AHSEC - 12: Reconstitution of Partnership (Admission, Retirement and Death of a Partner) Important Important Notes for MAY' 2021 Exam | Revised and Reduced Syllabus

Class 12 Accountancy Notes

Unit – 3: Reconstitution of Partnership 

Unit – 3: Reconstitution of Partnership (Admission, Retirement and Death of a Partner) FOR 2021 EXAM

Q.1. What do you mean by “Reconstitution of a Partnership”? Under what situations it takes place? Explain them.          2012

Ans: Reconstitution of Partnership: A Partnership agreement is an agreement between two or more persons for carrying out various business activities. Reconstitution of a partnership refers to a situation when there is a change in the existing partnership agreement. In such a case, a new partnership agreement is formed to replace the old partnership agreement. It means the firm continues to exist and the only change will take place in existing partnership agreement.  Thus, reconstitution of a partnership takes place in each of the following cases:

a)      Change on profit sharing ratio

b)      Admission of a partner (Refer below for explanation)

c)       Retirement of a partner

d)      Death of a partner

e)      Insolvency of a Partner

a) Change in the profit-sharing ratio among the existing partners means the reconstitution of firm without the admission or retirement or death of a partner. In such case one or more partner acquires share of profit in the business from another partner due to which share of profit of acquiring partners increases and share of profit of sacrificing partners’ decreases.

Q.2. What is revaluation and revaluation account? When and Why revaluation of Assets and Liabilities are done in Partnership Business?   2013

Ans: Revaluation: Revaluation is a process of placing a different valuation on an asset or liability from its book value. It is a process of recoding of an asset or a liability at its current value.

Revaluation Account: At the time of reconstitution of partnership, it is necessary to revalue the assets and liabilities of the firm because the book value of the assets and liabilities as shown in balance sheet may be different from their market value. To record any decrease or increase in the value of assets and liabilities, a separate nominal account is prepared which is called revaluation account. The Revaluation account is credited if there is an increase in the value of assets, decrease in the value of liabilities and unrecorded assets. On the other hand it is debited if there is any decrease in the value of assets, an increase in the value of liabilities and unrecorded liabilities. This account is a nominal account and is sometimes also called Profit and Loss adjustment account. The profit or Loss arising due to revaluation is divided among the old partners in their old ratio.

When? Revaluation of Assets and Liabilities takes place in each of the following cases:

a)      Admission of a partner

b)      Retirement of a partner

c)       Death of a partner

d)      Change on profit sharing ratio

Why/Objectives?

The actual value of the assets and liabilities may be different from their book value as shown by the balance sheet. When a new partner is admitted, he acquires ownership rights of the assets and also becomes liable for the liabilities of the business. Therefore, the new partner should get an assurance that these values are reasonable. The new partner should not be given any benefit of appreciation in the value of assets or reduction in the value of liabilities. Likewise, he should not be burdened because of decrease in the value of assets and increase in the value of liabilities. That’s why revaluation of assets and liabilities should be made in the interest of the new partner as well as the old partners. Similarly, revaluation of assets and liabilities are made at the time or retirement or death of a partner.

Again, sometimes either intentionally or by mistake, one or more assets and liabilities are not recorded in the books of accounts. But while preparing revaluation account, these assets and liabilities are to be recorded.

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ALSO READ (AHSEC ASSAM BOARD CLASS 12):

1. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE NOTES

2. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION (THEORY)

3. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION BANK (PRACTICAL)

4. AHSEC CLASS 12 ACCOUNTANCY PAST EXAM PAPERS (FROM 2012 TILL DATE)

5. AHSEC CLASS 12 ACCOUNTANCY SOLVED QUESTION PAPERS (FROM 2012 TILL DATE)

6. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE MCQS

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Q.3. What is Memorandum Revaluation Account? Distinguish between Revaluation and Memorandum revaluation account?

Ans: Memorandum Revaluation Account is prepared when at the time of admission/retirement of a partner; the partnership firm does not want to change the values of assets and liabilities in the balance but wants to give its effect through partners' capital accounts. Memorandum revaluation account is divided into two parts. First part is prepared to record the increase or decrease in the value of assets and liabilities and the second part is prepared to nullify the changes in the first part. The balance of first part (Profit or loss) is transferred to the Capital Accounts of Old Partners in their old profit-sharing ratio and the balance of second part is transferred to all Partners Capital Accounts in their new profit sharing ratio.

Difference between Revaluation Account and Memorandum Revaluation account

Basis

Revaluation Account

Memorandum Revaluation Account

1. Effect of Balance sheet

After preparation of revaluation account, assets and liabilities are shown in the balance sheet at the revalued figures.

