Reconstitution of A Partnership Firm: Admission of a Partner

Introduction

A partnership firm has two or more members who share the profits or losses of the firm according to pre-set limits. These limits and all other rules and regulations that will guide the firm are mentioned in a partnership deed. The partnership deed is the Bible of a partnership firm. However, if no partnership deed is formed among the partners of the firm, the Partnership Act of 1932 is applied to the partnership firms in running the businesses.

The partnership ratios mentioned in the partnership deeds may need to be restructured. This restructuring leads to a change in the partnership deed. Although partnership restructures often refer to changes in profit-sharing ratios, there may also be other formal decisions that lead to the restructuring or reconstitution of a partnership firm.

There are plenty of partnership firms in the business world, and some of them are astonishingly successful. Some popular partnership firms in the world include Google, Apple, and eBay. The success of partnership firms is probably derived from the dedication and bonding of partners which goes beyond just profit-sharing. The will to offer new dimensions and form a successful business are probably the reasons for success too.

Reasons for Reconstitution of a Partnership Firm

Partnership firms are lenient when it comes to reconstructing the partnership deeds and it happens to the partnership deeds in more than one case. A partnership firm may be reconstituted for four specific reasons −

• Due to the admission of a new partner in the firm.

• Due to a change in the profit-sharing ratios of the partners.

• Due to the retirement or resignation of an existing partner.

• When a partner of the firm dies or is rendered insolvent.

Admission of a Partner: Reconstitution of a Partnership Firm

The partnership deed and therefore the partnership terms need to be reconstituted when a new partner joins a partnership firm. In India, the partnership act of 1932 is applicable to issues related to new admissions of a partner.

For example, usually, the admission of a new partner in a partnership firm should be unanimous. However, when it is not so, the partnership act may be used to determine the rules and regulations of the firm.

The admission of a new partner usually brings new resources, ideas, and enhanced drive to the business. However, notably, there is no need for one partner to leave when a new partner joins the firm. The new partner must have a profit ratio and he can have a say in the general activities of the business. All assets and liabilities of the firm, including intangible assets like goodwill, must be re-stated to suit the new partnership form of the business.

Adjustment of Capital and Change in Profit Sharing Ratio Among Existing Partners

A change in the profit-sharing ratio may occur when a new partner is admitted to a partnership firm. In such a circumstance, no change occurs in the profit-sharing ratio of the existing partners who are carrying on the business. However, there may be a change in the profit-sharing ratio of other existing partners.

Existing partners may sometimes decide to change the profit-sharing ratio even without the admission of a partner. In such cases, some members gain a profit while other members suffer a loss. The members who gain a profit must compensate the sacrificing partner(s) in such cases.

• New profit-sharing ratio − There are two types of ratios in which the partners loss or gain profits after a new member is introduced into a partnership firm.

• Gaining Ratio − It is the ratio in which the partners have agreed to gain a share of profit from other existing members. It can be calculated as follows −

$$\mathrm{Gaining\:ratio\:=\:New\:Ratio\:-\:Old\:Ratio}$$

• Sacrificing ratio − It is the ratio in which the existing members have agreed to sacrifice their share of profit for the new entrants. It can be calculated as follows −

$$\mathrm{Sacrificing\:ratio\:=\:Old\:Ratio\:-\:New\:Ratio}$$

Other related adjustments

In the case of the entry of a member, a few adjustments are also made in the books of the partnership firm. These changes are the following:

Revaluation of Assets and Liabilities:

The reconstitution of the partnership firm’s assets and liabilities is needed during the entry of a new member. The reasons for this are the following −

• The assets and liabilities must be brought to their correct values in the books.

• Assets and liabilities of the firm that have not been recorded must be brought into the accounting books of the firm

• It is also done to ascertain the actual financial position of the firm.

• Profit and loss that is found due to such revaluation up to the date of reconstitution of the firm should be adjusted in the partner’s capital accounts in accordance with their sacrificing ratio.

Adjustments of Reserves, Accumulated Profits, and Losses

The reserves, or accumulated profits and losses that are on the balance sheet must be transferred to the new member’s account during the entry of the new member. If the already existing figures need to be maintained adjustments must be done to the books of the partnership firm. The gaining partner in such cases must compensate the losing one according to his/her proportion in the profit-sharing ratio.

Adjustments for the Goodwill

Along with shares in assets and liabilities, and reserves, the new member must also be entitled to the share of goodwill of the firm. The partners who are in gain must pay the sacrificing partner the share of goodwill that is due to the latter. It is a matter of the partnership deed which is responsible for the calculation of the amount of goodwill. It needs the approval of members unanimously to determine the exact amount of goodwill of the firm.

Conclusion

Admission of a new partner is one of the most common reasons for the reconstitution of a partnership firm. As the partnership deed which records all rules of the business needs to be changed, it is one of the most intricate policies the partnership firms need to rely on. Knowing the rules related to the reconstitution of the partnership firm is therefore an important aspect of businesses.

FAQs

Qns 1. What is meant by a partnership deed?

Ans. The limits of profits and losses and all other rules and regulations that guide the partnership firm are mentioned in a partnership deed. The partnership deed is the Bible of a partnership firm

Qns 2. What are the two new profit-sharing ratios that are applicable in the case of the entry of a new partner in a partnership firm?

Ans. The two new profit-sharing ratios that are applicable in the case of the entry of a new partner in a partnership firm are gaining and sacrificing ratios.

Qns 3. How is the gaining ratio calculated?

Ans. Gaining ratio = New Ratio – Old Ratio