Unit - 1

PARTNERSHIP FINAL ACCOUNTS BASED ON ADJUSTMENT OF ADMISSION/DEATH OF A PARTNER DURING THE YEAR

1.1 Introduction

We have already studied in (SYJC)12th Std how the partnership Final Accounts are prepared by considering the adjustments of closing stock, outstanding/prepaid expenses/incomes, depreciation, interest on capital to partners, interest on drawings from partners, salary to partners, adjustment of reserves, goodwill; on admission/retirement/death of a partner. This was when a partner is admitted/retires at the end of accounting year. In this unit, we will study how to prepare Final Accounts when a partner is admitted/retires during the accounting year.

1.2 Admission of a Partner

According to Section 31 of Indian Partnership Act 1932 "A Partner can be admitted only consent of all the Existing Partners."

Adjustments required when a New Partner is admitted

1. Calculation of New Profit Sharing Ratio / Sacrificing Ratio.
2. Valuation and Treatment of Goodwill.
3. Revaluation of Assets and Liabilities.
4. Adjustment of accumulated Profits, Reserve and Losses.
5. Necessary Adjustment of Capital Accounts of Partners.

Change in Profit Sharing Ratio

A New Partner acquires his share from the Old Partner in any of the following Manners:

-          In their Old Profit Sharing Ratio

-          In a Particular Ratio or Surrendered Ratio

-          In a Particular fraction from some of the partner

Accounting Treatment of Goodwill

1. When Goodwill (Premium) is paid by the New Partner Privately

No Entry

2.                  When Goodwill brought in Cash by the New Partner

(i) Cash/Bank A/c   ...Dr.

To Premium for Goodwill A/c

(ii) Premium for Goodwill A/c ... Dr.

To Sacrificing Partners' Capital A/c (In Sacrificing Ratio)

To Sacrificing Partners' Current A/c s (When Capital is Fixed)

3.                  Goodwill Withdrawn by the Sacrificing (Old) Partners

Sacrificing  Partners' Capital A/c s ...Dr.

To Cash/Bank A/c

4.                  Goodwill not brought in Cash

New  Partner's Capital or Current A/c ... Dr.

To Sacrificing Partners' Capital or current A/c [Sacrificing Ratio]

5.                  Goodwill brought in Kind

Assets  A/c ...   Dr.

To Premium for Goodwill A/c

Hidden or inferred goodwill

Sometimes the value of goodwill is not given at the time of admission of a new partner. In such a situation, goodwill is calculated on the basis of net worth of the business. Hidden goodwill is the excess of desired total capital of the firm over the actual combined capital of all partners’.

For Example

Capital of L and M are Rs.  2,00,000 and Rs.  1,50,000 respectively. They admit N as a Partner for  1/5 share with Rs. 1,00,000 as his Capital.

On the basis of N’s Capital, total Capital of the Firm should be Rs. 5,00,000 (1,00,000 × 5/1). But the actual Capital of the Firm is Rs. 4,50,000 (2,00,000 +1,50,000 +1,00,000). Hence, Hidden Goodwill:

= Rs. 5,00,000 - Rs. 4,50,000

= Rs. 50,000

Revaluation of Assets and Reassessment of Liabilities

Accounting Entries

(i)                 For increase in the value of Assets

Assets A/c (Individually)  Dr.

To Revaluation (or P & L Adjustment) A/C

(ii)               For a decrease in the value of Assets

Revaluation A/c   Dr.

To Assets A/c (Individually)

(iii)            For an increase in the amount of Liabilities

Revaluation A/c   Dr.

To Liabilities A/c (Individually)

(iv)             For a decrease in the amount of Liabilities

Liability A/c (Individually)  Dr.

To Revaluation A/c

(v)               For an accounting unrecorded Assets

Assets A/c (Individually)  Dr.

To Revaluation A/c

(vi)             For accounting unrecorded Liabilities

Revaluation A/c   Dr.

To Liability A/c (Individually)

Revaluation Account

Reserves and accumulated (undistributed) Profits/Losses

Accounting Entries

(i)                 For transfer of Reserves and Accumulated Profits:

Profit and Loss ...   Dr.

