<h5 id="21-modes-of-reconstitution-of-a-partnership-firm">2.1 Modes of Reconstitution of a Partnership Firm</h5> <ul> <li>A new partner can be admitted to a partnership firm when existing partners unanimously agree to it, as per the Partnership Act 1932. This leads to a reconstitution of the firm. For example, Hari and Haqque admitted John as a new partner with 1/6 share in profits.</li> <li>The profit sharing ratio among existing partners can be changed if there is a change in their roles in the firm. This results in a reconstitution of the firm. For example, Ram, Mohan and Sohan changed their profit sharing ratio from 3:2:1 to equal sharing.</li> <li>A partner can retire from the business of the firm anytime if the partnership is at will. This results in the reconstitution of the firm. For example, Roy, Ravi and Rao were partners sharing profits in the ratio of 2:2:1. Ravi retired from the firm on account of illness.</li> <li>The death of a partner can lead to the reconstitution of the firm if the remaining partners decide to continue the business of the firm. For example, X, Y and Z were partners sharing profits in the ratio of 3:2:1. X died on March 31, 2017. Y and Z decided to carry on the business sharing future profits equally.</li> </ul> <p>======</p> <h5 id="22-admission-of-a-new-partner">2.2 Admission of a New Partner</h5> <ul> <li>A new partner can be admitted into a firm with the consent of all existing partners, as per the Partnership Act 193</li> </ul> <p>======</p> <h5 id="23-new-profit-sharing-ratio">2.3 New Profit Sharing Ratio</h5> <ul> <li>On admission of a new partner, the old partners may sacrifice a share of their profit in favor of the new partner.</li> <li>The new partner’s share can be acquired from the old partners in the old profit sharing ratio, unless specified otherwise.</li> <li>The new profit sharing ratio is calculated based on the new partner’s share and the remaining share of the old partners.</li> <li>If the new partner acquires his share equally from two or more old partners, their shares will be adjusted accordingly.</li> <li>The new profit sharing ratio is determined by the mutual agreement among the old partners and the new partner, based on their contribution to the firm.</li> </ul> <p>======</p> <h5 id="24-sacrificing-ratio">2.4 Sacrificing Ratio</h5> <ol> <li>The new profit sharing ratio of A, B, and C will be 9:3:4. So, the option (a) is correct.</li> <li>Z acquires 3/20 from X and 1/20 from Y, so the new share of Z is 3/20 + 1/20 = 1/5. The new profit sharing ratio of X, Y, and Z will be 9:7:4. So, the option (a) is correct.</li> <li>When a new partner is admitted, the old partners usually surrender some part of their profits. The new ratio of A and B is 3:1 and C gets 1/4 ratio. The sacrificing ratio of A and B cannot be determined without knowing the old profit ratio of A and B. So, all the given options are incorrect.</li> </ol> <p>======</p> <h5 id="25-goodwill">2.5 Goodwill</h5> <ul> <li>Goodwill is a special aspect of partnership accounts.</li> <li>It requires adjustment during reconstitution of a firm, such as change in profit sharing ratio, admission of a partner, or retirement/death of a partner.</li> <li>Adjustment of goodwill might require valuation if not specified.</li> <li>Goodwill adjustment is necessary to maintain fairness and accuracy in the distribution of profits among partners.</li> <li>The specific methods for goodwill valuation and adjustment are not covered in the text.</li> </ul> <p>======</p> <h5 id="251-meaning-of-goodwill">2.5.1 Meaning of Goodwill</h5> <ul> <li>Goodwill is an intangible asset that represents the advantage a well-established business has over a newly set up one.</li> <li>It is the monetary value of a business’s reputation, name, and wide connections, which helps the business earn more profits.</li> <li>Goodwill is the present value of a firm’s anticipated excess earnings or the capitalized value attached to the differential profit capacity of a business.</li> <li>It only exists when a firm earns super profits, and there is no goodwill if a firm earns normal profits or incurs losses.</li> <li>In accounting, the monetary value of goodwill is added to other tangible assets on a balance sheet.</li> </ul> <p>======</p> <h5 id="252-factors-affecting-the-value-of-goodwill">2.5.2 Factors Affecting the Value of Goodwill</h5> <ul> <li>The value of goodwill is significantly affected by the nature of the business, with firms that produce high value-added products or have stable demand earning more profits and goodwill.