PARTNERSHIP ACCOUNTS – ADMISSION OBJECTIVES

LESSON – 10

PARTNERSHIP ACCOUNTS – ADMISSION
OBJECTIVES
After studying this unit, you should be able to:
• discuss the adjustments to be made on the admission of a partner
• calculate of new and sacrificing ratios
• explain the meaning of Goodwill and factors affecting Goodwill
• describe the different methods of valuing Goodwill
• pass adjustments regarding revaluation of assets and liabilities.
STRUCTURE
10.1 Definition of Partnership
10.2 Methods of Maintaining Capital Accounts
10.2.1 Fixed Capital Account
10.2.2 Fluctuating Capital Accounts
10.3 Admission
10.3.1 Introduction
10.3.2 Steps in Accounting
10.3.2.a Calculating New Profit Sharing Ratio
10.3.2.b Calculating Sacrificing Ratio
10.3.2.c Revaluation of Assets and liabilities
10.3.2.d Adjustment of accumulated Reserve Profit or Losses
10.3.2.e Treatment of Goodwill
10.3.2.f Adjustment of Capital Accounts
Unit Questions

10.1 DEFINITION OF PARTNERSHIP

In India. The main provisions governing partnership fro or organizations are given by the Indian partnership Act.1932. Section 4 of Indian partnership Act. 1933 defines a partnership as “the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all ”

From the above definition, the following special features of partnership are derived:
1. Minimum Two Persons: It is clear from the definition that partnership is the relation between persons, “ Persons” represent more than one person. Thus, to constitute a partnership firm, there must be at least two business and 20 in case of other businesses.
2. Presence of Agreement: A partnership firm comes into existence only by mutual agreement. i.e the persons involved should enter into an agreement. Thus, partnership can arise only from a contract and not from status.

3. Carrying out of Some Business: In partnership firm, the relation between two or more persons is established through agreement for the purpose of carrying out some business. Thus, the intention to carry on some business is an essential element. The word ‘business’ includes any trade, profession or vocation . It is also necessary the firm should not carry on a illegal business.

4. Sharing the Results of the Business: partnership is constituted by an agreement to share the profit of the business at an agreed proportion among the partners. However, in case of loss, if there is no say in the agreement then loss should be borne by the partners in the profit sharing ratio. Thus, the results of the business are share between partners in some agreed ratio.

5. Managing the Business: The business of partnership must be carried on by all or any of them acting for all. It means the business must be carried on by all the partners or by any one or more of the partners acting on behalf of all. Thus, there must be mutual agency among partners.

10.2 METHODS OF MAINTAINING CAPITAL ACCOUNTS
The capital accounts of partners can be maintained by adopting two methods. They are
10.2.1 Fixed capital Accounts
10.2.2 Fluctuating Capital Accounts.
10.2.1 FIXED CAPITAL ACCOUNTS
Under this method, except by special agreement, the amount of capital contributed by the partners remains counstant and shall not be increasd or decreased throughout the duration of partnership. As the capital accounts are kept unaltered. It is necessary to keep an additional account to make usual adjustments like interest on capital, interest on drawings salary, commission , etc. This additional account is called “Current Account”

It is clear from the above that under the fixed capital method, two account viz. (i) capital accounts and (ii) current accounts for each partner are maintained. In the capital accounts of partners. Only the capital introduced and withdrawn are recorded. Thus, the balance in the capital accounts of partners continues to show the same amount unless any adjustment like introduction of additional capital or withdrawal is made.

In the current accounts of partners, the transactions . relating to interest on capital,. Interest on drawings, Salary. Commission, share of profit or loss etc. are recorded. Thus, the balance in the current accounts of partners changes every year. A debit balance in current account is shown on the assets side and a credit balance on the liabilities side of the Balance sheet.

The specimen of Capital Accont and Current Account under Fixed Capital Method is as follows (assume two partners A and B are there):

CAPITAL ACCOUNTS OF PARTNERS.
Date Particulars Rs. Rs. Date Particulars Rs. Rs.

To Balance c/d A
xx

B
xx
By Balance b/d A
xx

xx B
Xx

xx
CUURENT ACCOUNTS OF PARTNERS.
Date Particulars Rs. Rs. Date Particulars Rs. Rs.

To drawings A/c

To Interest on
Drawings A/c

To P & L Appropriation
A/c*(share of loss)

To Balance c/d A
xx

xx

xx


xx


xx B
xx

xx

xx


xx


xx
By Interest on Capital A/c
By Salary A/c
By Commission
By P & L Appropriation A/c*(share of loss)




To Balance b/d
A
xx

xx

xx


xx


xx B
xx

xx

xx


xx


xx

* Only on figure shall appear.
10.2.2 FLUCTUATING CAPITAL ACCOUNTS
Under this method, one account called capital account for each partner is maintained. In the capital accouns of partners, with the capital introduced and withdrawn, the transactions relating to interest on capital, interest on drawings, salary, commission , share of profit or loss, etc., are recorded. Thus , the balance in the current accounts or partners charges every year. A debit balance in current account is shown on the assets side and a credit balance on the liabilities side of the Balance Sheet.

The specimen of Capital Account under Fluctuating Capital Method is as follows (assume two partners A and B are there)
CAPITAL ACCOUNTS OF PARTNERS.
Date Particulars Rs. Rs. Date Particulars Rs. Rs.

