Reconstitution of a Partnership Firm - Admission of a Partner
Class 12 · Accountancy
4 ideas in Class 12 Accountancy, explained in plain words, with games and quizzes to practise.
New Profit Sharing Ratio on Admission
Part of: Sharing profits with a newcomer
When a new partner joins, the old partners give up part of their combined profit share to make room for her. The new profit sharing ratio lists every partner's share, old and new, after this adjustment. For example, if two partners share 3 to 2 and the newcomer takes one fifth, the remaining four fifths is still split 3 to 2.
Why it matters. Every later adjustment at admission, from goodwill to reserves, depends on the old and new ratios. A wrong new ratio sends every partner's capital and compensation to the wrong place, so getting it right protects everyone's money.
Formulas
- New share = Old share - Share given up
- Remaining share = 1 - Newcomer share
- Check: all new shares add to 1
Key words
- New profit sharing ratio
- : List of every partner's profit share after the newcomer joins.
- Share given up
- : Part of an old partner's profit share passed to the newcomer.
- Newcomer share
- : Fraction of total profit promised to the joining partner.
- Old ratio
- : Profit sharing ratio of the partners before admission.
Try it in two minutes
- Use two pens for partner A and one pen for partner B to show shares 2 to 1. Ask: how many pens show the whole firm?
- Add a pencil for a newcomer with a one quarter share. Ask: whose pens must shrink, and why?
- Move half a pen's worth from each old partner to the newcomer. Ask: what are the three new shares now?
Try at home. Pick any old ratio such as 4 to 1 and a newcomer share such as one sixth. Work out the new ratio on paper and check that all shares add to one.
Sacrificing Ratio and Premium for Goodwill
Part of: Sharing profits with a newcomer
The sacrificing ratio measures how much profit share each old partner gives up for the newcomer, found by subtracting each new share from the old share. When the firm earns above-normal profits, the newcomer pays a premium for goodwill, which goes only to the partners who sacrificed, split in this ratio. For example, sacrifice shares of 3 parts and 1 part split a premium of 48000 as 36000 and 12000.
Why it matters. Without this split, a partner who gave up nothing could pocket money meant for one who gave up a lot. The ratio keeps the compensation honest and prevents disputes after admission.
Formulas
- Sacrifice = Old share - New share
- Premium share = Premium x Sacrifice parts / Total sacrifice parts
- Goodwill = Average profit x Years of purchase
Key words
- Sacrificing ratio
- : Share of profit each old partner gives up for the newcomer.
- Premium for goodwill
- : Amount the newcomer pays for a share in the firm's reputation.
- Average profit
- : Mean of past yearly profits used to value goodwill.
- Years of purchase
- : Number of years of profit paid as the goodwill price.
Try it in two minutes
- Use 8 coins to show an old 5 to 3 split between two partners.
- Take coins away to show the new shares and count what each partner lost.
- Share 8 more coins as the premium in the same lost-coins ratio. Ask: who gets more, and why is that fair?
Try at home. Take an old ratio of 4 to 1 and a new ratio of 3 to 1 to 1, find who sacrificed what, then split a premium of 25000 between the sacrificers.
Revaluation of Assets and Liabilities
Part of: Restating the books at admission
At admission, the firm lists its assets and liabilities at present market values instead of old book values. Rises in assets, newly found unrecorded assets and falls in liabilities create gains, while the reverse creates losses. The net result goes to the old partners in their old ratio, since it reflects their period. For example, a net gain of 10000 shared 3 to 2 credits 6000 and 4000.
Why it matters. The newcomer should neither gain from past price rises nor suffer past falls. Revaluation draws a clean line so she pays only for the firm as it stands today.
Formulas
- Gain = Rise in asset + Fall in liability
- Loss = Fall in asset + Rise in liability
- Net result shared in old ratio
Key words
- Revaluation account
- : Record that collects gains and losses from restating values.
- Book value
- : Value at which an item stands in the books.
- Unrecorded asset
- : Valuable item owned by the firm but not shown in books.
- Provision
- : Estimated amount set aside for an expected loss.
Try it in two minutes
- Pick three home items and guess what each would sell for today versus its old bill.
- Sort each change into a gain pile or a loss pile.
- Find the net pile and share pretend coins of it 3 to 2. Ask: who earned this gain, the old owners or a newcomer?
Try at home. List one asset that rose and one unpaid bill in your home budget, find the net effect, and split it between two people 2 to 1.
Reserves, Past Losses and Capital Adjustment
Part of: Restating the books at admission
General reserves and past undistributed profits belong to the old partners, so they are credited to them in the old ratio, while past losses and postponed spending are debited the same way. The newcomer shares none of these. Her capital is then fixed either by agreement or in proportion to her profit share. For example, with old capitals of 90000 and 60000 and a one fifth share, she brings 37500.
Why it matters. Mixing past savings with the newcomer's money would let her claim profits she never helped earn. Clean separation keeps old rewards with old partners and starts the newcomer on a fair footing.
Formulas
- Reserve share = Reserve x Old parts / Total old parts
- Newcomer capital = Old partners total x Her share / Their combined share
- Firm total = Newcomer capital / Her share
Key words
- General reserve
- : Past profits kept aside for future needs.
- Accumulated loss
- : Past losses not yet written off in the books.
- Capital adjustment
- : Fixing each partner's capital to match the new deal.
- Proportionate capital
- : Capital kept in line with the profit share.
Try it in two minutes
- Take 6 marbles as a general reserve shared 2 to 1 between two old partners.
- Give 4 to the first and 2 to the second, leaving the newcomer's cup empty. Ask: why does she get none?
- Take back 3 marbles as an old loss in the same 2 to 1 split. Ask: whose savings fell?
- Set her capital marbles so her share of all marbles matches her profit share.
Try at home. Share 9000 of old savings between two people 2 to 1, then find the fair amount a third person brings for a one quarter share of the new total.
What your child will practise
- New Profit Sharing Ratio on Admission: Jungle Quick Fire (Quick Fire)
- Reserves, Past Losses and Capital Adjustment: Candy Puzzle (Clue Puzzle)
- Reserves, Past Losses and Capital Adjustment: Candy Quick Fire (Quick Fire)
- Revaluation of Assets and Liabilities: Desert Quick Fire (Quick Fire)
- Sacrificing Ratio and Premium for Goodwill: Space Puzzle (Clue Puzzle)
- Quiz: New Profit Sharing Ratio on Admission (8 questions)
- Quiz: Reserves, Past Losses and Capital Adjustment (8 questions)
- Quiz: Revaluation of Assets and Liabilities (8 questions)
- Quiz: Sacrificing Ratio and Premium for Goodwill (8 questions)