</li> <li>The location of a business also plays a crucial role in determining goodwill. Central locations or those with heavy customer traffic tend to have higher goodwill.</li> <li>Efficiency of management is a key factor in determining goodwill. Well-managed concerns usually have higher productivity and cost efficiency, leading to higher profits and goodwill.</li> <li>Market situation, such as monopoly conditions or limited competition, allows firms to earn high profits and enjoy a higher value of goodwill.</li> <li>Special advantages like import licenses, low-rate electricity, long-term contracts, well-known collaborators, patents, and trademarks contribute to a higher value of goodwill.</li> </ul> <p>======</p> <h5 id="253-need-for-valuation-of-goodwill">2.5.3 Need for Valuation of Goodwill</h5> <ul> <li>The need for valuation of goodwill arises at the time of sale of a business.</li> <li>In a partnership firm, goodwill valuation is required in case of: <ol> <li>Change in profit sharing ratio amongst existing partners.</li> <li>Admission of a new partner.</li> <li>Retirement of a partner.</li> <li>Death of a partner.</li> <li>Dissolution of a firm involving sale of business as a going concern.</li> <li>Amalgamation of partnership firms.</li> </ol> </li> </ul> <p>======</p> <h5 id="254-methods-of-valuation-of-goodwill">2.5.4 Methods of Valuation of Goodwill</h5> <ul> <li>The value of goodwill, being an intangible asset, is difficult to calculate accurately.</li> <li>Various methods have been suggested for the valuation of goodwill of a partnership firm.</li> <li>The three important methods of valuation of goodwill are: <ol> <li>Average Profits Method: This method involves calculating the average profits for a certain period.</li> <li>Super Profits Method: This method calculates goodwill by considering the excess of actual profits over the normal profits.</li> <li>Capitalisation Method: This method calculates goodwill by capitalizing the super profits.</li> </ol> </li> <li>The method for calculating goodwill may be decided between existing partners and the incoming partner.</li> <li>Different methods may result in different values of goodwill.</li> </ul> <p>======</p> <h5 id="2541-average-profits-method">2.5.4.1 Average Profits Method</h5> <ul> <li>The table provided shows the annual sales, trading volumes, and net profits for a company from 2012 to 2</li> </ul> <p>======</p> <h5 id="2542-super-profits-method">2.5.4.2 Super Profits Method</h5> <ul> <li>The interest on the capital of Rs. 1,00,000 at 15% is Rs. 15,000 (equation i).</li> <li>The addition of the partner’s salary, which is Rs. 6,000 twice, is Rs. 12,000 (equation ii).</li> <li>The total profit (i+ii) is Rs. 27,000.</li> <li>The average profit, calculated from the 3rd to 5th lines of the text, is Rs. 36,000.</li> <li>The super profit is calculated as the difference between the average profit and the normal profit (Rs. 36,000 - Rs. 27,000), which is Rs. 9,000.</li> <li>The number of years’ purchase is calculated as the super profit divided by the normal profit (Rs. 9,000 / Rs. 27,000 x 2), which is approximately Rs. 18,000.</li> </ul> <p>======</p> <h5 id="2543-capitalisation-method">2.5.4.3 Capitalisation Method</h5> <ul> <li>The total profits for the years 2012-2016, after deducting a loss of Rs. 5,000 in 2015, is Rs. 30,000. The average profit is Rs. 6,000 (Rs. 30,000/5). Goodwill is calculated as average profit * 3 = Rs. 18,000.</li> <li>The firm’s average profit is Rs. 12,000, normal profit is Rs. 8,000 (Rs. 1,00,000 * 8/100), and super profit is Rs. 4,000 (average profit - normal profit). Goodwill is calculated as super profit * 3 = Rs. 12,000.</li> <li>The firm’s average profit is Rs. 30,000, normal profit is Rs. 20,000 (Rs. 2,00,000 * 10/100), and super profit is Rs. 10,000 (average profit - normal profit). Goodwill is calculated as super profit * 100/normal rate of return = Rs. 1,00,000.</li> </ul> <p>======</p> <h5 id="255-treatment-of-goodwill">2.5.5 Treatment of Goodwill</h5> <ul> <li>Goodwill is the additional amount paid by an incoming partner to compensate existing partners for their share in super profits.</li> <li>This amount is also referred to as the premium for goodwill.</li> <li>Goodwill is not recorded in the books of accounts initially.