Admission of a Partner Class 12 Notes: CBSE Accountancy Chapter 2

• When a new partner's admitted, the firm must adjust its books to include matters such as goodwill, revaluation of assets and liabilities, reserves, and accumulated profits and losses.

• The new partner's share in profits is acquired from the old partners, reducing their profits.

• The new partner's share is determined by deducting their share of sacrifice from their old share in profits. The sacrificing ratio is the ratio in which old partners agree to sacrifice profit share profit for the new partner. Goodwill, an intangible asset, is treated differently by the firm depending on the situation.

• When a partner is admitted, adjustments are made to assets and liabilities, reserves, and accumulated profits/losses.

• These adjustments are made through the Revaluation Account, and any gains or losses are distributed among the old partner in their old profit-sharing ratio. If agreed, partners' capital may be adjusted proportionately to their new profit-sharing ratio, with the new partner's capital used as a base.

• Changes in the profit-sharing ratio may result in some partners gaining future profits while others lose, requiring adjustments in partners' capital accounts, revaluation of assets, and reassessment of liabilities.

1. What are the modes of reconstitution of a partnership firm?

• Acceptance of a new associate

• Modification in the current partners' profit-sharing arrangement

• Retirement of a current associate

• Loss of a spouse

2. Rights acquired by newly admitted partner

A recently admitted partner's rights are:

• Possession of the right to divide partnership business assets

• The right to split partnership earnings

3. Things to be considered at the time of admission of a partner

• The distribution of accumulated profits (reserves).

• The new profit sharing ratio.

• The sacrifice ratio.

• The valuation and adjustment of goodwill.

• The revaluation of assets and the reevaluation of liabilities.

• Modification of partners.

4. New Profit Sharing Ratio

The existing partners give up a portion of their earnings upon the admission of a new partner. However, the old partners and the new partner decide jointly on the new partner's share and how he will purchase it from the current partners. It may be presumed that the new partner obtains his share from the existing partners in their profit-sharing ratio, nevertheless, if it is not made clear how he does so. Taking into account each old partner's contribution to the new partner's profit-sharing ratio, the old partner's profit-sharing ratio will alter. A new profit-sharing ratio must therefore be implemented.

5. What is the Sacrificing Ratio?

The term "sacrificing ratio" refers to the ratio at which the current partners consent to give up their profit-sharing to the new partner. In terms of math,

Sacrificing Ratio = Old share of profit- New share of profit

6. What is Goodwill?

Over some time, a well-established business develops the advantage of a good name, reputation, and wide business connections. This helps the business to earn more profits as compared to a newly set up business. In accounting, the monetary value of such an advantage is known as “goodwill”. It is an intangible asset. In other words, goodwill is the value of the reputation of a firm for the profits expected in the future over and above the normal profits.

7. Factors affecting the value of Goodwill

The following variables have an impact on goodwill's value:

• Character of a Business: Businesses improve society and bring about beneficial changes, which inevitably leads to a rise in goodwill.

• Location: Goodwill is more likely to be present if the company is in a busy area or is conveniently located.

• Efficiency of Management: High productivity and cost efficiency are the end consequences of effective management, which generates profit and, consequently, goodwill for the business.

• Market Situation: There is a greater chance of profit and, hence, goodwill if there is monopoly power or little competition in the market.

• Special Advantages: Companies benefit from low prices and guaranteed electricity supplies, import permits, reputable partners, long-term contracts for material supply, patents, trademarks, and a higher value of goodwill.

8. Need for valuation of Goodwill

• Modification of the current partners' profit-sharing percentage.

• A new partner's admission. 

• A partner's retirement. 

• A partner's death. 

• A firm's dissolution involving the sale of the business is a going concern

• Combining a partnership.

9. Methods of valuation of Goodwill

(i) Average Profits Method: Using the average profits of the previous few years as a starting point, goodwill is valued at a certain number of "years" of purchases. It is predicated on the idea that a startup company will not be able to turn a profit in the initial years of its existence. Therefore, the buyer of an existing business must pay an amount equal to the earnings he anticipates making in the next few years in goodwill. Therefore, the best way to determine goodwill is to multiply previous average profits by the number of years that the expected gains are estimated to accumulate.

