Matters requiring adjustments at the time of admission of a partner: Various matters which need adjustments in the books of firm at the time of admission of a new partner are: goodwill, revaluation of assets and liabilities, reserves and other accumulated profits and losses and the capitals of the old partners (if agreed).
Determining the new profit sharing ratio and calculating sacrificing ratio: The new partner acquires his share in profits from the old partners. This reduces the old partner’s share in profits. Hence, the problem of determining the new profit sharing ratio simply involves the determination of old partner’s new share in the profits of the reconstituted firm. Given the new partner’s share in profits and the ratio, in which he acquires it from the old partners, the new share of each old partner shall be worked out by deducting his share of sacrifice from his old share in profits.
The ratio in which the old partners have agreed to sacrifice their shares in profit in favour of the new partner is called the sacrificing ratio. It is usually same as the old profit sharing ratio. However, based on the agreement it can be different also.
Treatment of Goodwill: Goodwill is an intangible asset and belongs to its owner at a point of time. On the admission of a new partner the goodwill of the firm belongs to the old partners. It means that on the admission of a new partner some adjustments must be made into the capital accounts of the old partners for goodwill so that the new partner will not acquire a share in that profit which the firm earns because of its goodwill earned before admission without making any payment for the same. The amount that the new partner pays for goodwill is called goodwill.
From accounting point of view the firm may have to face different situations for the treatment of goodwill at the time of admission of a partner. The amount of premium brought in by the new partner is shared by old partners in the ratio of sacrifice. In case the new partner fails to bring his share of premium for goodwill in cash than the capital account of the new partner is debited for his share of premium of goodwill and the old partners capital accounts are credited in their sacrificing ratio.
Adjustments for Revaluation of Assets and Reassessment of Liabilities: If, at the time of admission of a partner, the assets and liabilities are revalued or some asset or liability is found unrecorded, necessary adjustments are made through the Revaluation Account. Any gain or loss arising from such exercise shall be distributed among the old partner’s in their old profit sharing ratio.
Adjustment for reserves and accumulated profits/losses: If, at the time of admission of a partner, any reserve and accumulated profits or losses exist in books of the firm, these should be transferred to old partner’s capital/current accounts in their old profit sharing ratio.
Determining/Adjusting partners’ capital: If agreed, the partner’s capital may be adjusted so as to be proportionate to their new profit sharing ratio. In that case, the new partner’s capital is normally used as a base for determining the new capitals of the old partners and necessary adjustment made through case or by transfer to partner’s current accounts. Other basis also may be available for determining capitals of the partners after admission of the new partner like sharing the total capital to be in the firm immeidately after admission of the new partner.
Change in profit sharing ratio: Sometimes the partners of a firm may agree to change their existing profit sharing ratio. With a result, some partners will gain in future profits while others will lose. In such a situation, the partner who gain by change in profit effecting amounts to one partner buying the share of profit from another partner. Apart from the payment for compensation, the change in profit sharing ratio also necessitates adjustment in partner’s capital accounts with respect to undistributed profits and reserves, revaluation of assets and reassessment of liabilities.