Class 12 Accountancy Notes
Unit – 3: Reconstitution of Partnership
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.
Q.3. What is Memorandum
Revaluation Account? Distinguish between Revaluation and Memorandum revaluation
account?
********************************************
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
********************************************
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
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.11. How deceased partner’s share of profit upto the date of
death is calculated? 2014
Ans: Calculation of profit upto the date of death of a partner
If the death of a partner occurs during the
year, the representatives of the deceased partner are entitled to his/her share
of profits earned till the date of his/her death. Such profit is ascertained by
any of the following methods:
(i) Time Basis:
(ii) Turnover or Sales Basis
(i) Time
Basis: In this case, it is assumed that profit has been earned uniformly
throughout the year. Profit taken here is either Last year’s profit Or Average
profits of last few years. For example:
The total profit of Last year is Rs. 2, 25,000
and a partner dies three months after the close of previous year, the profit of
three months is Rs. 31,250 i.e. 1, 25,000 × 3/12, if the deceased partner took
2/10 share of profit, his/her share of profit till the date of death is Rs.
6,250 i.e. Rs. 31,250 × 2/10.
Again, the profits of last three years is Rs.
100000, Rs. 75000 and Rs. 125000 and partner dies three months after the close
of previous year, the his share of profit upto date of death is calculated as
follows:
1. Average
profit of last three years = (100000+75000+125000)/3 = 100000
2. Profit of
last three years = 100000x3/12 = 25000
3. Deceased
partner’s share of profit = 25000 x 2/10 = 5000, if the deceased partner took
2/10 share of profit.
(ii) Turnover or Sales Basis: In this method, we have to take into consideration the profit and
the total sales of the last year. Thereafter the profit upto the date of death
is estimated on the basis of the following formula:
(Sales upto date of death/Sales of last year)
x profit of previous year
Profit
is assumed to be earned uniformly at the same rate. For example:
A, B and C were partners in a firm sharing
profits in the ratio of 2:2:1. C dies on 31st July, 2007. Sales
during the previous year upto 31st march, 2007 were Rs. 6, 00,000
and profits were Rs. 150000. Sales for the current year upto 31st
July were Rs. 2,50,000. Calculate C’s share of profits upto the date of his
death and pass necessary journal entry.
Here, Profit upto date of death (upto 31st
July, 2007) = (2,50,000/6,00,000) x 1,50,000 = 62,500 And C’s Share of profit =
62,500x1/5 = 12,500.
Journal
entry for Crediting Deceased Partner’s share of profit upto date of death is:
Profit and Loss Suspense A/c Dr.
To Deceased Partner’s Capital A/c
Q.11. 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