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Admission of a new partner

Sometimes, a new partner is admitted due to:

  • more capital is required for the business, especially when the business is expanding and the need increases for some kind of managerial or technical skill, or professional experience or expertise to run the business.
  • expanding the business or reducing competition
  • death of a partner

When a new partner is admitted, changes are likely in the following:

  1. Profit sharing ratio
  2. Sharing of goodwill
  3. Revaluation of assets
  4. Transfer of reserves and accumulated profits / losses
  5. Adjustment to Capital Accounts

1. Profit sharing ratio

When a new partner joins a partnership business, the old partners have to adjust their profit sharing ratio to cater to the share of profit of the new partner. Usually, this is a priority item that is considered on admission of a new partner. The old partners’ shares of available profit after the new partner’s share is met are calculated in accordance with the old profit sharing ratio which is now incorporated into the new profit sharing ratio.

2. Sharing of goodwill

When a new partner is admitted, the question of goodwill inevitably arises. Goodwill is an intangible asset which exists because of the business’s reputation, customers’ support, the trade name or the brand name. On admission of a new partner, the value of goodwill is calculated for sharing among the existing partners. One of the ways the value is arrived at is finding the average operating profits for a number of years. Goodwill is dealt with in partners’ capital accounts.

3. Revaluation of assets

Before admission of a new partner, revaluation of assets and liabilities is undertaken to determine their true book value. The book value of the assets which is their cost price less accumulated depreciation, and their market value are likely to differ considerably. A revaluation enables the assets and liabilities of the old partners to be updated and their capitals adjusted accordingly. Any increase in the value of the assets increases the capitals of the partners, and any decrease causes their capitals to decrease. A revaluation account which is a temporary account is opened when the values of assets and liabilities are revised. Any gain in the revision is credited to the revaluation account and any loss is debited. The revaluation account is closed when its closing balance is transferred to the capital accounts of the partners in the profit sharing ratio.

4. Transfer of reserves and accumulated profits / losses

Reserves and the profit and loss balances are transferred to the partners’ capital accounts using the old profit sharing ratio. Credit balances are credited to the capital accounts, and losses to the debit side of the capital accounts. They are then no longer balance sheet items. In other words, the reserves and the accumulated balance of the profit and loss account do not appear on the new balance sheet.

5. Adjustment to Capital Accounts

When the profit sharing ratio is revised on admission of a new partner, the capital accounts are also adjusted. In most partnerships, capital contribution is used as a basis for determining the profit sharing ratio. Readjustment of capitals is usually done by withdrawing or bringing in cash

Last Updated (Saturday, 11 September 2010 14:49)