Reserve Fund A/c or General Reserve Dr.

Workmen Compensation Reserve  Dr. [Excess of Reserve over Actual

Liabilities]

Investment Fluctuation Reserve A/c ...Dr. [Excess of Reserve over the

Difference between Book Value and market Value]

To Old Partners' Capital A/c s [In old Ratio]

(Being the reserve and profit transferred to old partners in their old ratio)

(ii)               For transfer of Reserves and Accumulated Losses:

Old Partners' Capital A/c s  Dr.

To Profit and Loss A/c [In old Ratio]

To Deferred Revenue Expenditure A/c (Like Advertisement Expenditure)

(Being the accumulated losses transferred to old partners in their old ratio

Adjustment of Partners' Capital

Case 1. Calculation of New Partner's Capital on the basis of Old Partners

Step 1. Calculate the adjustment closing capitals of old Partners (after all adjustments have been made)

Step 2. Calculate the total closing Capital of New Firm as under:

Total capital of New Firm = Combined adjusted Closing Capitals of Old Partners  X Reciprocal of remaining share of profit of old partners.

Step 3. Calculate the proportionate Capital of New Partner as under:

New Partner's Capital =Total capital of new firm x New partner's proportion of share  of  profit.

Case 2. Adjustment of Old Partners’ Capital on the basis of New Partner's Capital

Step 1. Calculate total capital of new firm on the basis of new partner's capital i.e. new partner's capital X Reciprocal of proportion of share profit of new partner.

Step 2. Calculate the new capital of old partners by dividing the total capital in their new  profit sharing ratio.

Step 3. Calculate the adjusted closing capitals of old partners (i.e. after all adjustments have been made)

Step 4. Calculate the surplus /deficiency in each of the old partner's capital account by comparing the new capital with their adjusted old capital which is adjusted through cash or transferred to their Current A/c

Adjustment of Surplus/Deficiency through Cash:

(a)               If Capital of Old Partners falls short (Deficit), bring in cash:

Cash/Bank A/c  Dr.

To Partners' Capital A/c s

(b)               If capital of old partner has a surplus, withdraw cash:

Partners' Capital A/cs Dr.

To Cash/Bank A/c

Adjustment of Surplus/Deficiency through Partner's Current Account:

(a)               If the existing capital is more than his required capital (surplus)

Partner's Capital A/c  Dr.

To Partner's Current A/c

(b)               If the existing capital is less than his required capital (deficit)

Partner's Current A/c Dr.

To Partner's Capital A/c

If Current Account shows a Credit Balance, it is taken to the Liabilities side of the Balance    Sheet. However, if Current Account shows a Debit Balance, it is placed on the Assets side of the Balance Sheet.

1.3 Retirement and Death of a Partner

Meaning

Retirement of a Partner means living the firm by a partner. A Partner may retire from the  firm in the following conditions-

I.                   If  there is an agreement about the retirement.

II.                If all the partners consent to his retirement.

III.            If the partnership is at will, by giving a notice in writing to all the other partners in

Advance.

Adjustment for Retirement of a Partner

(a)               Finding out the New Profit-Sharing Ratio and Gain Ratio.

(b)              Treatment of Goodwill.

(c)               Revaluation of Assets and Reassessment of Liabilities.

(d)              Treatment related to Unrecorded Assets and Liabilities.

(e)               Adjustments in respect to Accumulated Profits and Losses.

(f)                 Ascertain of Share of Profits or Losses up to the date of Retirement/Death.

(g)              Adjustment of Capital if required.

(h)               Settlement of Capital, if required.

(i)                 Change in Profit- Sharing Ratio

New Profit-Sharing Ratio

The New Profit-sharing Ratio on Retirement of a Partner is the Ratio in which the continuing or remaining Partners decide to share the future Profits and Losses.

New Share of a Partner = Old Share + Acquired Share

Case 1. When one Partner Retires and the New Profit -Sharing Ratio among the Remaining Partners is not given.

Case 2. When Remaining Partners Purchase the Share of the Retiring Partner in a Specific Ratio.

