Complete Guide to Admission of a Partner (HSC Accounts)
1. Meaning and Need for Admission
According to Section 31(1) of the Indian Partnership Act, 1932, a person can be admitted as a new partner only with the consent of all existing partners. When a new member is introduced into an existing partnership firm to join the business, it is called the Admission of a Partner.
A new partner is usually admitted into the firm for the following core reasons:
- To increase the capital base of the firm for business expansion.
- To acquire specialized skills, managerial abilities, or technical expertise from the incoming partner.
- To encourage a highly capable and experienced employee by offering them a partnership stake.
2. Important Calculations (Ratios)
When a new partner is admitted, the old partners have to surrender a part of their existing profit share in favor of the new partner. This necessitates the calculation of new ratios to prevent future disputes.
- New Profit Sharing Ratio: The revised ratio in which all partners (including the new partner) will share future profits and losses of the firm.
- Sacrificing Ratio: The ratio in which the old partners surrender their share of profit in favor of the newly admitted partner. This ratio is exclusively used to distribute the Goodwill brought in cash by the new partner.
Formulas:
$$Sacrificing\ Ratio = Old\ Ratio - New\ Ratio$$
$$Balance\ of\ 1 = 1 - Share\ of\ New\ Partner$$
$$New\ Ratio = Old\ Ratio \times Balance\ of\ 1$$
3. Revaluation of Assets and Liabilities
At the time of admission, the assets and liabilities of the firm are revalued. This ensures that the new partner neither benefits from an unrecorded appreciation nor suffers from an unrecorded loss that belongs solely to the period before their admission.
- A Revaluation Account (also known as the Profit & Loss Adjustment Account) is prepared to record these changes.
- Any increase in the value of assets or decrease in the value of liabilities is recorded on the credit side (Gains/Profits).
- Any decrease in the value of assets or increase in the value of liabilities is recorded on the debit side (Losses).
Note: The final balance of the Revaluation Account (whether it is a Profit or Loss on Revaluation) is transferred only to the Old Partners' Capital or Current Accounts in their Old Profit Sharing Ratio.
4. Treatment of Goodwill
Goodwill is the monetary value of the reputation of the business earned by the old partners through hard work. The new partner must compensate the old partners for acquiring a share in the future profits. There are two primary methods handled in HSC boards:
- Premium Method: The new partner brings their share of goodwill in cash. This cash is distributed among the old partners strictly in their Sacrificing Ratio. The partners may choose to retain this cash in the business or withdraw it fully/partially.
- Valuation Method: The new partner does not bring goodwill in cash. Instead, the total goodwill of the firm is raised in the books and credited to the old partners in their Old Ratio. If the partners decide not to show goodwill in the new balance sheet, it is immediately written off among all partners (including the new one) in their New Ratio.
5. Distribution of Accumulated Profits, Reserves, and Losses
Any past accumulated profits, reserves (such as General Reserve or Reserve Fund), or accumulated losses (such as a debit balance of the Profit & Loss Account) appearing in the old Balance Sheet belong entirely to the old partners because they were earned prior to the new partner's admission.
Solution Rule: Always distribute the General Reserve or accumulated profits to the credit side of the Old Partners' Capital Accounts. Conversely, transfer any accumulated losses to the debit side of the Old Partners' Capital Accounts. This must be done using the Old Profit Sharing Ratio before recording the new partner's capital entry.