(ii) Super Profits Method: According to this method, the value of goodwill is determined using excess profits rather than actual profits because it is argued that the buyer's true benefit is restricted to profits that exceed the typical return on capital used in businesses that are similar to the buyer's.

Mathematically,

Normal Profit = Firm’s Capital X Normal Rate of Return / 100

(iii) Capitalization Method: This approach bases its calculation of goodwill on two factors:

(a) Capitalization of Average Earnings: Using the usual rate of return, the capitalised value of average earnings is divided by the actual firm capital invested in the business to determine the goodwill value. The following actions are necessary for this:

• Determine the average earnings by looking at the last few years.

• To get the capitalised value of average earnings, capitalise the average profits based on the standard rate of return. This can be done as follows: Profits on Average 100/Normal Rate of Return

• After subtracting outside obligations from the total assets (goodwill and fictional assets excluded), find the true capital of the company, or net assets. Capital of Firm's = Total Assets (goodwill excluded) Liabilities from the Outside where both long-term and short-term liabilities are included in the outer liabilities.

(b) Capitalization by Super Profits: Direct capitalization of the super profit is another way to calculate goodwill. It is not necessary to calculate the capitalised value of average earnings while using this method. The following actions are involved.

Determine the firm's capital, which is equal to its total assets less its external liabilities (goodwill and fictional assets excluded).

Determine the typical capital gains.

Determine the historical average profit, as

Subtract regular profits from average profits to determine extraordinary profits.

Add the necessary rate of return multiplier to the super earnings, that is,

Goodwill = Super Profits  X 100 Normal Rate of Return

Journal Entries:

Treatment of Goodwill

Incoming partners, who acquire a share of the firm's profits from existing partners, bring in an additional amount called their share of goodwill, or premium for goodwill.

When the new Partner brings goodwill in cash: The new partner's premium is shared among existing partners in their ratio of sacrifice. If paid privately, no entry is made in the firm's books.

(i) Bank A/c Dr. To Premium for Goodwill A/c (Amount brought by new partner as premium) 

(ii) Goodwill A/c Dr. To Sacrificing Partners Capital A/c (Individually)(Goodwill distributed among the existing partners’ in their sacrificing ratio).

Alternatively,

(i) Bank A/c Dr. To New Partner’s Capital A/c (Amount brought by the new partner for his share of goodwill). 

(ii) New Partner’s Capital A/c Dr. To Sacrificing Partner’s Capital A/c’s (Individually) (Goodwill brought by new partners distributed among the existing partners in their sacrificing ratio)

When the new partner does not bring goodwill in cash, partly or fully

(a) Goodwill does not exist in the books: When goodwill does not exist in the books, sacrificing partners are credited with their share of goodwill and the new partner is debited by the amount of goodwill not brought by him. The journal entry in this case is :

Incoming (New) Partners Current A/c Dr. To Sacrificing Partners Capital A/c (individually) (Account of goodwill not brought in by new partner)

(b) Goodwill exists in the books: Goodwill appearing in the books will be written off by debiting old partners ‘capital accounts in their old profit sharing ratio. Thereafter new value of goodwill will be given effect by crediting sacrificing partners' capital accounts and debiting new partners’ current accounts.

(i) When the value of goodwill appears in the books and is written off Partners capital A/c (old) Dr. (In profit sharing ratio) To Goodwill A/c (Goodwill appearing in the books written-off)

(ii) For the new value of goodwill:- Incoming partners' current A/c. Dr. To Sacrificing partners capital A/c. [In sacrificing ratio) (individually)

Hidden Goodwill

Goodwill value is often inferred from capital and profit sharing ratios. In a case where A and B share profits equally, C is admitted for a third share. The total capital of the newly formed firm is Rs. 1,80,000, but the actual total is Rs. 1,50,000. The difference is due to goodwill, which is to be shared equally by A and B, raising their capital accounts to Rs. 60,000 each and the firm's total capital to Rs. 1,80,000.