To drawings A/c

To Interest on
Drawings A/c

To P & L Appropriation
A/c*(share of loss)

To Balance c/d A
xx

xx

xx


xx


xx B
xx

xx

xx


xx


xx
By balance b/d
By interest on Capital A/c
By Salary A/c
By Commission
By P & L Appropriation A/c*(share of loss)




To Balance b/d
A
xx
xx
xx
xx
xx


xx


xx B
xx
xx
xx
xx
xx


xx


xx
* Only one figure shall appear.
Example:-
Ganesh and Mahesh commenced business with capitals of Rs.15,000 and Rs.12,000 on 1st January 2000 Mahesh is entitled to a salary of Rs.450 per month. Interest is allowed on capital for Ganesh is Rs.1,800 and for Mahesh Rs, 1,440. During the year, Ganesh withdrew Rs.1,000 and Mahesh with drew Rs. 4,000 Interest on drawings woks out ot Rs.150 for Ganesh and Rs.200 for Mahesh. Profit are to be distributed equally after the above given adjustments. The profit for the year. Before the above adjustments. Was Rs.10,000 . Prepare Profit and Loss
Appropriation Account and Capital Accounts of partners when (a) capitals are fixed and (b) capitals are fluctuating.
Solution:
(a) When Capitals are Fixed:
M/s. Ganesh and Mahesh
Profit and Loss Appropriation A/c
Date Particulars Rs. Rs. Date Particulars Rs.
To Mahesh’s Current A/c
Salary
To Interest on Capital
- Ganesh’s Current A/c
- Mahesh’s Current A/c
To Profit transferred to
Ganesh’ Current A/c
Mahesh’s Current A/c






855
855



5,400
1,800
1,440


1,710

10,350 By Net profit

By Interest on Drawings
Ganesh’s Current A/c
Mahesh’s Current A/c 10000


150
200




10,350
CAPITAL ACCOUNTS OF PARTNERS
Date Particulars Rs. Rs. Date Particulars Rs. Rs.
2000
Dec.31
To Balance c/d
Ganesh
15,000
Mahesh
12,000
2000
Jan.1
2000
Jan.1
By Bank A/c

By Balance b/d Ganesh
15,000

15,000 Mahesh
12,000

12,000

CURRENT ACCOUNTS OF PARTNERS
Date Particulars Rs. Rs. Date Particulars Rs. Rs.
2000
Dec.31
ToBank Drawing A/c

To Interest on Drawing A/c

To Balance c/d Ganesh
1,000

150

1,505

2,655
Mahesh
4,000

200

3,495

7,695
2000
Dec.31
2000
,,





2001
Jan.1
By interest on By Salary A/c

ByP & L Appropriation A/c





Balance b/d Ganesh
1,800
-
855



2,655

1,505 Mahesh
1,440
5,400
855



7,695

3,495

(b) When capitals are Fluctuating:
M/s. Ganesh and Mahesh
Profit and Loss Appropriation A/c
Date Particulars Rs. Rs. Date Particulars Rs.
To Mahesh’s Capital A/c
Salary
To Interest on Capital
- Ganesh’s Current A/c
- Mahesh’s Current A/c
To Profit transferred to
Ganesh’ Current A/c
Mahesh’s Current A/c





855
855

5,400
1,800
1,440


1,710

10,350 By Net profit

By Interest on Drawings
Ganesh’s Current A/c
Mahesh’s Current A/c 10,000


150
200



10,350

CAPITAL ACCOUNTS OF PARTNERS
Date Particulars Rs. Rs. Date Particulars Rs. Rs.
2000
Dec.31
ToBank Drawing A/c

To Interest on Drawing A/c

To Balance c/d Ganesh
1,000

150

16,505

17,655
Mahesh
4,000

200

15,495

19,695
2000
Dec.31
2000
,,






2001
Jan.1
By Bank A/c
By interest on
Capital A/c

By Salary A/c
By P & L Appropriation A/c (share of profit)




By Balance b/d Ganesh
15,000
1,800

-

855


17,655

16,505 Mahesh
12,000
1,440

5,400

855


19,695

15,495


10.3 ADMISSION OF A PARTNER
10.3.1 INTRODUCTION
According to the Indial Partnership Act,1932,Sec 31(1) a person can be admitted as a new partner only with the consent of all the existing partners unless otherwise agreed upon. An incoming partner acquires two legal rights. Viz., 1) right to share the assets of the firm and 2) right to share the future profits of the business. The new partner has to contribute an agreed amount of capital to acquire the right to share the assets of the firm. Nevertheless, the Indian partnership Act is silent in this regard. Likewise, he has to bring his share of goodwill to acquire the right to share the future profits or losses. The good will amount brought in by the new partner is to be shared between the old partners for sacrificing their part of share in favors of a new partner.

10.3.2 STEPS IN ACCOUNTING
When a new partner is admitted. Various accounting adjustments are to be made. Because, the old partners are responsible for the state of affairs of business till the time of admission and hence, they have to share the undistributed reserves. Profits or losses, profit or loss on the change in the value of assets and liabilities. Thus, the following accounting steps are followed while solving problems, when a partner is admitted:

10.3.2.a Calculation of New Profit Sharing Ratio of all partners including new partner.
10.3.2.b Calculation of Sacrificing Ratio of old partners.
10.3.2.c Revaluation of Assets and Liabilities
10.3.2.d Adjustment of accumulated reserves, profits or losses.Treatment of Good will
10.3.2.e Adjustment of Capital Accounts of partners.
10.3.2.a CALCULATION OF NEW PROFIT SHARING RATIO
When a person is admitted as a new partner. The profit sharing ratio of old partners change and a new profit sharing ratio of al the partners (including new partner) is to be found. Thus, new profit sharing ratio is the ratio in which all the partners share profits and loss after admission. With the given information, the new profit sharing ratio is to be calculated . Following are the different types of examples.
When the share of new partner alone is given : In this case the remaining profits are to be shared by old partners in the old ratio.