</li> <li>It is only when the new partner pays for his share of goodwill that it is recorded.</li> <li>The journal entry for recording goodwill would be: <ul> <li>Debit: Partners’ Capital/Current Account(s)</li> <li>Credit: Goodwill A/c</li> </ul> </li> </ul> <p>======</p> <h5 id="2551-when-the-new-partner-brings-goodwill-in-cash">2.5.5.1 When the new Partner brings goodwill in cash.</h5> <ul> <li>The text discusses the accounting treatment of goodwill in a partnership firm.</li> <li>When goodwill exists in the books, it is written-off by debiting old partners’ capital accounts in their old profit sharing ratio.</li> <li>For new value of goodwill, incoming partners’ current accounts are debited and sacrificing partners’ capital accounts are credited in their sacrificing ratio.</li> <li>If there is no goodwill appearing in the books, and a new partner is admitted, no journal entry is passed for goodwill.</li> <li>If goodwill appears in the books at a certain value, and a new partner is admitted, the difference between the book value and the new valuation is to be adjusted among partners’ capital accounts.</li> <li>AS 26 states that intangible assets should be recognized by fulfilling certain criteria, and internally generated goodwill should not be recognized as an asset.</li> </ul> <p>Please note that the examples and their solutions have been excluded from the summary as per the instructions.</p> <p>======</p> <h5 id="2552-hidden-goodwill">2.5.5.2 Hidden Goodwill</h5> <ul> <li>The value of goodwill can be inferred when it is not given at the time of admission of a new partner, by comparing the total capital and profit sharing ratio.</li> <li>This can be understood through an example where A and B are partners sharing profits equally with capitals of Rs. 45,000 each. When C is admitted as a new partner for one-third share in the profit, bringing in Rs. 60,000 as his capital, the total capital of the newly constituted firm is Rs. 1,80,000, while the actual total capital of A, B and C is Rs. 1,50,000. The difference of Rs. 30,000 is the hidden goodwill, to be shared equally by A and B.</li> <li>The value of goodwill can also be calculated based on the firm’s profits and capital investment. For example, if a firm’s profits for the last three years are Rs. 5,00,000; Rs. 4,00,000 and Rs. 6,00,000, the value of goodwill on the basis of four years’ purchase of the average profits for the last three years would be Rs. 20,00,000.</li> <li>The value of goodwill can also be calculated based on the firm’s super profits. For example, if a firm’s profits during 2013, 2014, 2015 and 2016 were Rs. 16,000; Rs. 20,000; Rs. 24,000 and Rs. 32,000 respectively, the firm has capital investment of Rs. 1,00,000 and the fair rate of return on investment is 18% p.a, the goodwill based on three years’ purchase of the average super profits for the last four years would be Rs. 48,000.</li> <li>When a new partner brings his share of goodwill, the journal entries would differ compared to when he does not bring his share of goodwill. This can be understood through an example where Hem and Nem are partners in a firm sharing profits in the ratio of 3:2, and they admit Sam on Jan. 1, 2017 as a new partner for 1/5 share in the future profits. If Sam brings his share of goodwill, the journal entries would differ compared to when he does not bring his share of goodwill.</li> </ul> <p>======</p> <h5 id="26-adjustment-for-accumulated-profits-and-losses">2.6 Adjustment for Accumulated Profits and Losses</h5> <ul> <li>Accumulated profits, if any, not yet transferred to capital accounts of partners, are usually in the form of general reserve, reserve, and/or Profit and Loss Account.</li> <li>A new partner is not entitled to have any share in such accumulated profits.</li> <li>Accumulated profits are distributed among the partners by transferring it to their capital current accounts in old profit sharing ratio.</li> <li>Accumulated losses, if any, are adjusted by transferring it to the old partners’ capital accounts.</li> <li>This adjustment is done by passing necessary journal entries, as illustrated in the example provided.</li> </ul> <p>======</p> <h5 id="27-revaluation-of-assets-and-reassessment-of-liabilities">2.7 Revaluation of Assets and Reassessment of Liabilities</h5> <ul> <li>At the admission of a new partner, assets and liabilities are revalued and reassessed to ensure they are at their current values. This process can lead to unrecorded assets or liabilities being discovered and added to the firm’s books.