There is no change in book value of assets and liabilities after the preparation of memorandum revaluation account.

2. Parts

It is not divided into two parts. It is prepared to record the increase and decrease in the value of assets and liabilities.

It is divided into two parts. First part is prepared to record the increase or decrease in the value of assets and liabilities and the second part is prepared to nullify the changes in the first part.

3. Necessity

Making of Revaluation account is compulsory in case of reconstitution of partnership.

Making of Memorandum Revaluation account is not compulsory in case of reconstitution of partnership.

4. Transfer of profit

The balance of revaluation account (profit or loss) is transferred to Old Partners Capital Accounts in their old profit-sharing ratio.

The balance of first part (Profit or loss) is transferred to the Capital Accounts of Old Partners in their old profit-sharing ratio and the balance of second part is transferred to all Partners Capital Accounts in their new profit sharing ratio.

5. Object

It is prepared to record the effect of revaluation of assets and liabilities when the assets and liabilities are to be shown at their revalued amounts.

It is prepared to record the effect of revaluation of assets and liabilities when the assets and liabilities are to be shown at their old values.

Q.4. What do you mean admission of a partner? Why a New Partner is admitted into Partnership? Also mention its effect.

Ans: Admission of a partner: In order to acquire additional capital and managerial skill, a new partner is admitted into the firm with the consent of old existing partners. This process is called admission of a partner. After admission of a partner, the firm is reconstituted and existing agreements comes to an end and new agreement among all the partners comes into effect. The new partner on joining becomes liable for the liabilities of the firm and entitled to assets and profits of the firm.

Reasons why a new partner is admitted?

Sometimes, it becomes difficult to run the partnership business due to lack of sufficient capital or managerial help or both. In this case a firm may decide to admit a new partner into the firm. But according to Indian Partnership Act 1932, no partner can be admitted into the firm without the consent of all the existing partners.

A person who is admitted as a partner into the firm does not thereby becomes liable for any act of the firm done before his admission. A partner is admitted for any one or more of the following reasons:

a)      In order to acquire more capital for the business.

b)      In order to have more managerial skill, a competent and experienced person is needed.

c)       In order to expand and boost up the business.

d)      In order to increase the goodwill by admitting a well-reputed person into the business.

e)      In order to reduce the competition.

Effect of admission of a new partner:  The effects of admission of a new partner are the following:

a) The admission of a partner constitutes the termination of existing partnership deed and the commencement of a new one.

b) The new partner is entitled to a share of future profits.

c) The new partner has to contribute an agreed amount of capital to the business.

d) The new partner acquires ownership rights of the assets and also becomes liable for the liabilities of the business.

e) Goodwill of the firm has to be valued and necessary adjustments are to be made in partners account.

Q.5. What is Sacrifice and Gaining Ratio? Distinguish between them.                    2008, 2010, 2012, 2013, 2015, 2020

Ans:  Sacrificing Ratio: At the time of admission of an incoming partner, existing partners have to surrender some of their share in favour of the new partner. The ratio in which they surrender their profits is known as sacrifice ratio. The purpose of determining sacrificing ratio is to determine the amount of compensation that partners should pay to the sacrificing partners for the share of profits sacrificed by them.

Gaining Ratio: Gaining Ratio is calculated at the time of retirement or death of partner. It is the excess of new share over old share. It is calculated as follows: Gaining Ratio = New share - Old share. Calculation of gaining ratio is necessary to compensate the outgoing partners by payment of goodwill in their gaining ratio.

Distinguish between sacrificing ratio and gaining ratio:

Basis

Sacrifice Ratio

Gaining Ratio

Meaning

Sacrificing Ratio is a ratio in which the old partners have agreed to surrender their share of profit in favour of new partner.

Gaining Ratio is ratios in which remaining partners’ gain the retiring partner’s share.

Objective

The main purpose to calculate the sacrificing ratio is to ascertain the compensation to be paid by incoming partner to the sacrificing partner’s in the form of goodwill.

The main purpose to calculate the gaining ratio is to find out the compensation to be paid by the gaining partner’s to the retiring partner.

When to Calculate

Sacrificing Ratio is calculated at the time of admission of a new partner.

Gaining Ratio is calculated at the time of retirement or death of a partner.

Method

Sacrificing Ratio = Old Ratio – New Ratio

Gaining Ratio = New Ratio – Old Ratio

Effect

It reduces the profit sharing ratio of the existing partners.

It increases the profit sharing ratio of the remaining partners.