When the new partner gets his share from old partners in a specific ratio : In this case, the old partners shares are to be reduced by the specific ratio sacrificed in favour of new partner.
When surrenders by old partners alone are given : In this case, new partner’s share is to be reduced by the surrender portion of share.
Example –1
Bannalal and Vadilal are partners in a firm sharing profits and losses in the ratio of 5:2 Rakesh is admitted for 2/5 th share in the profits. Calculate the new profit sharing ratio of all partners.

Solution :
Assume the Total Profit = 1
Less: Rakesh’s share = 2/5
Remaining profit = 1-2/5 =3/5
Remaining Profit of 3/5 is to be shared between old partners in the old ratio .Thus,
Bannalal’s share of profit = 5/7 of 3/5 = 5/7 x3/5=15/35
Vadilal’s Share of profit = 2/7 of 3/5 = 2/7 x 3/5=6/35
Net Profitd Sharing Ratio of all partners is
Bannalal Vadilala Rakesh
15/35 : 6/35 : 2/5
15/35 : 6/35 : 2/5 x7/7
15/35 : 6/35 : 14/35
15 : 6 : 14

Example :2
Madu and Sethu are partners sharing profits in the ratio of 5:4 .They admit Velu into partnership for 1/4th share of profit which he takes 1/8 from Madu and 1/8 from Sethu. Calculate the new profit sharing ratio of all partners.

Solution :
Velu’s share of profit = ¼
Madhu’s new profit sharing ratio is calculated as follows:
Madu’s old profit sharing ratio = 5/9
Less: Given to Velu = 1/8
Madu’s new profit sharing ratio = 5/9 – 1/8
= 40-9
-------- = 31/72
72
Sethu’s new profit sharing ratio is calculated as follows:
Sethu’s old profit sharing ratio = 4/9
Less: Given to Velu = 1/8
Sethu’s new profit sharing ratio = 4/9 – 1/8
= 32 - 9
---------- = 23/72
72
The new profit sharing ratio of partners is

Madhu Sethu Velu
31/72 : 23/72 : 1/4
31/72 : 23/72 : 18/72
31 : 23 : 18
Example:-
Vanitha and Savitha are partners sharing profit and losses in the ratios of 5:3 .They decided to admit Sangeetha. Vanitah surrenders 3/8th sahre of her profit and Savitha 2/8 th share of her profit in favour of Sangeetha. Calculate the new profit sharing ratio of all partners.
Solution:
To find the new partner, Sangeetha’s share, the surrenders from old partners are to be found.
Surrender from Vanitha = 5/8x3/8 = 15/64
Surrender from Savitha = 3/8 x 2/8=6/64
Thus,Sangeetha’s share = 15/64 +6/64 = 21/64

Vanith’s new profit sharing ratio is calculated as follows:
Vanith’s old profit sharing ratio = 5/8
Less: Given to Sangetha = 15/64
Vaniths’s new profit sharing ratios = 5/8-15/64
= 40-15
------- = 25/64
64
Savitha’s new profit sharing ratio is calculated as follows:
Savitha’s old profit sharing ratio = 3/8
Less: Given to Sangetha = 6/64
Vaniths’s new profit sharing ratios = 3/8-6/64

24 - 6
= --------- = 18/64
64
NEW RATIO 25 : 18 : 21
10.3.2.b CALCULATION OF SACRIFICING RATIO

While admitting a new partner, the old partner’s profit sharing ratio is reduced to the extent they sacrifice.

Sacrificing Ratio = Old Ratio –New Ratio

Example:
Zeenath ,Kamath are partners sharing profits and losss in the ratio of 3:2 .They admit surath into partnership and the new profit sharing ratio of all partners Zeenath, Kamath and Surath is agred at 7:4:1 respectively, Calculate the sacrificing ratio and the share of incoming partner.
Solution :
When the old and new profit sharing ratios are given. The sacrificing ratio is found by applying the following formula:
Sacrificing Ratio = Old Ratio – New Ratio
Sacrificing Ratio of Zeenath = 3/5-7/12 = 36/60-35/60=1/60
Sacrificing Ration of Kamath = 2/5-4/12 = 24/60-20/60=4/60
Thus, Sacrificing Ration of Zeenath and Kamath is 1:4
Share of Surath is 1/12(1/60+4/60=5/60 or 1/12)
10.3.2.c REVALUATION OF ASSETS AND LIABILITIES
There are two methods of maintaining revaluation account.
Revaluation Account Method to record the revised values of asets and liabilities.
Memorandum Revaluation Account Method to record the original values of assets and liabilities.
REVALUATION ACCOUNT METHOD
Following are the accounting entries to be passed to record the revised values of assets and liabilities:
1. For any increase in the value of asset:
Asset A/c Dr. (With the increased amount)
To Revaluation A/c
2. For any decrease in the value of asset:
To Revaluation A/c Dr.
To Asset A/c (With the decreased amount)
3. For any increase in the value of liability
Revaluation A/c Dr. (With the increased amount)
To liability A/c
4. For any decrease in the value of liability
Liability A/c Dr. (With the decreased amount)
To Revaluation
5. For any unrecorded asset:
Unrecorded Asset A/c Dr. (With the value of asset)
To Revaluation
6. For any unrecorded liability:
Revaluation A/c Dr. (With the value of liability)
To Unrecorded Liability A/c
7.For any decrease in the existing provision for doubtful debts:
It results in increase of existing debtors (assets)and hence the
revaluation account is to be credited.
Provision for Doubtful Debt A/c Dr. (With the decreased amount)
To Revaluation A/c
8.For any decrease in the existing provision for doubtful debts:
It results in increase of new liability and hence the revaluation account is to be debited
Revaluation A/c Dr. (With the amount of new provision)
To Provision for Doubtful Debts A/c
9. For closing the revaluation account:
If Profit:
Revaluation A/c Dr.
To Old partner’s CapitalA/c (in the old ratio)
If Loss:
Old Partners’ Capital A/c Dr. ( in the old ratio)
To Revaluation A/c
The specimen of a Revaluation Account is given below.
Revaluation A/c
Dr. Cr.
To Decrease in the value of assets
To Increase in the value of liabilities
To Unrecorded Liabilities
To New provision for doubtful debts