Gaining Ratio

Ratio  in which they Continue Partner acquires the Retiring of Deceased Partners' Share. Calculation of Gaining Ratio under different situations is given below:

(i)                 When No Agreement Exists

In this case gain to the continuing partners is in the old profit-sharing ratio.

(ii)              When the New Profit-sharing Ratio is given

In this case, the gaining ratio is calculated by deducting the old ratio from the new ratio.

Gaining Ratio=New Ratio - Old Ratio

Accounting Treatment of Goodwill

When a Partner Retires (or Dies) his Share of Profit is acquired by the Remaining Partners. The following Entry is recorded for this purpose:

Remaining Partner's A/cs .... Dr.  [Gaining Ratio]

To Retiring Partners' Capital  [Retiring Partner's Share of Goodwill]

All Partners' Capital/Current A/c’s Dr.  [Old Ratio]

To Goodwill (or Premium) A/c

Revaluation of Assets and Reassessment of Liabilities

(Same as admission)

Adjustment for Reserves and Undistributed profits/Losses

For Distribution of Accumulated Profits:

General Reserve A/c  Dr.

Reserve Fund A/c  Dr.

Profit and Loss A/c  Dr.

To All Partners' Capital A/c s

For Distribution of Accumulated Losses;

All Partner's Capital A/c Dr.

To Profit and Loss A/c

Accounting treatment of joint life policy;

Case 1. When there is no Joint Life Policy is present in the Balance Sheet but Joint Life Policy will paper in the Balance Sheet after Retirement.

Joint Life Policy A/c .... Dr.  (Surrender Value of J.L.P)

To All Partner’s Capital A/c’s (Old Ratio)

Case 2. When there is no Joint Life Policy in the present Balance Sheet and Joint Life Policy will not be shown in the Balance Sheet after Retirement.

In this situation adjustment is carried out through Partners' Capital Accounts by passing the following entry:

Continuing Partner’s Capital A/c’s ....Dr.  (Gaining Ratio)

To Retiring Partner's Capital A/c (Share of Surrender Value)

Case 3. When there is Joint Life Policy in the Balance Sheet: In this case, Joint Life Policy is treated as an asset. Any Revaluation of Joint Life Policy is carried out through Revaluation Account.

Calculation of amount due to the Retiring Partner

(i)                 Capital on the date of the last Balance Sheet.

(ii)               Interest or salary, if any, payable to him.

(iii)            Share of profit or losses till the date of retirement. (i) If the amount is paid in Cash or by Cheque;

(iv)             Share in the profits or losses on revaluation of assets and reassessment of liabilities.

(v)               Share in the goodwill of the firm.

(vi)             Share in the general reserve or profits and losses account appearing in the Balance Sheet.

Settlement of the Account Due to the Retiring Partner

(i) If the amount is not paid in cash;

Retiring Partner's Capital A/c Dr.

To Cash/Bank A/c

(ii) If the amount is not paid in cash;

Retiring Partner's Capital A/c Dr.

To Retiring Partner's Loan A/c

Construction of Retiring Partner's Loan Account

(i)                 For Interest due;

Interest on Loan A/c   Dr.

To Retiring Partner's Loan A/c

(ii)               For payment of Instalment with Interest:

Retiring Partner's Loan A/c   Dr.

To Cash /Bank A/c

Adjustment of partners’ capital in new profit sharing ratio

Adjustment of Partner's Capital in New Profit Sharing Ratio

(i)                 If Capital of Remaining Partner falls short, bring in Cash:

Cash/Bank A/c  Dr.

To Remaining Partner's Capital A/c

(ii)              If capital of remaining partner has a surplus, withdraw Cash:

Remaining Partner's Capital A/c Dr.

To Cash/Bank A/c

(iii)           If the deficit in their capital account is adjusted by transferring to their current accounts:

Remaining Partner's Current A/c Dr.

To Remaining Partner's Capital A/c

(iv)            If the surplus in their capital accounts is adjusted by transferring to their Current Capital Account

Remaining Partner's Capital A/c Dr.

To Remaining Partner's Current A/c

Note: If no information is given then any surplus or deficiency should be adjusted  in  cash and not by transferring it to partner's current account.

1.4 Death of a Partner

The Accounting Procedures on the Death of a Partner are very similar to the Retirement of a Partner.