Q.6. Define Hidden Goodwill and Joint Life Policy.                         2007, 2009, 2013, 2014

Ans: Hidden goodwill means that amount of goodwill which is not known at the time of admission of a new partner but which is calculated on the basis of total capital of the firm and profit sharing ratio. Hidden goodwill at the time of admission of a partner is calculated as follow:

1. Calculate the total capital of the firm on the basis of the capital brought in by new partner:

Total capital of the firm = New Partner’s capital x reciprocal of new partner’s share

2. Find the total combined capital of all the partners including new partner as below:

Capital Balance of Old partner’s + Capital of new partner+ Accumulated profits-accumulated losses

3. Hidden goodwill will be = Total capital of the firm – Combined capital of all the partners

A Joint Life Policy is an assurance policy taken on the joint lives of the partners. On the death of a partner, the firm becomes liable to pay the executors of deceased partner his capital, interest on capital, his share of profit, his share of reserves, goodwill etc from the closing of the previous year upto the date of death. The total amount thus becoming due to the executors is usually significant and immediate payment of such heavy amount out of firm’s resources is likely to affect firm’s finances very adversely. To cover this liability, a joint life policy is taken.

Q.7. What do you mean by retirement of partner? Mention the causes and effect of retirement of partner. How the amount due to retiring Partner is calculated?    2013, 2016, 2017

Ans: A partner may withdraw himself from the partnership. This means that the old partnership agreement comes to an end and new partnership among the remaining partners, comes into existence. The exit or withdrawal of a partner is called retirement. As a result of retirement of a partner his relations with the firm are severed. But a retiring partner remains liable for all the acts of the firm upto the date of his retirement.

A partner may retire from the firm for various reasons such as old age, bad health, strain relationship with other partners, financial problems, residence shifting or any other reasons. A partner may quit the firm with the consent of all the partners or when there is an express agreement to this effect.

Effect of retirement of a partner: The effects of retirement of a partner are the following:

a) The retirement of partner will terminate the existing partnership deed and a new partnership deed is constituted.

b) The assets and liabilities are revalued and proper adjustments are made in retiring partner’s account.

c) Goodwill of the firm has to be valued and necessary adjustments are to be made in partners account.

d) An adjustment is to be made in regard to undrawn profit or accumulated losses.

e) The claim of the retiring partner is to be determined and settled.

Calculation of amount due to the retiring partner: The amount due to the retiring partner is paid according to the terms of partnership agreement. Amount due to the retiring partner is determined by preparing capital account of the retiring partner. Retiring partner’s capital account is debited with:            2017

(a) The credit balance of Capital Account;

(b) His/her share in the Goodwill of the firm;

(c) His/her share in the Revaluation Profit:

(d) His/her share in General Reserve and Accumulated Profit;

(e) His/her share of profit till the date of his retirement.

(f) Interest on Capital, partner’s salary and commission.

But, the following items are debited in capital account to find amount due:

(a) His/her share in the Revaluation loss.

(b) His/her Drawings and Interest on Drawings up to the date of retirement.

(c) His/her share of any accumulated losses.

(d) Loan taken from the firm.

Payment of amount due to the retiring partners

The total amount so calculated is the claim of the retiring partner. He/she is interested in receiving the amount at the earliest. Total payment may be made immediately after his/her retirement. However, the resources of the firm may not be adequate to make the payment to the retiring partner in lump sum, then firm makes payment to retiring partner in installments together with interest.

Q.8. Explain the liability of retiring partner. What adjustments are necessary at the time of admission, retirement or death of a partner?

Ans: Liability of a retiring partner:

a) A retiring partner remains liable for all the acts of the firm upto the date of his retirement. But if there is an agreement between the continuing partner and third party, the retiring partner may be discharged from his liability.

b) If a public notice is not given by the retiring partner, then he will remain liable for all the acts of the firm after the retirement.

Adjustments required in case of admission, retirement and death of a partner:

a) Determination of new profit-sharing ratio and sacrifice/gaining ratio.

b) Accounting treatment of goodwill.

c) Revaluation of assets and liabilities.

d) Distribution of past reserves and accumulated profits or losses.

e) Calculation of interest and profits upto the date of his retirement or death.

f) Adjustment of capital of partners.

Q.9. Explain the treatment of accumulated profits or losses at the time of reconstitution of the firm.