To Profit transferred to old partners Capital account (in old ratio)
Rs.
xxx
xxx

xxx
xxx


xxx*




xxx By Increase in the value of assets
By Decrease in the value of liabilities
By Unrecorded Assets
By Decrease in the existing provision for doubtful debts

By loss transferred to old partners
Capital accounts (in old ratio)

Rs.
xxx

xxx
xxx

xxx



xxx*


xxx

* Only one figure shall appear.
Example:-
Raju and Nagu are partners sharing profits and losses in the ratio of 5:3 . Their Balance Sheet as on 31st March 2000 was as under.
Liabilites Rs. Rs. Assets Rs. Rs.
Creditors
Outstanding expenses
Capitals:
Raju
Nagu


6,52,500
3,37,500
8,66,250
90,000



9,90,000



19,46,250 Cash
Stock
Prepaid Insurance
Debtors
Less. Provision

Machinery
Buildings
Furniture


2,11,500
9,000
45,000
3,37,500
33,750


2,02,500
4,27,500
7,87,500
1,12,500
19,46,250

Partners decided to admit Somu as a new partner who introduced Rs.3,60,000 as capital. The new profit sharing ratio of partners is 6:4:3 .Following are the changes taken place in the assets and liabilities:
i) Stock to be depreciated at 5%
ii) Provision for doubtful debts is to be Rs. 11,250
iii) Furniture to be depreciated at 10%
iv) Building is valued at Rs.9,00,000
You are required to pass necessary journal entries and prepare Revaluation Account.
Journal Entries
Date Particulars L.F Rs. Rs.
2000
Mar.31



,,



,,




,,


,,



,,




Revaluation A/c
To Stock A/c
(Depreciation on stock is recorded)
Revaluation A/c
To Provision for Doubtful Debts A/c
(Increase in the provision for doubtful debts is recorded)
Revaluation A/c
To Furniture A/c
(Depreciation on furniture at 10% on Rs.1,12,500 is recorded)
Buildings A/c
Revaluation A/c
(increase in the value of building is recorded)
Cash A/c
To Somu’s Capital A/c
(Capital brought by new partner Somu is recorded)

Revaluation A/c
To Raju’s Capital A/c
To Nagu’s Capital A/c
(Profit on revaluation of assets and liabilities transferred to old partners in the old ratio 5:3)

Dr.


Dr.



Dr.



Dr.



Dr.



Dr.
16,875


2,250



11,250



1,12,500



3,60,000



82,125

16,875


2,250



11,250



1,12,500



3,60,000



51,328
30,797
Revaluation A/c



To Stock A/c
To Provision for doubtful debts A/c
To Furniture A/c

To Profit transferred to
Raju (5/8)
Nagu (3/8) Rs.







51,328
30,797

Rs.

16,875
2,250
11,250





8,125

1,12,500

By Building A/c
Rs.

1,12,500









1,12,500

MEMORANDUM REVALUATION ACCOUNT METHOD

In this method, the revised values of assets and liabilities are not shown in the books of reconstituted firm. A new account called “
Memorandum Revaluation Account” is opened and recording is done in two stages.
The specimen of a Memorandum Revaluation Account is given below.
Memorandum Revaluation A/c
Dr. Cr.

To Decrease in the value of assets
To Increase in the value of liabilities
To Unrecorded Liabilities
To New provision for doubtful debts
To Profit transferred to old partners’
Capital accounts (in old ratio)


To Increase in the value of assets
To Decrease in the value of liabilities
To Unrecorded Assets
To Decrease in the existing
Provision for doubtful debts
To Profit transferred to all partners

Capital accounts (in new ratio)

Rs.
xxx
xxx
xxx
xxx
xxx

xxx
xxx
xxx
xxx

xxx*


xxx

By Increase in the value of assets
By Decrease in the value of liabilities
By Unrecorded Asserts
By Decrease in the existing provision
For doubtful debts.
By loss transferred to old partners’
Capital accounts (in old ratio)

By Decrease in the value of assets
By Increase in the value of liabilities
By Unrecorded Liabilities
By New provision for doubtful debts
By loss transferred to all partners’
Capital accounts (in new ratio)
Rs.
xxx
xxx
xxx



xxx
xxx
xxx
xxx

xxx*


xxx


10.3.2.d ADJUSTMENT OF ACCUMULATED RESERVES PROFITS AND LOSSES

When a partner is admitted one of the accounting adjustmens to be made is transfer of accumulated reserves, profits and losses.

