Reconstitution of a Partnership Firm

Any change in the existing agreement among partners is called reconstitution of a partnership firm: the old agreement ends and a new one comes into force. In this chapter you will study the main modes of reconstitution, namely change in the profit sharing ratio among existing partners, admission of a new partner, and retirement or death of a partner. You will calculate the new profit sharing ratio, the sacrificing ratio and the gaining ratio, and learn why goodwill must be valued at each reconstitution, using the average profit, super profit and capitalisation methods as prescribed in AS 26. The chapter then explains the accounting adjustments that accompany each change: treatment of goodwill through premium brought in by a new partner or adjustment through partners' capital accounts, revaluation of assets and reassessment of liabilities through the Revaluation Account, distribution of accumulated profits, reserves and losses, and adjustment of partners' capitals. For retirement and death, you will also compute the amount due to the outgoing partner, including the deceased partner's share of profit up to the date of death.

Detailed Worksheet: Reconstitution of a Partnership Firm Section A - Definitions (10 marks) 1. What is meant by reconstitution of a partnership firm? State any three modes of reconstitution. (2 marks) 2. Define sacrificing ratio and gaining ratio. When is each calculated? (2 marks) 3. What is goodwill? State any four factors affecting the value of goodwill. (2 marks) 4. What is a Revaluation Account? Why is it prepared at the time of admission of a partner? (2 marks) 5. State any two rights acquired by a newly admitted partner. (2 marks) Section B - Calculations and Applications (15 marks) 6. A and B share profits in the ratio 3:2. They admit C for a 1/5 share in future profits. Calculate the new profit sharing ratio and the sacrificing ratio. (3 marks) 7. The profits of a firm for the last four years were Rs 40,000, Rs 50,000, Rs 60,000 and Rs 70,000. Calculate goodwill at two years' purchase of the average profit. Also calculate the premium that a new partner must bring for a 1/5 share and show how it is shared by old partners A and B whose sacrificing ratio is 3:2. (3 marks) 8. A firm has capital employed of Rs 5,00,000, a normal rate of return of 10% and average profits of Rs 80,000. Calculate goodwill by (i) three years' purchase of super profit and (ii) capitalisation of super profit. (3 marks) 9. On admission of a partner, it was agreed that the building would be appreciated by Rs 50,000, machinery depreciated by Rs 10,000, and a provision for doubtful debts of Rs 2,000 created. Calculate the profit or loss on revaluation and its distribution between A and B in the ratio 3:2. (3 marks) 10. P, Q and R were partners sharing profits 2:2:1. R died on 30 June 2025. Profits for the last year were Rs 1,20,000. Calculate R's share of profit up to the date of death on the basis of last year's profit, and pass the journal entry. (3 marks) Section C - Diagrams (10 marks) 11. Draw a flowchart showing the accounting steps on admission of a new partner, from calculation of the new ratio to adjustment of capitals. (4 marks) 12. Draw a chart comparing the Revaluation Account and the Realisation Account on four bases. (3 marks) 13. Draw a chart showing the three methods of valuing goodwill, with the formula used in each method. (3 marks) Section D - Analysis and Higher-order Thinking (15 marks) 14. X, Y and Z share profits 2:2:1. Y retires and his share is taken by X and Z in the ratio 3:2. Calculate the new ratio and the gaining ratio. The goodwill of the firm is valued at Rs 60,000. Pass the journal entry for treatment of Y's share of goodwill, and explain why the gaining partners must compensate him. (5 marks) 15. M and N share profits equally with capitals of Rs 1,50,000 and Rs 1,20,000 after all adjustments. O is admitted for a 1/4 share and is to bring capital proportionate to his share. Calculate O's capital. Explain how the answer changes if the capitals of M and N are to be adjusted on the basis of O's capital of Rs 1,00,000, and calculate the surplus or deficit for each. (5 marks) 16. Sita, a partner who has worked for twenty years in a successful firm, retires. The remaining partners argue that goodwill should not be valued because it is not shown in the Balance Sheet. Evaluate their argument with reference to AS 26 and the nature of self-generated goodwill, and suggest the fair treatment. (5 marks) Instructions: Time allowed 2 hours. Attempt all sections. Show all working notes and present ledger accounts in prose line form.