</li> <li>The Revaluation Account is used to record the gain or loss on revaluation of each asset and liability. The balance of the Revaluation Account is then transferred to the capital accounts of the old partners in their old profit sharing ratio.</li> <li>The journal entries for revaluation of assets and reassessment of liabilities involve crediting or debiting the Revaluation Account based on whether there is a gain or loss on the revaluation.</li> <li>For an unrecorded asset, the asset account is debited and the Revaluation Account is credited, while for an unrecorded liability, the Revaluation Account is debited and the liability account is credited.</li> <li>The final balance of the Revaluation Account, whether credit or debit, is transferred to the capital accounts of the old partners in their old profit sharing ratio.</li> <li>Examples are provided to illustrate the application of the revaluation process in journal entries and the preparation of the Revaluation Account and partners’ capital accounts.</li> </ul> <p>======</p> <h5 id="28-adjustment-of-capitals">2.8 Adjustment of Capitals</h5> <ul> <li>At the time of a new partner’s admission, partners may agree to adjust their capitals to be proportionate to their profit sharing ratio.</li> <li>If the capital of the new partner is given, it can be used as a base to calculate the new capitals of the old partners. These calculated capitals should be compared with their old capitals after adjustments for goodwill, revaluation of assets and liabilities, etc.</li> <li>Any partner whose capital falls short will bring in the necessary amount to cover the shortage, and any partner who has a surplus will withdraw the excess amount of capital.</li> <li>In some cases, the total capital of the firm may be agreed upon, and each partner’s capital (including the new partner’s capital) is calculated on the basis of his share in profits.</li> <li>Any surplus or deficiency in each old partner’s capital accounts can be taken care of by transfer to their respective current accounts, subject to agreement among the partners.</li> </ul> <p>======</p> <h5 id="29-change-in-profit-sharing-ratio-among-the-existing-partners">2.9 Change in Profit Sharing Ratio among the Existing Partners</h5> <ol> <li>The new partner’s share in profits is acquired from the old partners, leading to adjustments in their shares and the sacrificing ratio.</li> <li>Goodwill belongs to the old partners at the time of a new partner’s admission, requiring adjustments in the capital accounts of the old partners.</li> <li>In case of revaluation of assets, liabilities, reserves, or accumulated profits/losses, necessary adjustments are made through the Revaluation Account.</li> <li>Partners’ capital may be adjusted to be proportionate to their new profit sharing ratio, with the new partner’s capital often used as a base for determining the new capitals of the old partners.</li> <li>A change in profit sharing ratio necessitates adjustments in partners’ capital accounts, including undistributed profits, reserves, revaluation of assets, and reassessment of liabilities.</li> <li>The total capital to be in the firm immediately after the admission of the new partner can be shared to determine the capitals of the partners.</li> </ol> <p>======</p> <h5 id="questions-for-practice">Questions for Practice</h5> <ul> <li>At the admission of a new partner, various matters that need adjustments include determining the new profit sharing ratio, the value of the firm’s assets and liabilities, and the new partner’s share of goodwill.</li> <li>A new profit sharing ratio must be ascertained for old partners when a new partner is admitted to ensure fair profit distribution among all partners.</li> <li>Sacrificing ratio is calculated to determine the proportion of profit or loss that old partners sacrifice due to the admission of a new partner. It is used to distribute the existing goodwill among the old partners.</li> <li>Existing goodwill is dealt with by bringing in the new partner’s share of goodwill in cash. If the new partner is unable to bring their share of goodwill in cash, alternative methods like credit to the old partners or writing off the goodwill can be used.