Lets say a business is running well, but its owners decide to bring in a fresh face. Perhaps for extra capital, maybe for fresh skills, or even for strategic alliances. This moment – when a new person is allowed to share the profits and responsibilities – is called Admission of a partner. It is one of the most examined topics in Partnership Accounting because it combines several adjustments like Goodwill, Revaluation of assets, Reserves, and apCital balances.
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Meaning of Admission
Admission of a partner means including a new partner into the existing partnership firm with the consent of all existing partners. After admission, the new partner becomes entitled to share in the future profits (and losses) of the business. This is usually done through a formal agreement, either by preparing a fresh Partnership Deed or by amending the existing one.
Why does admission matter?
Because whenever a new partner comes in, the financial rights of existing partners change – their share of profits reduces. Naturally, adjustments must be made so that everyone’s contribution and sacrifice are fairly recorded.
Key Adjustments on Admission
Admission of a partner typically requires the following adjustments to bring fairness:
- Valuation and treatment of Goodwill
- Revaluation of assets and liabilities
- Adjustment of accumulated reserves and undistributed profits
- Determination of new profit-sharing ratio and sacrificing ratio
- Adjustment of partners’ capital accounts
Goodwill
Goodwill is the reputation of a firm that enables it to earn super profits compared to other firms. When a new partner is admitted, he/she compensates the old partners for the share of goodwill earned by them over the years.
a. Methods of Valuing Goodwill
- Average Profit Method:
Goodwill = Average Profit × Number of Years’ Purchase.
Example: Average profit of last 3 years = ₹40,000; No. of years purchase = 3
Goodwill = 40,000 × 3 = ₹1,20,000 - Super Profit Method:
Goodwill = Super Profit × Number of Years’ Purchase.
Super Profit = Actual Average Profit – Normal Profit.
Normal Profit = Capital Employed × Normal Rate of Return / 100. - Capitalization Method:
Goodwill = Capitalized Value – Net Assets.
Capitalized Value = Average Profit × 100 / Normal Rate of Return.
b. Accounting Treatment of Goodwill
There are two scenarios:
| Scenario | Journal Entry |
|---|---|
| Goodwill brought in cash by new partner | Bank A/c Dr. To Goodwill A/c Goodwill A/c Dr. To Old Partners’ Capital A/cs (in sacrificing ratio) |
| Goodwill not brought in cash | New Partner’s Capital A/c Dr. To Old Partners’ Capital A/cs (in sacrificing ratio) |
Revaluation of Assets and Liabilities
Whenever a partner is admitted, assets and liabilities must be shown at their current values to ensure the new partner is neither overcharged nor undercharged. For this, a Revaluation Account is prepared.
a. Format of Revaluation Account
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Decrease in value of assets | xxx | |
| Increase in liabilities | xxx | |
| Increase in value of assets | xxx | |
| Decrease in liabilities | xxx | |
| Profit on Revaluation (transferred to Old Partners’ Capital A/cs) | Bal. fig. | |
| Loss on Revaluation (transferred to Old Partners’ Capital A/cs) | Bal. fig. |
Adjustment of Reserves & Accumulated Profits
General Reserve, Profit & Loss A/c (credit balance), Workmen Compensation Reserve (excess) etc., are distributed among old partners in their old profit-sharing ratio before admission of the new partner.
New Profit-Sharing Ratio & Sacrificing Ratio
When a new partner is admitted, we must calculate the New Profit-Sharing Ratio (NPSR) among all partners. This depends on the share given to the new partner.
Sacrificing Ratio is the portion of profit given up by existing partners in favour of the new partner. It is calculated as:
Sacrificing Ratio = Old Ratio – New Ratio
This ratio is essential to determine how goodwill compensation is credited to old partners.
Capital Adjustments
After all the above adjustments, capital accounts may be adjusted to be in proportion to the new profit-sharing ratio. This can be done either by introducing additional capital by partners with lesser balance or by withdrawing capital by partners with excess balance.
Example: A and B are partners sharing profits in 3:2 ratio. Their capitals are ₹1,00,000 and ₹80,000. C is admitted for 1/4th share. Goodwill of the firm is valued at ₹60,000. C brings capital and goodwill in cash. Assets are revalued upwards by ₹20,000.
Journal Entries:
Bank A/c Dr. 1,05,000
To C’s Capital A/c 90,000
To Goodwill A/c 15,000
Goodwill A/c Dr. 15,000
To A’s Capital A/c 9,000
To B’s Capital A/c 6,000
Revaluation A/c Dr. 20,000
To A’s Capital A/c 12,000
To B’s Capital A/c 8,000
After these entries, capital accounts are rebalanced to match new profit-sharing ratio, if required.
Quick Notes
- Formula for Sacrificing Ratio: Old Ratio – New Ratio
- Always adjust reserves and accumulated profits before calculating new capital accounts.
- Revaluation profit or loss is shared only by old partners in old ratio.
- If goodwill is not brought in cash, debit new partner’s capital account directly.
Admission of a partner is about rebalancing the entire financial structure of the firm. Goodwill compensation, revaluation adjustments, and capital equalization ensure that all partners – old and new – stand on fair ground. When you prepare for your exams, practice journal entries thoroughly and work out sacrificing ratio problems until they feel natural. The clarity you gain will make these questions easy marks in the paper.