Class 12 Book Keeping and Accountancy Chapter 3: Reconstitution of Partnership (Admission of Partner)

Key concepts: Reconstitution of Partnership (Admission of Partner)

Reconstitution of partnership

A change in the partnership agreement that alters the relationship and profit shares of partners. Forms: change in profit ratio, admission, retirement and death of a partner.

Admission of a partner

A new partner can join only with the consent of all existing partners (Sec 31(1), Partnership Act 1932). He brings capital and usually his share of goodwill, and shares future profits.

New ratio and sacrifice ratio

New share of an old partner = old share x (1 - new partner's share). Sacrifice ratio = old ratio - new ratio; it shows how much each old partner gives up.

Goodwill

The value of a firm's name, reputation and goodwill with customers that helps it earn extra profit. Average profit method: average profit x years' purchase.

Super profit method

Super profit = average profit - normal profit, where normal profit = capital employed x normal rate of return. Goodwill = super profit x years' purchase.

Treatment of goodwill

Premium method: new partner brings goodwill in cash and it goes to old partners in the sacrifice ratio. Valuation method: goodwill is raised in the books and credited to old partners in the old ratio.

Revaluation account

A nominal account (or Profit and Loss Adjustment A/c) in which changes in assets and liabilities are recorded. Its profit or loss is shared by old partners in their old ratio.

Reserves and capital adjustment

Reserves and undistributed profits go to old partners' capital accounts, accumulated losses are debited to them. Capitals may then be adjusted to the new ratio, with the difference settled in cash, current or loan account.

Quick revision: important points

• New ratio = old ratio x (1 - new partner's share); sacrifice ratio = old ratio - new ratio.
• Average profit = total profit / number of years; goodwill = average profit x years' purchase.
• Super profit = average profit - normal profit; normal profit = capital employed x NRR / 100.
• Goodwill privately paid to old partners needs no entry in the firm's books.
• Revaluation profit or loss and reserves are shared by old partners in the old ratio.
• Total capital = new partner's capital x reciprocal of his share; surplus capital is withdrawn, deficit is brought in.

Practice MCQs with answers

1. Reconstitution of a partnership firm mainly means:

   1. Closing down the firm and selling all its assets
   2. A change in the partnership agreement that alters partners' relationship and profit shares
   3. Converting the firm into a joint stock company
   4. Preparing the final accounts at the end of the year
   Show answer

   Answer: B. A change in the partnership agreement that alters partners' relationship and profit shares
   Reconstitution is a change in the agreement among partners which changes their relationship and their shares of profit or loss.

2. Which of the following is NOT a form of reconstitution of a partnership?

   1. Admission of a partner
   2. Retirement of a partner
   3. Death of a partner
   4. Purchase of a new machine by the firm
   Show answer

   Answer: D. Purchase of a new machine by the firm
   The forms are change in the profit sharing ratio, admission, retirement and death of a partner. Buying a machine does not change the agreement.

3. As per Section 31(1) of the Partnership Act 1932, a new partner can be admitted:

   1. Only with the consent of all existing partners, unless otherwise agreed
   2. By the decision of the senior-most partner alone
   3. Only if the Registrar of Firms gives permission
   4. By a simple majority of the partners
   Show answer

   Answer: A. Only with the consent of all existing partners, unless otherwise agreed
   Admission needs the consent of all the existing partners unless the agreement says otherwise.

4. Why is a new partner generally admitted to a firm?

   1. To reduce the total capital of the firm
   2. To avoid keeping books of accounts
   3. To increase the capital and use his skills to improve the firm's performance
   4. To close down old loans of the firm
   Show answer

   Answer: C. To increase the capital and use his skills to improve the firm's performance
   A new partner is brought in to widen the capital base and to use his skills for better performance.

5. Goodwill of a firm is best described as:

   1. A physical asset such as machinery
   2. The benefit of the firm's name, fame and reputation that helps it earn more profit
   3. The amount owed to trade creditors
   4. Cash kept aside as a reserve
   Show answer

   Answer: B. The benefit of the firm's name, fame and reputation that helps it earn more profit
   Goodwill is an intangible advantage of reputation and image that helps the business earn more profit.

All Class 12 Book Keeping and Accountancy chapters

• Chapter 1: Introduction to Partnership and Partnership Final Accounts
• Chapter 2: Accounts of Not for Profit Concerns
• Chapter 3: Reconstitution of Partnership (Admission of Partner)
• Chapter 4: Reconstitution of Partnership (Retirement of Partner)
• Chapter 5: Reconstitution of Partnership (Death of Partner)
• Chapter 6: Dissolution of Partnership Firm
• Chapter 7: Bills of Exchange
• Chapter 8: Company Accounts - Issue of Shares
• Chapter 9: Analysis of Financial Statements
• Chapter 10: Computer in Accounting

Class 12 Book Keeping and Accountancy notes: all chapters