</li> <li>Assets and liabilities are revalued at the time of admission of a new partner to reflect their current market values. This affects the firm’s total net worth and the new partner’s capital contribution.</li> </ul> <p>(Note: There are more than 6 bullet points in the response, but it was necessary to include all the essential points from the text.)</p> <p>======</p> <h5 id="numerical-questions">Numerical Questions</h5> <ul> <li> <p>The given text contains problems related to the calculation of goodwill and journal entries regarding the admission of a partner.</p> </li> <li> <p>Goodwill is calculated using the formula: 3 years purchase of super profit, average super profits of the last 5 years, or capitalization method.</p> </li> <li> <p>In problem 14, the goodwill is calculated as Rs. 54,000.</p> </li> <li> <p>In problem 15, the goodwill is calculated as Rs. 30,000.</p> </li> <li> <p>In problem 16, the goodwill is calculated as Rs. 2,50,000.</p> </li> <li> <p>In problem 17, the goodwill is calculated as Rs. 1,80,000.</p> </li> <li> <p>Journal entries are made for the amount of goodwill brought in by the new partner, and for the distribution of goodwill among the old partners.</p> </li> <li> <p>In problem 18, journal entries are made for the admission of a partner with the amount of goodwill brought in and withdrawn.</p> </li> <li> <p>In problem 19, journal entries are made for the admission of a partner with the amount of goodwill brought in and old partners withdrawing their share of goodwill.</p> </li> <li> <p>In problem 20, journal entries are made for the admission of a partner with the amount of goodwill brought in and existing goodwill written-off in old profit sharing ratio.</p> </li> <li> <p>In problem 21, journal entries are made for the admission of a partner with the amount of goodwill brought in and goodwill already appearing in the books.</p> </li> <li> <p>In problem 22, journal entries are made for the admission of a partner with the amount of goodwill agreed but unable to bring the full amount in cash.</p> </li> <li> <p>In problem 23, journal entries are made for the admission of a partner with the amount of goodwill agreed but unable to bring the amount in cash.</p> </li> <li> <p>In problem 24, journal entries are made for the admission of a partner with the amount of goodwill agreed and goodwill already appearing in the books.</p> </li> <li> <p>In problem 25, journal entries are made for the admission of a partner with the amount of goodwill agreed but unable to bring the amount in cash and not showing goodwill in the balance sheet.</p> </li> <li> <p>In problem 26, journal entries are made for the admission of a partner with the amount of goodwill agreed but unable to bring the amount in cash and without opening a goodwill account.</p> </li> <li> <p>In problem 27, journal entries are made for the admission of a partner with the amount of capital brought in and the revaluation of assets and liabilities.</p> </li> <li> <p>In problem 28, journal entries are made for the admission of a partner with the amount of capital brought in and the treatment of general reserve and profit and loss account balance.</p> </li> <li> <p>In problem 29, journal entries are made for the treatment of the debit balance in the profit and loss account.</p> </li> <li> <p>In problem 30, journal entries are made for the admission of a partner with the amount of capital brought in and the revaluation of assets and liabilities.</p> </li> <li> <p>In problem 31, journal entries are made for the admission of a partner with the amount of capital brought in and the adjustment of partner’s capitals according to the new profit sharing ratio.</p> </li> <li> <p>In problem 32, journal entries are made for the admission of a partner with the amount of capital brought in and the adjustment of partner’s capitals according to the new profit sharing ratio.</p> </li> <li> <p>In problem 33, journal entries are made for the admission of a partner with the amount of capital and goodwill brought in and the revaluation of assets and liabilities.</p> </li> <li> <p>In problem 34, journal entries are made for the admission of a partner with the amount of capital and goodwill brought in and the revaluation of assets and liabilities.</p> </li> <li> <p>In problem 35, journal entries are made for the admission of a partner with the amount of capital brought in and the revaluation of assets and liabilities.</p> </li> </ul> <p>======</p>