The accounting entries to be passed in this regard are as follows:

For transfer of accumulated reserves, profits
General Reserve A/c Dr.
Profit and Loss A/c Dr.
Workmen Compensation Fund A/c Dr.
Any other reserve A/c Dr.
To Old partner’s Capital or Current A/c (in old ratio)

For transfer of accumulated losses:
Old Partners’ Capital or Current A/c Dr. (in old ratio)
To Profit and Loss A/c
To Deferred Revenue Expenditure A/c

10.4. Goodwill and its treatment in accounts.
Goodwill may be defined as the benefit and the advantage of the good name or reputation of a business. It enables a concern to earn more profits on the capital employed by attracting more customers than in comparable organizations. The following of the judicial definitions of goodwill.
Goodwill of a business is the advantage, whatever it may be which a person gets by continuing to carry on and being entitled to represent to the outside would that he carrying on a business, which has been carried on for some time previously’.
‘Goodwill is a thing very easy to describe, very difficult to define. It is the benefit or advantage of the good name, reputation or connection of a business. It is the attractive force which brings in customers.’

10.4.1. Methods of valuation of goodwill
The method of valuing goodwill is usually mentioned in the Partnership Deed. The following are the usual methods of valuation of goodwill:
(1) Simple Profit Method
(2) Super Profit Method
(3) Capitalisation Method

10.4.1.a) Simple Profit Method
Under this method, the goodwill is valued at agreed number of years’ purchase of the average profit of the past few years. Thus, for calculating the value of goodwill, the average profit of the past few years, is to be ascertained first. This advantage profit is multiplied by an agreed number of years during which the anticiupated profits are expected to accure. The resultant figure is considered to be the value of goodwill.
Example:
From the information given below compute the value of goodwill at 3 years’ purchase of 5 years average profits.
Year 1992 1993 1994 1995 1996
Profit (Rs.) 20,000 21,000 22,000 25,000 30,000
Solution:
Total Profit
Average Profit = --------------------------
Number of years
20,000 + 21,000 + 22,000 + 25,000 + 30,0000
= --------------------------------------------------------------
5
1,18,000
= -----------------
5
Goodwill = 3 years’ purchase of 5 years’ average profits
= 3x23,600 = Rs.70,800
Note: If there is loss in a given year that should also be considered.
10.4.1.b) Super Profit Mehtod
Super profit is the excess of actual average profit of a firm over the normal earning on capital. Normal earning on capital is ascertained by multiplying capital employed with the normal rate of return enjoyed by similar firms.
Under the method, goodwill is valued by multiplying the super profit with the decided number of years. The steps involved in the calculation of the value of goodwill, under this are given below:
1. Calculate the actual average profit.
2. Ascertain the normal earning on capital employed. It can be ascertained using he formula given below:
Normal rate of earning
Normal earning on capital = Capital employed x -----------------------------
100
3. Ascertain the super profit
Super profit = Actual average profit – Normal earning on capital employed.
Calculate goodwill by multiplying the super profit by the decided number of years.
Example – 6
Profits of the firm for the last five years were:
Year 1994 1993 1992 1991 1990
Profit(Rs.) 30,000 28,000 25,000 4,00,000 18,000
The capital employed in the firm is Rs. 4,00,000. You are required to compute the value of goodwill at 2 year’s purchase of super profits, assuming that the normal rate of return on capital employed is 5%.
Ans.:
30,000+28,000+25,000+24,000+18,000
Acutal average profit = ------------------------------------------------
5
Normal rate of earning
Normal profit = Capitalemployed x ---------------------------
100
5
= 4,00,000 x ------ = Rs.20,000
100
Super profit = Actual average profit – Normal Profit
= 25,000 – 20,000 = Rs.5,000
Goodwill = 2 years’ purchase of super profit
= 2 x 5,000 = Rs.10,000

10.1.4.c) Capitalisation Method
Under the method the average profit is to be capitalized on the basis of normal rate. From the value so obtained the total of net tangible assets is subtracted to arrive at the value of goodwill. Thus the steps involved for the computation of goodwill, under this method are
1. Ascertian the average profit of the past few years.
2. Capitalise the average profit on the basis of normal rate by following the formula:
100
Average profit x --------------------------
Normal rate of return
3. Ascertain the net assets by deducting outside liabilities from the total value of assets (excluding Goodwill).
Compute the value of Goodwill by subtracting net assets from the capitalized value of average profit.
10.3.2.e TREATMENT OF GOODWILL
When a partner is admitted , goodwill of the firm is to be adjusted and treated according to the goodwill of the firm at the time of admission of a partner . They are
Revaluation Methods
Memorandum Revaluation Method
Premium Method.
Revaluation Method:
This method is followed when the new partner does not bring any cash as the amount of his share or good will. Under this method, the following are the steps involved.
Total amount of good will of the firm is calculated . Calculation of goodwill may be based on the following methods.
Based on average profits or super profits or
capitalization of profits method (which are already
explained under the head methods of calculating
goodwill in chapter 22a – Introduction Aspects)
Based on the share of new partner. Under this method the total amount of goodwill of the firm is calculated by taking the share of the new partner in the firm as base. For example A and B are partners. C is admitted for 1/6 th share of the profit in the new firm and he is required to bring Rs.15,000 as capital and Rs.7,000 as his share of good will . Calculate the value of goodwill of the firm.