Ans: For the purpose of expansion of the firm, partnership firm may create reserves out of profits. These reserves appear in the liabilities side of balance sheet. These undistributed profits belong to the old partners. Therefore, these reserves are distributed amongst the old partners in old ratio. Journal entry for distribution of reserves:

General Reserve A/c                        Dr

To Old Partners Capital Account

In the same manner, it is possible that firm incurs losses and these losses appear in the assets side of the balance sheet. These accumulated losses are also distributed amongst the partners at the time of reconstitution of the partnership. Journal entry for distribution of accumulated losses:

Old Partners Capital Account                   Dr

To Accumulated losses account

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ALSO READ (AHSEC ASSAM BOARD CLASS 12):

1. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE NOTES

2. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION (THEORY)

3. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION BANK (PRACTICAL)

4. AHSEC CLASS 12 ACCOUNTANCY PAST EXAM PAPERS (FROM 2012 TILL DATE)

5. AHSEC CLASS 12 ACCOUNTANCY SOLVED QUESTION PAPERS (FROM 2012 TILL DATE)

6. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE MCQS

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Q.10. How the amount due to the executor’s of Deceased Partner is calculated? Explain the provisions of Sec.37 of the Partnership Act regarding payment of the amount due to the executor’s of the deceased partner? 2014, 2016

Ans: The death may come at any time. On the death of a partner, the legal heirs of the deceased partners are entitled to get the amount due to the deceased partner as per the provisions of partnership deed. On the death of a partner, the legal heirs or representatives are entitled to get the following:

a)      The amount standing to the credit to the capital account of the deceased partner

b)      Interest on capital, if provided in the partnership deed upto the date of death:

c)       Share of goodwill of the firm;

d)      Share of undistributed profit or reserves;

e)      Share of profit on the revaluation of assets and liabilities;

f)       Share of profit upto the date of death;

g)      Share of Joint Life Policy.

The following specimen of deceased partner’s capital will help to find out the amount due to the deceased partner.

Particulars

Amount

Particulars

Amount

To Balance B/d (If there is a debit balance)

To Share in Revaluation loss

To Accumulated losses

To Drawings

To Interest on Drawings

To Profit and Loss Suspense A/c

(Share in loss upto death)

To Assets taken over

To Executors Account (Balancing figure)

 

By Balance B/d (If there is a credit balance)

By Share in Revaluation Profit

By Accumulated Profits and Reserves

By Interest on Capital

By Profit and Loss Suspense A/c

(Share In profits upto death)

By Liabilities taken over by legal heirs

 

Amount Due to Deceased Partner (Sec. 37 of the partnership act)

The amount due to the deceased partner is transferred to a loan account opened in the name of executor of the deceased partner and payable by the existing partners. The agreement normally provides for the interest payable on the loan and the conditions for the repayment of such loan. In the absence of any agreement, it is provided in sec. 37 of partnership act that the estate of deceased partner has the option either to claim interest on the amount due @6% p.a. or to such a share of the subsequent profits as may be attributable to the use of his share of the property of the firm.

Q.12. What is Premium for Goodwill? Explain the treatment of goodwill at the time of admission of a new partner.

Ans: Premium for Goodwill: When a new partner is admitted into the firm, he is required to compensate in favour of partners who sacrifices their shares in favour of new partner. The Compensation paid in cash by the new partner to the sacrificing partners is called premium for goodwill.                           2020

Treatment of Goodwill at the time of admission of a new partner:

At the time of admission of a partner, an adjustment is necessary in respect of goodwill. The goodwill can be treated in the books of account I any of the following manners:

a) When premium of goodwill is paid privately: A new partner may premium to the old partners privately. In this case, no entry is passed in the books of the firm as it is not a transaction of the firm.

b) When capital and premium for goodwill is brought in cash/kind by new partner:

1) Journal entries for cash/kind brought in

Cash account                                                                             Dr

Sundry asset account                                                               Dr (If capital and premium brought in kind)

To New Partner’s Capital account (New partner’s share of capital)

To Premium for goodwill account (New partner’s share of goodwill)

2) For sharing of premium of goodwill:

Premium for goodwill account                                             Dr

To Sacrificing partner’s capital account

3) If premium for goodwill is withdrawn either fully or partly by sacrificing partners:

Sacrificing partner’s capital account                                   Dr

To Cash/Bank account

c) When premium for goodwill is not brought in by new partner:

New partner’s capital account                                                           Dr

To Sacrificing partner’s capital account

d) If goodwill already appears in balance sheet of the old firm, then it is to be written of in every case

Old partner’s capital account                                            Dr

To Goodwill account

Treatment of goodwill in case of retirement and death of a partner:

At the time of retirement or death of a partner, goodwill is to be adjusted amongst the partners on the basis of sacrifice or gain. First of goodwill of the firm is valued on the retirement or death of a partner and the retiring or deceased partner’s share in new goodwill of the firm is to be contributed by the remaining partners in gaining ratio.

Journal entry for recording retiring or deceased partner’s share of goodwill

Retiring partner or deceased partner’s capital account                      Dr

To Gaining or remaining partners capital account