1. Modes of reconstitution of a partnership firm, Admission of a new partner

(MODES OF RECONSTITUTION)

A partnership firm may go for reconstitution for various reasons such as;

• Change in the profit-sharing ratio among the Existing Partners.
• Admission of a Partner.
• The Retirement of an Existing Partner.
• Death or Insolvency of a Partner.

ADMISSION OF A PARTNER

• Admission of a partner is one of the modes of reconstitution of partnership firm because when a new partner is admitted, the existing agreement among the partners comes to an end & a new agreement comes into existence which results in change in profit sharing ratio, goodwill valuation & reassessment of assets & liabilities.
• The capital contribution of the new partner, his liabilities, and share of profits is decided upon.
• As per Section 31 of the Indian Partnership Act, the new partner shall not be admitted to the firm without the consent of all existing partners.
• After admission, the new partner gets the following two rights :

• Right to share future profits of the firm
• Right to share in the assets of the firm
• He/she  also becomes liable for any liability of the business incurred after admission & any loss incurred by the firm

• The new/incoming partner receives share in future profits that is equal to the sacrifice of profit by an existing partner/partners of the firm & the same new partner has to compensate the partner/partners who are sacrificing their share in profits in his/her favor.
• Such amount paid by the incoming partner is known as Goodwill or Premium for Goodwill.
• Besides Goodwill/Premium for Goodwill, the new partner also contributes in Capital to get the rights in the assets of the firm.

Effects of Admission of Partner

1. Old partnership agreement comes to an end & a new agreement is formed.
2. New or incoming partner becomes entitled to the future share of profits & losses of the firm.
3. New or incoming partner contributes an agreed amount of capital in the firm.
4. New or incoming partner gets a right to the assets of the firm.
5. Adjustments are made regarding the accumulated profits & losses
6. Assets are revalued & liabilities are reassessed & the net change is adjusted in existing or old partner’s capital accounts in their old profit sharing ratio.
7. Goodwill of the firm is valued in order to pay the sacrificing partner for their sacrificed share by the gaining partners through their capital accounts.

What are the adjustments required on the admission of a partner?

1. Determining new profit sharing ratio
2. Valuation of adjustment of goodwill
3. Adjustment of profit/loss arising from revaluation of assets & reassessment of liabilities.
4. Adjustments of accumulated profits, reserves & losses.
5. Adjustment of capital (if agreed)

 

CHAPTER -3

Reconstitution of a Partnership Firm – Admission of a Partner

 

Partnership is an agreement between two or more persons (called partners) for sharing the profits of a business carried on by all or any of them acting for all. Any change in the existing agreement amounts to reconstitution of the partnership firm. This results in an end of the existing agreement and a new agreement comes into being with a changed relationship among the members of the partnership firm and/or their composition. However, the firm continues. The partners often resort to reconstitution of the firm in various ways such as admission of a new partner, change in profit sharing ratio, retirement of a partner, death or insolvence of a partner. In this chapter we shall have a brief idea about all these and in detail about the accounting implications of admission of a new partner or an on change in the profit sharing ratio.

Modes of Reconstitution of a Partnership Firm

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

Admission of a new partner: A new partner may be admitted when the firm needs additional capital or managerial help. According to the provisions of Partnership Act 1932 unless it is otherwise provided in the partnership deed a new partner can be admitted only when the existing partners unanimously agree for it. For example, Hari and Haqque are partners sharing profits in the ratio of 3:2. On April 1, 2017 they admitted John as a new partner with 1/6 share in profits of the firm. With this change now there are three partners of the firm and it stands reconstituted.

Change in the profit sharing ratio among the existing partners: Sometimes the partners of a firm may decide to change their existing profit sharing ratio. This may happen an account of a change in the existing partners’ role in the firm. For example, Ram, Mohan and Sohan are partners in a firm sharing profits in the ratio of 3:2:1. With effect from April 1,2017 they decided to share profits equally as Sohan brings in additional capital. This results in a change in the existing agreement leading to reconstitution of the firm.

Retirement of an existing partner: It means withdrawal by a partner from the business of the firm which may be due to his bad health, old age or change in business interests. In fact a partner can retire any time if the partnership is at will. For example, Roy, Ravi and Rao are partners in the firm sharing profits in the ratio of 2:2:1. On account of illness, Ravi retired from the firm on March 31, 2017. This results in reconstitution of the firm now having only two partners.

Death of a partner: Partnership may also stand reconstituted on death of a partner, if the remaining partners decide to continue the business of the firm as usual. For example, X,Y and Z are partners in a firm sharing profits in the ratio 3:2:1. X died on March 31, 2017. Y and Z decide to carry on the business sharing future profits equally. The continuity of business by Y and Z sharing future profits equally leads to reconstitution of the firm.

Admission of a New Partner

When 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. With the admission of a new partner, the partnership firm is reconstituted and a new agreement is entered into to carry on the business of the firm.

A newly admitted partner acquires two main rights in the firm–

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

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

For the right to acquire share in the assets and profits of the partnership firm, the partner brings an agreed amount of capital either in cash or in kind. Moreover, in the case of an established firm which may be earning more profits than the normal rate of return on its capital the new partner is required to contribute some additional amount known as premium or goodwill. This is done primarily to compensate the sacrificing partners for loss of their share in super profits of the firm.

Following are the other important points which require attention at the time of admission of a new partner:

1. New profit sharing ratio;

2. Sacrificing ratio;

3. Valuation and adjustment of goodwill;

4. Revaluation of assets and Reassessment of liabilities;

5. Distribution of accumulated profits (reserves); and

6. Adjustment of partners’ capitals.