For 1/6th the share of goodwill brought by C = Rs.7,000
Therefore, the full share of good will is = Rs.7,000 x6/1
Value of goodwill of the firm =Rs.42,000
The total goodwill of the firm is compared with the existing bookd value of goodwill and the diference between them is found. When no goodwill appears in the Balance Sheet. Then the book value of goodwill is to be taken as zero.
If the total goodwill of the firm is more than the books value of goodwill, then the difference amount of goodwill is to be raised and the old partners’ capital accounts are to be credited in the old profit sharing ratio. Following is the journal entry to be passed:
Goodwill A/c Dr.
To Old Partners’ Capital A/c (in old ratio)
If the total amount of goodwill of the firm is less than the book value of goodwill, then the difference amount of goodwill is to be reduced and the old partners’ capital accounts are to be debited in the old profit sharing ratio, Following is the journal entry to be passed:
Old Partners’ Capital A/c Dr. (in old ratio)
To Goodwill A/c
Example:
Patil and Sazena ae partners in a firm sharing profits and losses in the ratio of 5:3 . They admit Dave as a partner with 1/6th share of profit.Dave acquires his share from Patil and Saxena in the ratio of 2:1 Dave’s share of goodwill is calculated at Rs.36,000 pass the necessary journal entries under each of the following cases.

If no good will appears in the books of the firm.
If the goodwill account appears in the books of firm at
Rs.2,16,000
If the goodwill account appears in the books of firm at
Rs.1,35,000
If the goodwill account appears in the books of the firm at
Rs.2,97,000
Solution:
As the new partner , Dave does not bring goodwill in the form of cash, the Revaluation Method of treating good will is adopted.
Step – 1. Calculation of total value of good will of the firm:
For 1/6 the share, the share of goodwill of the Dave= Rs.36,000
Therefore, the total value of goodwill of firm =Rs.36,000x6/1
= Rs. 2,16,000
Step -- 2. Comparing the total value of goodwill of firm with the book value of goodwill .Following are the goodwill amount to be raised for each case:
If no goodwill appears in the books of the Firm: In this case, the book value of goodwill is taken as zero. Hence , the goodwill to be raised is as follows:
Goodwill = Total Good will – Book value of Good will
= Rs.2,16,000 - 0 = Rs.2,16,000
If the good will account appears in the books of the firm at
Rs.2,16,000 : In the case, the goodwill to be raised is as follows:
Goodwill = Total Good will – Book value of Good will
= Rs.2,16,000 = Rs.2,16,000 = 0
If the goodwill account appears in the books of the firm at
Rs.1,35,000 : In this case, the goodwill to be raised is as follows:
Goodwill = Total Good will – Book value of Good will
= Rs.2,16,000 = Rs.1,35,000 = Rs.81,000
If the goodwill account appears in the books of the firm at Rs. 2,97,000 : In this case , the goodwill to be raised is as follows:
Goodwill = Total Good will – Book value of Good will
= Rs.2,16,000 = Rs.2,97,000 = - Rs.81,000
Following are the journal entries to be passed for each case:
Journal Entries
Particulars L.F Rs. Rs.


Good will A/c
To Patil’s Capital A/c
To Saxena’s Capital A/c
(The value of goodwill raised to its present value.i.e. 2,16,000 and is credited to old partners’ capital account in the old ratio 5:3)

NoEntry is required because the book value of goodwill is equivalent to its present value.

Good will A/c..
To Patil’s Capital A/c
To Sazena’s Capital A/c
(The difference is present value of goodwill is raised and goodwill is raised to its present value ie. 2,16,000 and is credited old partner’s capital accounts in old ratio 5:3)

Patil’s CapitalA/c Dr.
Saxena’s Capital A/c Dr.
To Goodwill A/c
(The difference is present value of goodwill is reduced and goodwill is brought down to its present value ie. 2,16,000 and is debited to old partner’s capital accounts in old ratio 5:3)
Dr.











Dr.



2,16,000











81,000





50,625
30,375



1,35,000
85,000










50,625
30,375





81,000


Memorandum Revaluation Method:
In the method , the amount of goodwill to be increased is found by adopting the steps given in the revaluation method and the same accounting entry is passed . The entry is
Goods will A/c… Dr.
To Old Partners’ Capital A/c (in old ratio)
Then, the raised goodwill is written off by debiting all the partners capital accounts including the new partner in the new profit sharing ratio. The amount of goodwill to be written off may be full or part. The accounting entry for writing off good will is
All Partner’s Capital A/c… Dr. (in new ratio)
To Goodwill A/c
Premium Method:
This method is followed when the new partner brings cash for his share of goodwill. The following are the accounting entries to be passed:
For cash brought in by the new partner as goodwill :
Cash A/c.. Dr.
To New Partner’s Capital A/c
For crediting the goodwill to sacrificing old partners and which is retained in the business:
New Partner’s Capital A/c Dr.
To Sacrificing Old Partners’ Capital A/c ( in sacrificing ratio)
For withdrawal of good will by old partners:
Sacrificing Old Partners’ Capital A/c
To Cash A/c
10.3.2.f ADJUSTMENT OF CAPITAL ACCOUNTS
When a partner is admitted, the capitals of the partners should be adjusted in their profit share assets and liabilities, i.e profit or loss on revaluation, treatment of goodwill, transfer of accumulated reserves, profits and losses, capital brought in by the new partner are to be incorporated into the capital accounts of the partners. The capitals of the partners may be adjusted in two ways. They are a) on the basis of the share of capital of the new partner of b) on the basis of the adjusted capitals of old partners.
a) On the basis of the share of capital of the new partner: Under this method, following are the steps followed to adjust the capital accounts of partners:
The total capital of the firm is found by taking the new partner’s share of capital as the basis. For example, if a new partner brings Rs.50,000 as capital for 1/4th share. then the total capital of the firm taking his share of capital as base is = Rs.50,000 x4/1= Rs.2,00,000

The total capital of the firm is divided in the profit sharing ratio to find the new capitals of old partners.
The capitals of the old partners are adjusted with profit or loss on revaluation, goodwill and accumulated reserves, profits or losses.

