Admission of a Partner: Capital Adjustment

 

CAPITAL ADJUSTMENT: ADMISSION OF A PARTNER

At the time of admission of a partner, it may be agreed between the partners that the capitals of the partners may be adjusted as per agreement. The adjustment may take any of the following forms:

Case l. Determination of Capital of New Partner on the basis of Old Partners' Capital.
Case 2. Adjustment of old Partners' capital on the basis of New Partner's capital.
Case 3. Total capital of Reconstituted Firm is given which is to be adjusted in New Ratio.

Case 1: Determination of Capital of New Partner on the basis of old partners’ capital

Sometimes, at the time of admission, the capital of the new partner is not given and expected to bring capital on the basis of capitals of old partners.
There can be net) situations:
IA. When the New Partner is required to bring Proportionate Capital. (In this case, Capital of Firm is calculated on the basis of total adjusted capital of old partners),
1B. When the New Partner has to bring capital on the basis of combined capitals of partners.
(In this case, "Total Adjusted Capital of Old Partners" is calculated).
Let us understand the two situations, one by one.

Case IA:  When New Partner is required to bring Proportionate Capital

If the partner has to bring "Proportionate Capital", then the following steps are taken:
Step 1. Calculate total adjusted capital of old partners, i.e., after making adjustments for goodwill, reserves, accumulated profits/losses and profit and loss on revaluation, etc.
Step 2. Calculate "Total Capital" of New Firm as:
Total adjusted capital of old partners × Reciprocal of remaining share of old partners
Step 3. Calculate capital of the new partner as:
Total Capital (as per Step 2) × Share of New Partner.

It must be noted that in case of capital adjustment, if the new partner is unable to bring full or part of his share of Premium for Goodwill in Cash, then unpaid share of "Premium for Goodwill" should be adjusted through his Current Account and not Capitol Account. In this case, Debit Balance of Current Account will appear on the Assets side.

Case 1B. When New Partner has to bring capital on the basis of combined capitals of partners.

Step 1. Calculate adjusted combined capital of old partners, i.e., after making adjustments for goodwill, reserves, accumulated profits/losses and profit and loss on revaluation, etc.
Step 2. Calculate Capital of the new partner as:
Combined Capital (as per Step 1) × Share of New Partner.

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

If capital of the new partner is given, then the same is used as a base for calculating the new capitals of the old partners. In such a situation, the following steps are taken:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Calculate "Total Capital of the Firm" on the basis of capital of new partner as:
New Partner's Capital × Reciprocal of share of new partner
Step 3. Determine new capital of old partners, i.e. divide total capital in their new profit-sharing ratio.
New Capital of Old Partner Total Capital of the Firm × New share of Old Partner
Step 4. Calculate present adjusted capital of the old partners, i.e., after making adjustments for goodwill, reserves, accumulated profits/ losses and profit and loss on revaluation etc.
Step 5. Calculate the surplus or deficit by comparing the new capital (determined in Step 3) and present adjusted capital (determined in Step 4).
            Surplus = Present Adjusted Capital > New Capital
            Deficit = Present Adjusted Capital < New Capital

Case 3. Total capital of Reconstituted Firm is given which is to be adjusted in New Ratio.

Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Determine new capital of all partners - divide given total capital in their new profit-sharing ratio.
New Capital of Partners = Total Capital given of the Firm × New share of all Partners
Step 3. Calculate present adjusted capital of the old partners, i.e., after making adjustments for goodwill, reserves, accumulated profits/losses and profit and loss on revaluation etc.
Step 4. Calculate the surplus or deficit by comparing the new capital (determined in Step 2) and present adjusted capital (determined in Step 3).
            Surplus = Present Adjusted Capital > New Capital
            Deficit = Present Adjusted Capital < New Capital

Pass necessary Journal entry for adjusting the above surplus/ deficit.

            (i) If Present Adjusted Capital is more than the New Capital, i.e. in case of surplus
                       Concerned Partner's Capital A/c                                                          Dr.
                                   To Cash/ Bank/Concerned Partner's Current A/c           
            (ii) If Present Adjusted Capital is less than the New Capital, i.e. in case of deficit.
                        Cash/ Bank/Concerned Partner's Current A/c                                      Dr.
                                    To Concerned Partner's Capital A/c

 SUMMARY OF CASES OF CAPITAL ADJUSTMENT

Common Facts of each Case: A and B were partners sharing profits and losses in the ratio of 3:2, having capitals of 3,00,000 and 2,00,000 respectively. They decided to admit C as a new partner for share. The new profit-sharing ratio is agreed at 3:2:1. The adjusted capitals Of A and B (after an adjustment of premium for goodwill, reserves, accumulated profits and revaluation profit) are 3,50,000 and 2,50,000 respectively. Calculate the new capitals of A, B and C and the amount of actual Cash to be brought in or to be paid to the partners in each case. 

Case IA: When 'the Partner is requited to bring Proportionate Capital.	Case 1B: When the New Partner has to bring Capital on the basis of Combined Capitals of old Partners.
Total Adjusted Capitals (A and B) = 3,50,000 + 2,50,000 = 6,00,000. Remaining Share for A and B = 1–1/6 = 5/6  Total Capital of New Firm = Total Adjusted Capitals × Reciprocal of remaining share of A and B = 6,00,000 × 6/5 = 7,20,000. C's Capital = Total Capital × C's Share  = 7,20,000 × 1/6 = 1,20,000.	Total Capital of New Firm = Total Adjusted Capitals of A and B = 3,50,000 + 2,50,000 = 6,00,000. C's Capital = Total Capital × C's Share             = 6,00,000 × 1/6 = 1,00,000.
Case 2: Adjustment of Old Partners Capital on the   basis of New Partner’s Capital. C brings 1,40,000 for 1/6th share.	Case 3: Total Capital of Reconstituted Firm is as 9,60,000, which is to be adjusted in New Ratio.
New Ratio = 3:2:1 Total Capital on basis of C's Capital = C's Capital × Reciprocal of C's share = 1,40,000 × 6/1 = 8,40,000. Total Capital in New Ratio = Total Capital × New share A's Capital = 8,40,000 × 3/6 = 4,20,000 B's Capital = 8,40,000 × 2/6 = 2,80,000 Present Adjusted Capitals: A = 3,50,000 and B = 2,50,000. So, A and B will bring cash of 70,000 and 30,000 respectively.	New Ratio = 3:2:1; Total Capital = 9,60,000 Total Capital in New Ratio = Total Capital × New share A's Capital = 9,60,000 × 3/6 = 4,80,000 B's Capital = 9,60,000 × 2/6 = 3,20,000 C's Capital = 9,60,000 × 3/6 = 1,60,000 Present Adjusted Capitals: A = 3,50,000 and B = 2,50,000. So, A and B will bring cash of 1,30,000 and 70,000 respectively. C will bring in cash of Rs. 1,60,000 as his capital.

Important Points

            (i) It must be noted that as per the terms of agreement, surplus capital is withdrawn by the old partners or alternatively, it may be transferred to Current Account. Similarly, deficit capital  is brought in by the old partners or it is transferred to their Current Accounts.
            (ii) However, in the absence of any specific information, surplus or deficit is to be adjusted in "Cash" and not by transfer to Current Account.
            (iii) In case of capital adjustment, if the new partner is unable to bring full or part of his share of Premium for Goodwill in Cash, then unpaid share of "Premium for Goodwill" is to be adjusted through his Current Account and not Capital Account. In this case, Debit Balance of Current Account will appear on the Assets side of Balance Sheet.