the new partner. This ratio determines how all partners both existing and newly admitted will share the future profits or losses of the firm.

The determination of the new ratio depends on how the incoming partner acquires his or her share from the existing partners, and several possibilities may arise based on the terms agreed upon among them.

New Profit Sharing Ratio

On the admission of a new partner, the old partner sacrifices a share of them in favour of the new partner. Decided mutually among the old partners and the new partner. This is the ratio in which all partners, including new or incoming partner, share future profits or loss of the firm. New profit-sharing ratio depends upon how does the new partner acquires his share from the old partners for which there are many possibilities.

Case 1 – When new or incoming partner acquires his share from the old partners in their old profit-sharing ratio.

Illustration: A and B are partners sharing profits in the ratio of 3: 2. They admitted C as a new partner for 1/5 share in the future profits of the firm. Calculate the new profit-sharing ratio of A, C and C.

Solution

• C’s share = 1/5
• Remaining share = 1-1/5=4/5
• A’s new share 3/5of 4/5=12/25
• C’s new share 2/5of 4/5=8/25

Thus, the new profit-sharing ratio of A, B and C is: 12: 8: 5

Note: It has been assumed that the new partner acquired his share from old partners in their old ratio.

Illustration 2 A and B are partners sharing profits in the ratio of 3: 2. They admit C as a new partner for 1/5 share in the future profits of the firm, which he gets equally from A and B. Calculate the new profit-sharing ratio of A, B and C.

Solution

• C’s share 1/5, Since he gets this share equally from A and B: Share taken from each=1/5÷2=1/10
• A’s new share 3/5-1/10, Convert to like fractions: 3/5=6/10. So, 6/10-1/10=5/10
• B’s new share 2/5-1/10, Convert to like fractions: 2/5=4/10. So, 4/10-1/10=3/10
• New Profit-Sharing Ratio A: B: C =5/10:3/10:1/5. Convert C’s share: 1/5=2/10
• Thus, the ratio becomes: 5:3:2

Case 2: When a new or incoming partner acquires his share from old or existing partners in a particular ratio.

Illustration 3 - A and B are partners sharing profits in the ratio of 3: 2. They admitted C as a new partner for 3/10 share, which she acquired 2/10 from A and 1/10 from B. Calculate the new profit-sharing ratio of A, B and C.

Solution

• C’s share =3/10
• A’s new share 3/5-2/10. Convert to like fractions: 3/5=6/10. So, 6/10-2/10=4/10
• B’s new share. Old share - Share surrendered 2/5-1/10. Convert to like fractions: 2/5=4/10. So, 4/10-1/10=3/10
• New Profit-Sharing Ratio A: B: C =4/10:3/10:3/10. 
• Simplified ratio: 4:3:3

Case 3: When a new partner acquires his share by surrender of a particular fraction of their share by the old partner.

Illustration 4 - R and S are partners in a firm sharing profits in the ratio of 3 : 2. They admit G as a new partner. R surrenders 1/4 of his share and S surrenders 1/3 of his share in favour of G. Calculate the new profit-sharing ratio of R, S and G.

Solution

1. R’s old share =3/5. 
• Share surrendered by R =1/4  of   3/5=3/20
• R’s new share =3/5-3/20
• Convert: 3/5=12/20
• So: 12/20-3/20=9/20
2. S’s old share =2/5
• Share surrendered by S =1/3  of   2/5=2/15
• S’s new share = 2/5-2/15
• Convert: 2/5=6/15
• So: 6/15-2/15=4/15
3. G’s new share =R’s sacrifice + S’s sacrifice
• Convert R’s sacrifice: 3/20=9/60
• Convert S’s sacrifice: 2/15=8/60
• So: 9/60+8/60=17/60
4. New Profit-Sharing Ratio R: S: G =9/20:4/15:17/60
• Convert all to denominator 60: 
• R: 9/20=27/60
• S: 4/15=16/60
• G: 17/60
• So final ratio: 27:16:17

Related Posts

Previous

Next