The difference between the new capitals and adjusted capitals(arrived in step3) is found. If the new capitals are more than the adjusted capitals, the excess capital is paid to the partners or credited to the current account of the partners. If the new capitals are less than the adjusted capital, the shortage in capital is received from the partners or debited to the current account of the partners.
Example:
Bina and Ganguly are partners sharing profits and losses in the ratios of 5:3 with capitals of Rs. 30,000 and Rs.13,500 respectively. They decided to admit Susan as a partner with Rs.18,750 for 1/3th share of the profits of the new firm. Adjust the capitals of the partners according to the profit sharing ratio and transfer the same to current accounts of partners.
Solution
It is asked to adjust the capitals of the partners on the basis of new partner’s capitals . The following steps are followed.
Calculation of total capital of the firm:
For 1/3rd share , capital of Susan = Rs. 18,750
Therefore, the total capital of firm = Rs. 18,750 x 3/1
= Rs. 56,250
Calculation of newcapitals of partners in the new profit sharing ratio:
For this , the new profit sharing ratio of partners is required.
Assume the Total Profit =1
Less: Susan’s share = 1/3
Remaining profit = 1-1/3 = 2/3
Remaining Profit of 2/3rd is to be shared between old partners in the old ratio. Thus.
Bina’s share of profit = 5/8 of 2/3 = 5/8x2/3=5/12
Ganguly’s share of profit = 3/8 of 2/3 = 3/8 x2/3=3/12
New Profit Sharing Ratio of all partners is
Bina : Ganguly : Susan
5/12 : 3/12 : 1/3
5/12 : 3/12 : 4/12
5 : 3 : 4
The new capitals of the partners in new profit sharing ratio is
Total capital of the firm = Rs.56,250
Share of Bina Rs.56,250 x5x12 = Rs.23,438
Share of Ganguly Rs.56,250 x3/12 = Rs.14,062
Share of Susan Rs. 56,250 x4/12 = Rs.18,750

Comparing the old capitals and new capitals:
Excess of shortage of capital = Old Capital - New Capital
For Bina = Rs.30,000 – 23,438 = +Rs.6,562(Excess)
For Ganguly = Rs.13,500 – Rs.14,062 = Rs.562 (Shortage)
The Journal entries are
Bina’s Capital A/c.. Dr 6,562
To Bina’s Current 6,562
(The surplus capital creditedto
Bina’s current account)
Ganguly’s Current A/c Dr. 562
To Ganguly’s Capital A/c 562
(The shortage of capital debited
to Ganguly’s current account)

b) On the basis of the adjusted capitals of old partners: Under this method, following are the steps followed to adjust the capital account of partners:
The capitals of the old partners ae adjusted with profit or loss on revaluation, goodwill and accumulated reserves, profits or losses.
The total capital of the firm is found by taking the adjusted capitals of old partners as base.
The proportionate capital of the new partner is calculated taking the total capital of the firm (arrived in step2) as base. The proportion of new partner’s capital will be given in the problem.
If any capital is already introduced by the new partner, the same is compared with his proportionate capital (arrived in step2). If the proportionate capital is move than the capital already introduced by him. Then the new partner has to bring cash for the shortage of capital and if the proportionate capital is less than the capital already introduced by him. Then the new partner has to withdraw the excess amount of capital.

Example:-
Mangesh and Suresh are partners sharing profits and losses equally. They admit Natesh as partner who has to be contribute sufficient capital to acquire a 1/4th share of the total capita of the new firm equally from both the partners Mangesh and Suresh . The adjusted capitals of Mangesh and Suresh are Rs.50,000 and 40,000 respectively, Calculate the capitals to be brought in by Naresh.
Solution:-
Calculation of adjusted capitals of old partners:
Total Adjusted Capitals = Rs.50,000 + Rs.40,000
= Rs. 90,000
Calculation of total capital of the firm based on adjusted capitals of old partners:
Assume Total Profit = 1
Less: Share of Naresh = ¼
Remaining share = 1-1/4 = ¼
For 3/4th share, the adjusted capital = Rs.90,000
Therefore, the total capital of firm = Rs.90,000 x4/3
= Rs.1,20,000
Calculation of Proportionate capital of new partner:
Capital of Naresh = Total Capital x1/4th share
=Rs.1,20,000x1/4=Rs.30,000
PROBLEMS WITH ALL ADJUSTMENTS
Example :-
Jaiveer and Vishnu are partners sharing profits and losses in the ratio of 3:2 Following is their Balance Sheet as on 31st December 1993.
Liabilities Rs. Assets Rs. Rs.
Sundry Creditors
Bills Payable
General Reserve
Capital Accounts
Jaiveer
Vishnu 18,000
2,000
5,000

30,000
25,000
80,000 Cash in hand and at bank
Sundry Debtors
Less: Provision

Stock in trade
Furniture
45,000
1,000
10,000


44,000
20,000
6,000
80,000

On 1.1.94 they admit Rajesh as a partner on the following terms:
The provision for doubtful debts is to be increased to Rs.1,800
Unrecorded investments amounting to Rs.4,000 are to be recorded in the books of accounts.
Goods of the firm should be valued at Rs.25,000
The new profit sharing ratio of Jaiveer, Vishnu and Rajesh shall be 5:3:2 respectively.
Rajesh shall bring in a capital of Rs.25,000
You are required to give the journal entries to carry out the above arrangement. Prepare Revaluation Account, show the capital accounts and the Balance Sheet of the firm after admission of the new partner, Rajesh.
Journal Entries
Date Particulars L.F Rs. Rs.
2000
Mar.31



