The admission of a partner is a significant undertaking for a partnership firm. It essentially changes the structure of the firm, and along with that comes the necessity of making certain adjustments and recalculating values to ensure a smooth transition. In this article, we’ll explain the meaning of admission of a partner, the reasons a partner may have been admitted, and the adjustments that may take place.
What is Admission of a Partner?
The admission of a partner implies the event of adding a new partner to the existing partnership firm. A partner is admitted into the firm in return for a portion of the firm’s profits, a claim on its assets, and is personally responsible for the firm’s liabilities. When admitting a new partner, the existing partners intend to expand operations.
Reasons for Admission of a Partner
There are several reasons why a partnership firm may decide to admit a new partner:
- Expansion of Business: To grow and expand the business operations, a new partner with additional capital or new ideas may be required.
- Capital Requirements: When a firm needs more funds for working capital or investment, a new partner can bring in the necessary finances.
- Specialized Skills and Expertise: Sometimes, a new partner is admitted because they possess special skills, expertise, or market knowledge that can benefit the firm.
- Sharing of Responsibilities: As businesses grow, existing partners may find it hard to manage everything on their own, and a new partner can help share the managerial and operational responsibilities.
Changes to Be Made on Admission of a Partner
On the admission of a new partner, the following are the changes that need to be done on the financial books of the firm. Such changes promote equity among all partners.
- Revaluation of Assets and Liabilities: Assets and liabilities of the firm are revalued at current market value. This ensures that the older asset values do not benefit or disadvantage the new partner unfairly.
- Goodwill Adjustment: Goodwill is the reputation of the firm and its ability to generate profits in the long run. Once a new partner joins, goodwill must be worked out, and the current partners are compensated for the sacrifices that they must undergo when sharing the profit.
- Profit Sharing Ratio: The profit sharing ratio must be recalculated as the new partner’s share of profit. The existing partners can also compromise by reducing a part of their share of profit for the new partner.
- Reserves and Accumulated Profits: Reserves, profits, or losses accumulated before admitting a new partner are distributed between the old partners following the old profit-sharing ratio.
Calculation of New Profit-Sharing Ratio
This is one of the most important adjustments during the admission of a new partner. So, as to determine through the new ratio how the profits are going to be shared by the new and existing partners.
There are two common methods for calculating the new profit ratio:
Sacrifice Ratio Method
The present partners consent to sacrifice a specific proportion of their profit in lieu of the new partner. The amount sacrificed by each partner is defined as the sacrifice ratio.
Formula for Sacrificing Partner’s Ratio: Old Ratio − New Ratio
Gaining Ratio Method
If existing partners want to give up their share in a different proportion than they currently hold, then a gaining ratio is calculated.
Formula for Gaining Partner’s Ratio = New Ratio − Old Ratio
Accounting Treatment for Admission of a Partner
The admission of a partner involves several accounting entries to reflect the changes in capital, profit-sharing, goodwill, and revaluation. Below are the common accounting treatments:
Goodwill Adjustment:
- If the new partner brings in goodwill in cash, the entry is:
- Bank A/C Dr.
- To Goodwill A/C
- If goodwill is adjusted through the capital accounts:
- New Partner’s Capital A/C Dr.
- To Existing Partners’ Capital A/Cs (in sacrifice ratio)
Revaluation of Assets and Liabilities:
- If there is an increase in the value of assets:
- Asset A/C Dr.
- To Revaluation A/C
- If there is a decrease in the value of assets or an increase in liabilities:
- Revaluation A/C Dr.
- To Asset/Liability A/C
- Profit or loss on revaluation is distributed among the existing partners in their old profit-sharing ratio.
Adjustment of Reserves and Accumulated Profits:
- Reserves and profits earned before the admission are transferred to the capital accounts of the existing partners:
- Reserve A/C Dr.
- To Old Partners’ Capital A/Cs (in the old profit-sharing ratio)
New Partner’s Capital Contribution:
- When the new partner contributes capital, it is credited to their capital account:
- Bank A/C Dr.
- To New Partner’s Capital A/C
Conclusion
Admission of a new partner is a significant event in the life of a partnership firm, which calls for several adjustments regarding profit-sharing, goodwill, and revaluation of assets. It provides proper structure for treatment so that there are no disputes or uncomfortable feelings or sensations in regard to whether the new partner is being treated rightly and the existing partners are compensated for their sacrifices made. Only accurate accounting treatment can reflect the changes in the books of the firm, which ensures transparency for maintaining the balance among all partners.
Admission of a Partner FAQs
1. What is meant by admission of a partner?
Admission of a partner is admitting a new partner in an existing firm, changing its structure, profit-sharing ratios, and responsibilities for earning profits and losses.
2. Why should a partnership admit a new partner?
A partnership firm may admit a new partner for various reasons, like expanding the scope of business operations, securing additional capital, acquiring specialised skills, and accomplishing managerial responsibilities by sharing among them.
3. What changes are to be made if a new partner is admitted?
Revaluation of assets and liabilities, change in goodwill, changes in profit-sharing ratios. Of course, the transfer of reserves and accumulated profits amongst existing partners.
4. How will the new profit-sharing ratio be arrived at?
A new profit-sharing ratio is arrived at either on a sacrifice ratio (how much existing partners give up) or on a gaining ratio (how much existing partners gain), with the new partner’s share being the denominator.
