Admission of new partners within a partnership firm indicates that a new partner or associate is included within the existing firm. On account of such inclusion, the newly added partner brings with him or her, share of goodwill or premium, and consequently retains the right in profit-sharing.
It is only in such situations that are in the best interest of the business, can a new partner be admitted in the partnership firm. Business considerations may include requiring managerial assistance or additional capital. It may also include expansion of business, for which the new partner may be able to supplement the resources which are at the disposal of the firm.
In such a scenario, the partnership firm undergoes reconstitution, and for carrying on the usual course of business, the firm executes a new agreement.
Under the Partnership Act 1932, it is mandated that a new partner can only be admitted into an already existing partnership firm solely in the instance of consent obtained from the existing partner of such a firm.
The consent of the existing partners is indicated in the Deed of Admission, which is usually a signed agreement. Such deed contains the regular provision as found in Partnership Deed along with an additional provision as introduction on admission of a partner. The deed of admission will incur a stamp duty pursuant to the relevant provisions of the Stamp Act.
Before we start with the ways of how to treat goodwill brought by the new partner, we should have a clear understanding of the concept of goodwill.
Goodwill, in this context, pertains to the benefit of reputation, benefit of good name and the resultant connections in business. It is critical for a business to earn a greater amount of profit as opposed to a firm which has recently been set up. In accounting terms, it includes the monetised version of such a specific advantage.
Now that we have gained some idea about the concept of Goodwill, let us move on to understanding the ways in which goodwill can be treated.
Within the revaluation method, the newly added partner usually falls short of paying the cash component of his or her share of goodwill. In such an instance, the existing partners will be able to generate the entire goodwill value in the books. It is done by debit of goodwill account and simultaneously crediting existing partners’ capital accounts. The valuation will follow the previous profit sharing quotas.
In case of a premium method of treating goodwill, the incoming partner infuses cash as his or her share of goodwill. It is divided within the existing customers consistent with sacrificing ratio. It should be noted in this regard that if the goodwill amount is paid privately to the existing partners in cash, it will not be entered in the books.
With the admission of a partner in an already existing partnership firm, a few changes will have to be integrated in the existing system. Those are –
Adjustment in Capital of Partners
The adjustment in capital will be consistent with partners' contribution and rearranged based on the newer profit-sharing ratio.
Adjustment and Valuation of Goodwill
The methods of valuation and adjustment of goodwill mainly include capitalisation method, super-profits method, annuity method and average profits method.
Accuracy in goodwill valuation is very important as it eventually leads to an increase in the customer base, and reputation, among others.
Revaluing Assets and Reassessing Liabilities
Revaluation of assets and liabilities means its accurate description of the true value. There are, however, multiple methods of recording these revaluations.
Alteration in Profit Sharing Ratio
The changes in profit sharing ratio may involve a few partners gaining or losing some amount. It relates to the ratio by which the partners will be sharing profits and losses prospectively.
Sacrificing ratio is essentially the proportion in which the partners have arrived at a consensus to ‘sacrifice’ their profit share in the interest of other partners.
Distributing the Accumulated Profits
The profits and losses that are accrued in the previous accounting, which are yet to be distributed among the partners are termed as accumulated profits. The accumulated profits are usually distributed among the existing partners consistent with the old profit sharing ratio. However, with the admission of a new partner, the accumulated profits will have to be distributed accordingly.
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Can the admission of a new partner cause a partnership firm to be reconstituted?
Yes, the admission of a new partner can lead a partnership firm to be reconstituted. Other situations which may cause such reconstitution include death of a partner or retirement of a partner. However, it must be noted that a partnership firm cannot be reconstituted with the dissolution of partnership.
When is a new partner considered to be admitted in a partnership firm?
The act of inclusion of the new partner to an already existing firm will be considered to be admitting him or her in the partnership firm. The admission of a new partner usually takes place when the partnership firm is usually in need of greater managerial skill or more capital, among others.
What kinds of rights are enjoyed by the newly admitted partner?
A newly admitted partner primarily enjoys two kinds of rights. Those are (a) right to share in the firm’s profits and (b) right to share in the firm’s assets.
For the right to share in the profits, the newly admitted partner has to bring his or her share of goodwill. For the right to share in assets, the newly admitted partner has to infuse a certain corpus of capital.