From Accounting Point of view the following point are Important;

(i)                 Calculation of New Ratio and Gaining Ratio.

(ii)               Treatment of Goodwill.

(iii)            Revaluation of Assets and Reassessment of Liabilities.

(iv)             Distribution of Accumulated Profits and Losses.

(v)               Treatment of Joint Life Policy: Insurance amount is distributed among all partners including deceased partner in their old ratio.

(vi)             Interest on capital, share of profit to the deceased partner till the date of death, drawings, interest on drawings, is credited or debited to the deceased partner's account.

(vii)           Preparation of deceased partner's capital account and its settlement

Having given effect to the above 6 points, the balance in the Deceased Partner's Capital Account is transferred to his Executor's Account and may be paid in cash or transferred to his Loan Account.

Note: The Executors of the Deceased Partner are entitled to the following:

1. Balance of Capital and Current Account of the Deceased Partner
2. Share of Accumulated Profit/Loss
3. Share of Revaluation Profit/Loss
4. Share of Goodwill of the Firm
5. Share of Goodwill of the Firm
6. Share of Joint Life Policy taken by the Firm

Date of death is important factor while calculating the balance of deceased Partner.

Date is considered     Date is not considered

To calculate Share of Profit    To calculate Share of Goodwill

To calculate Interest on Capital   To calculate Share of General Reserves

To calculate Interest on Drawings   To calculate Share of Joint Life Policy

To calculate Interest on Deceased   To calculate Share of Profit and Loss A/c

Partner’s loan A/c     (given in Balance Sheet)

1.5 Points to remember to solve adjustments  during the year

If a partner is admitted or retired or dies during the year i.e in between the accounting year, following additional points to be remembered:

1. Trading/Profit & Loss A/c will have two amount columns i.e before and after such change.
2. Expenses related to time will be distributed in time ratio (ex: salary, depreciation etc) and expenses related to sales will be distributed in sales ratio(ex: advertising, bad debts, carriage outwards etc).
3. Profit & Loss Appropriation A/c will also have two amount columns i.e before and after such change. Accordingly; Interest on drawings/capital, salary to partner, net profit/loss shall also be distributed in two columns.
4. Balance Sheet will be prepared normally as usual.

1.6 Solved Examples

Q. 1: From the following Trial Balance of Ajit and Sujit, you are required to prepare a Trading and Profit & Loss A/c for the year ended 31st December 2003 and a Balance Sheet as on that date:

Trial Balance Sheet as on 31st December 2003

Adjustments:

1. The closing stock on 31st December 2003 was valued at Rs. 56,000.
2. The outstanding expenses were: (a) Wages Rs. 2,000 and (b) Salaries Rs. 930.
3. Goods of Rs. 2,000 were distributed as free samples.
4. Interest on partner’s capital was to be provided at 7% p.a.
5. Prepaid Insurance was Rs. 100.
6. Depreciation was to be provided on furniture at 10% and on machinery at 5%.
7. A reserve for bad and doubtful debts was to be created at 5% of sundry debtors.

Solution:

In the books of Ajit & Sujit

Trading, Profit & Loss A/c for the year ended 31st Dec, 2003

Balance Sheet as on 31st Dec, 2003

Notes:

1. In absence of information, partner’s share is assumed to be equal.
2. Numbers written in brackets are effect of adjustment numbers.

Q. 2: A, B and C carried on business in partnership as Ready Made Cloth Dealers. The partnership agreement provided that –

1. The partners were to be credited at the end of each year with interest at 5% per annum on Opening Balance of Capital.
2. No Interest was to be charged on drawings.
3. Profits and Losses were to be shared as to A5, B 3 and C2. It was agreed that C’s Share of profit in any should not be less than Rs. 10,000 and any deficiency in such share was to be borne by the other two partners in their profit sharing ratio.

