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Reconstitution of Partnership
Meaning of Reconstitution:
Any change in agreement of partnershipis called reconstitution of partnership firm. In following circumstances a partnership firm may be reconstituted:
1. Change in Profit Sharing Ratio
2. Admission of a partner
3. Retirement/Death of a partner
Change in profit sharing ratio among the existing partners
When all the partners of a firm agree to change their profit sharing ratio, the ratio may be changed. In this case one profit is purchasing a share of partner from another one. In other words, share of one partner may increase and share of another partner may decrease.
Accounting treatment of goodwill:
In case of change in profit sharing ratio, the gaining partner must compensate the sacrificing partner by paying the proportionate amount of goodwill.
Illustration 1 Amit and Kajal were partners in a firm sharing profits in the ratio of 3:2. With effect from January 1,2012 they agreed to share profits equally. For this purpose the goodwill of the firm was valued at ‘60,000. Pass the necessary journal entry.
Accounting treatment of Reserves and Accumulated Profits: Case (i) When reserves and accumulated profits/losses are to be distributed At the time of change in profit sharing ratio, if there are some reserves or accumulated profits/losses existing in the books of the firm, these should be distributed to partners in their old profit sharing ratio.
Illustration 2 : Vaishali, Vinod and Anjali are partners sharing profits in the ratio of 4:3:2. From April 1,2011, they decided to share the profits equally. On that date their books showed a credit balance of ‘3,60,000 in the profit and loss account and a balance of ‘ 90,000 in the General reserve. Record the journal entry for distribution of these profits and reserves.
Case (ii) When accumulated profits/losses are not be distributed at the time of change in ratio
Partners may decide that reserves and accumulated profits/losses will not be affected and remains in the books with same figure. In this case, the gaining partner must compensate the sacrificing partner by the share gained by him i.e. Gaining Partner's Capital A/c Dr.
To Sacrificing Partner's Capital A/c.
Illustration 4: Keshav, Meenakshi and Mohit sharing profit and losses in the ratio of 1:2:2,decide to share future profit equally with effect from April 1, 2011. On that date general reserve showed a balance of ` 2,40,000. Partners do not want to distribute the reserves. You are required to give the adjusting entry.
Solution: Keshav : Meenakshi : Mohit
Old ratio 1/5 : 2/5 : 2/5
New ratio 1/3 : 1/3 : 1/3
Sacrifice or Gain:
Keshav = 1/5 – 1/3 = 35/15 = 2/15 (Gain)
Meenakshi = 2/5 – 1/3 = 65/15 = 1/15 (Sacrifice)
Mohit = 2/5 – 1/3 = 65/15 = 1/15 (Sacrifice)
Illustration 5: Neha, Niharika, and Nitin are partners sharing profits and losses in the ratio of 2:3:4. They decided to change their ratio and their new ratio is 4:3:2. They also decided to pass a single journal entry to adjust the following without affecting their book values: ` Profit & Loss account 80,000
General Reserve 40,000
Advertisement Suspense A/c 30,000
You are required to give the single journal entry to adjust the above.
Profit & Loss account 80,000
Add: General Reserve 40,000
Less: Advertisement Suspense 30,000
Total amount to be adjusted 90,000
Neha Niharika Nitn
Old ratio 2/9 3/9 4/9
New ration 4/9 3/9 2/9
Sacrifice or Gain :
Neha = 2/94/9=2/9 (Gain)
Niharika = 3/93/9=0 (No change)
Nitin = 4/92/9=2/9 (Sacrifice)
Accounting treatment for Revaluation of Assets and reassessment of Liabilities on change in Profit sharing ratio:
At the time of change in profit sharing ratio of existing partners, Assets and liabilities of a firm must be revalued because actual realizable value of assets and liabilities may be different from their book values. Change in the assets and liabilities belongs to the period prior to change in profit sharing ratio and therefore it must be shared in old profit sharing ratio.
Revaluation of assets and liabilities may be treated in two ways: (i) When revised values are to be shown in the books.
(ii) When revised values are not to be shown in the books
When revised values are to be shown in the books:
In this case revaluation of assets and liabilities is completed with the help of "Revaluation Account”. This account is also known as “Profit and Loss Adjustment Account”. All losses due to revaluation are shown in debit side of this account and all gains due to revaluation are shown in credit side of this account.
Note : (1) Increase in the value of an Asset and decrease in the value of a liability result in profit.
(2) Decrease in the value of any asset and Increase in the value of liability gives loss. Illustration 6:
Piyush, Puja and Praveen are partners sharing profits and losses in the ratio of 3:3:2. There balance sheet as on March 31st 2011 was as follows.
Partners decided that with effect from April 1, 2011, they would share profits and losses in the ratio of 4:3:2. It was agreed that:
(i) Stock be valued at ` 2,20,000.
(ii) Machinery is to be depreciated at 10%.
(iii) A provision for doubtful debts is to be made on debtors at 5%. (iv) Building is to be appreciatd by 20%.
(v) A liability for ` 5,000 included in sundry creditors is not likely to arise.
Partners agreed that the revised value are to be recorded in the books. You are required to prepare journal, revaluation account, partners capital account and revised balance sheet.
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