Adjustment for Accumulated Profits and Losses

A firm may have accumulated profits not yet transferred to partners' capital accounts, such as general reserve, reserve, or Profit and Loss Account. New partners aren't entitled to share these profits. Accumulated losses, such as debit balances or deferred revenue expenditure, should be transferred to old partners' capital accounts.

Revaluation of Assets and Reassessment of Liabilities

When a new partner is admitted, the firm must ensure its assets and liabilities are displayed at their current values. If assets are overstated or understated, they are revalued. Unrecorded assets and liabilities must also be accounted for. The Revaluation Account is created to track the gain or loss of each asset and liability, with the balance transferred to the old partners' capital accounts in their old profit sharing ratio. A credit balance indicates net gain, while a debit balance indicates net loss.

(i) For increase in the value of an asset Asset A/c Dr. To Revaluation A/c (Gain) 

(ii) For reduction in the value of an asset Revaluation A/c Dr. To Asset A/c (Loss) 

(iii) For appreciation in the amount of a liability Revaluation A/c Dr. To Liability A/c (Loss) 

(iv) For reduction in the amount of a liability Liability A/c Dr. To Revaluation A/c (Gain) 

(v) For an unrecorded asset Asset A/c Dr. To Revaluation A/c (Gain) 

(vi) For an unrecorded liability Revaluation A/c Dr. To Liability A/c (Loss) (vii) For transfer of gain on Revaluation if credit balance Revaluation A/c Dr. To Old Partners Capital A/cs (Old ratio) (individually) 

(viii) For transferring loss on revaluation of Old partner’s Capital A/cs Dr. (Individually) (Old ratio) To Revaluation A/c

Adjustment of Capitals

Partners may adjust their capital proportionate to their profit sharing ratio during admission. The new partner's capital can be used to calculate the old partner's new capital. After adjustments, partners with short capital bring in the necessary amount, while those with surplus capital withdraw excess capital.

Change in Profit Sharing Ratio among the Existing Partners

A firm's partners may change their profit sharing ratio without a partner's admission or retirement, resulting in a gain for some partners and a loss for others.

5 Important Topics of Class 12 Chapter 2 You Shouldn’t Miss!

Importance of Revision Notes

• Revision notes highlight the key points and important information frequently asked in exams.

• These notes save time during last-minute revisions by quickly summarising the entire chapter.

• These notes are structured to cover all relevant topics systematically, aiding comprehensive preparation. 

• Practical examples and solved problems help in understanding the application of theoretical concepts. The notes are tailored to focus on exam preparation, ensuring that students are well-prepared for the questions they might encounter.

• With downloadable PDFs available, students can easily access these notes anytime, facilitating flexible study schedules.

Tips For Learning the Class 12 Accountancy Chapter 2 Admission of a Partner

• Make sure to become familiar with important terms such as goodwill, sacrificing ration, and other topics covered in this revision note.

• Work on solving different problems and exercises from your textbook and reference books to improve your understanding and application skills.

• Create summary charts or tables to revise concepts, formulas, and journal entries quickly.

• Review previous years' question papers to understand the types of questions asked and the marking scheme.

• To reinforce your learning, use online resources provided by Vedantu, such as educational videos, interactive quizzes, and practice tests.

Conclusion

Chapter 2 of Class 12 Accountancy, Admission of a Partner Notes is important for understanding the complexities involved when a new partner joins a partnership firm. Key topics such as the calculation of the new profit-sharing ratio, treatment of goodwill, revaluation of assets and liabilities, adjustment of capital, and the accounting treatment for reserves and accumulated profits are essential for accurate financial management and fair distribution of profits and losses. Understanding these concepts in the Admission of Partner short note ensures that students are well-prepared for their exams and can handle real-life partnership scenarios effectively.

Chapter-wise Revision Notes Links for 12 Accountancy Part I 

Chapter-wise Revision Notes Links for 12 Accountancy Part II

Important Study Materials For Class 12 Accountancy