Trial Balance of the Partnership as on 31stDecember 2003

You are given the following additional information:

1. Stock on December 31, 2003 was valued at the market value of Rs. 35,000 but if valued at cost it was Rs. 42,000.
2. Goods worth Rs. 1,000 were destroyed by fire and the Insurance Company has admitted claim for Rs. 700 only.
3. A debt of Rs. 600 is to be written off and provision for doubtful debts is to be at 5%.
4. Salaries and wages include the following monthly drawings by the partners: A: Rs. 500; B: Rs. 300 and C: Rs. 250.
5. Partners had during the year been supplied with goods worth Rs. 600 to A and Rs. 400 to B
6. On December 31, 2003 rates paid in advance and office and trade expenses owing were Rs. 2,500 and Rs. 2,100 respectively.
7. Depreciation of shop fittings to be provided at 5% p.a. On cost.
8. Professional Charges include Rs. 2,500 fees paid in respect of the acquisition of leasehold premises.
9. The cost of addition and alterations to the leasehold premises were to be written off over 25 years commencing from 1-1-2003.

You are requested to prepare the Trading Account and Profit & Loss Account for the year ending. 31st December, 2001 and Balance Sheet as at 31st December 2003.

Solution:

In the books of A,B & C

Profit & Loss A/c for the year ended 31 Dec, 2003

Balance Sheet as on 31 Dec, 2003

Partner’s Current Accounts

Q.3. A and B were partners sharing profits and losses in the ratio of 3:2. With effect from 1-10-2002, C joins as a third partner. The new profit sharing ratio was 2:2:1.

The following is their trial balance as on 31st March, 2003:

Other Information:

1. Stock on 31-3-2003 was Rs. 1,80,000.
2. Purchases from 1-4-2002 to 30-9-2002 were Rs. 4,00,000.
3. Sales from 1-4-2002 to 30-9-2002 were Rs. 6,00,000.
4. Wages from 1-4-2002 to 30-9-2002 were Rs. 60,000.
5. Stock on 30-9-2002 was Rs. 80,000.
6. Furniture worth Rs. 1, 00,000 was purchased 1-1-2003. Write off depreciation on furniture at 20% p.a.
7. Interest on partner’s capital is to be provided at 12% p.a.
8. No Interest is to be charged on partners drawings.

You are required to prepare:

1. Trading A/c containing the columns for: 1-4-2002 to 30-9-2002 and 1-10-2002 to 31-3-2003.
2. Profit & Loss A/c containing the columns for: 1-4-2002 to 30-9-2002 and 1-10-2002 to 31-3-2003.
3. Balance sheet as on 31st March, 2003.

Solution:

M/s A, B, C

Trading, Profit & Loss A/c for the year ended 31st March, 2003

Partner’s Capital A/c

Balance Sheet as on 31st March, 2003

Working Notes:

1. Sacrifice by partners

SR = OR – NR

A = (3/5) - (2/5) = 1/5

B = (2/5) - (2/5) = NIL

2.       General Expenses: Time Basis & Selling Expenses: Sales Basis.

3.       Depreciation on Furniture

Q.4. X and Y shared profits and losses equally. Their Trial Balance as on 31st December 2003 was as under:

Additional Information:

1. Z retired on 30th June 2003. His capital was paid off but the amounts due to him for (i) Profit of the year (ii) Share of Goodwill Rs. 10,000 (iii) Interest on his capital Rs. 1,250 were to be paid.
2. X, Y and Z were sharing profits and Losses 2:2:1.
3. Closing Stock was Rs. 6,250 on 30-6-2003 and Rs. 7,500 on 31-12-2003
4. Item   Up to 30-6-2003  after 1-7-2003     Purchase                            37,500                                          25,000                                                                                    Wages                                          3,750                                          2,500                                                                                    Sales                                          75,000                                          37,500                                                                     

Other expenses were to be equally distributed between the two periods.

5.      Depreciate Fixed Assets by 10% p.a.

6.      Allow interest at 10% p.a. On capital.

Show the Final Accounts.

Solution:

M/s X & Y

Trading, Profit & Loss A/c for the year ended 31st Dec, 2003

Balance Sheet as on 31st Dec, 2003

Partner’s Current A/c

Notes:

1. Expenses are divided in the ratio of Time (6:6) i.e (1:1).
2. Profit/Loss upto the date of retirement is distributed in old ratio & Profit/Loss after the date of retirement is distributed in new ratio.
3. Share of goodwill is distributed in gain ratio between remaining partners