,,



,,




,,


,,



,,



1994
Jan.1
Revaluation A/c
To Provision for doubtful debts
(Increase in the provision for doubtful debts recorded)
Investment A/c
To Revaluation A/c
(Unrecorded investment recorded
Revaluation A/c
To Jaiveer’s Capital A/c
T0 Vishnu’s Capital A/c
(Profit on revaluation of assets transferred to old partner ‘s capital accounts in the old ratio 3:2
General Reserve A/c
To Jaiveer’s Capital A/c
T0 Vishnu’s Capital A/c
(General Reserve transferred to old partners, Capital account in old ratio 3:2
Goodwill A/c
To Jaiveer’s Capital A/c
T0 Vishnu’s Capital A/c
(Goodwill of the firm valued at Rs.25,000 and is credited to old partners’capital accounts in old Ratio)
Cash will A/c
To Rajesh’s A/c
(Capital brought by Rajesh Rs.25,000 is recovered )

Dr.



Dr.



Dr.



Dr.



Dr.



Dr.




Dr.
800



4,000



3,200




5,000




25,000*





25,000

800



4,000



1,920
1,280



3,000
2,000



15,000
10,000




25,000


Revaluation A/c
1993
Dec.31
Dec.31

To Provision for doubtful debts
To Profit on Revaluation
Transferred to
Jaiveer’s Capital A/c (3/5) 1,950
Vishnu’s Capital A/c (2/5) 1,280
Rs.
800




3,200
4,000 1993
Dec.31
Investment A/c Rs.
4,000





4,000


Capital Accounts of Partners

Jaiveer
Rs. Vishnu
Rs. Rajesh
Rs. Jaiveer
Rs. Vishnu
Rs. Rajesh
Rs.
To Balance c/d
49,920





49,920
38,280





38,280 25,000





25,000 By Balance b/d
By Revaluation A/c
By General Reserve
By Goodwill A/c
By Cash A/c


By Balance b/d 30,000
1,920
3,000
15,000


49,920
49,920 24,000
1,280
2,000
10,000


38,280
38,280 --



25,000

25,000
25,000

Balance Sheet of Jaiveer, Vishnu and Rajesh As on 1.1.1994.

Liabilities Rs. Assets Rs. Rs.
Sundry Creditors
Bills Payable

Capital Accounts
Jaiveer
Vishnu
Rajesh 18,000
2,000


49,920
38,280
25,000


1,33,200 Cash in hand and at bank
Sundry Debtors
Less: Provision

Stock in trade
Furniture
Investment
Goodwill
45,000
1,800 35,000


43,200
20,000
6,000
4,000
25,000

1,33,200

Working Notes:
(1) Cash A/c

To Balance b/d
To Rajesh’s Capital A/c


To Balance b/d Rs.
10,000
25,000

35,000
35,000

By Balance c/d Rs.
35,000


35,000



Unit Questions:
1. Define the term ‘Partnership’. List its essential elements.
2. What is meant by fixed capital method? How does it differ from fluctuating capital accounts?
3. Show how the following items will appear in the capital accounts of the partners Babu and Gopu when their capitals are fluctuating.
Babu
Rs. Gopu
Rs.
Capital on 1-1-1987 8,00,000 7,00,000
Drawings during 1987 1,60,000 1,40,000
Interest at 5% on drawings 4,000 2,000

Shares of profits for 1987 84,000 66,000
Interest on capital at 6% 48,000 42,000
Salary 72,000 Nil

4. What are the adjustments to be made while admitting a new partner?
5. What is a Revaluation Account? How does it differ from Memorandum Revaluation Account?
6. Explain the various methods of treating goodwill at the time of admission of a partner?
7. P and Q were sharing profits in the ratio of 4:3. R was admitted in the business as a partner on 1st January, with 3/7th share in profits of the firm which he takes 2/7th from P and 1/7th from Q. Find the new and sacrificing ratio.

8. L and M are partners sharing profits and losses in the ratio of 7:3. N is admitted into the partnership. L surrenders 1/7th of his share and M surrenders 1/3rd of his share in favour of N. Calculate the new and sacrificing ratio.

9. A and B are partner sharing profits in the ratio 3:2. They admit C into partnership, C paying a premium of Rs.4,000 for 1/4th share of profit. No goodwill account appears in the books. They withdrew the amount of goodwill. Pass journal entry.

10. The following was the Balance Sheet of Sharma, Varma and Seshan on 31st March, 2000.
Liabilities Rs. Assets Rs.
Bills Payable 19,800 Cash 3,600
Creditors 36,000 Debtors 64,800
Capital accounts Stock 68,400
Sharma 1,00,800 Furniture 14,400
Varma 75,600 Building 1,17,000
Seshan 36,000
2,68,200 2,68,200

They agree to admit Gil into partnership for 1/4th share in the profits on the following terms:
That Gil should bring in Rs.54,000 for goodwill and Rs.90,000 as capital.
That one half of the goodwill shall be withdrawn by the old partners.
That stock and furniture be depreciated by 10%
That a provision of 5% on debtors be created against bills discounted.
That a liability for Rs.6,840 be created against bills discounted.
That the value of the building is undervalued by Rs.51,000
That the value of liabilities and assets other than cash are not to be altered.
You are required to give necessary journal entries to give effect to the above arrangements and prepare Revaluation Account and the opening Balance Sheet of the newly constituted firm.

Dinesh Kandagatla
Dinesh
Kandagatla
an email at crmnldan1729@gmail.com