What is a Partnership?
A partnership is a kind of arrangement between two or more people whereby they agree to manage the business operations and share its profits and losses in an agreed ratio between them. The agreement that is drafted and signed by the partners of the firm is termed as a partnership deed and contains various important clauses agreed between the partners such as profit/loss sharing, interest on capital, remuneration allocation of each partner, drawings of a partner, etc.
Admission and Withdrawal of a Partner in Accounting:
Admission of a Partner
Admission describes the inclusion of a new person in the existing partnership firm and to claim the rights of sharing profits/losses in the firm, the incoming partner is required to bring in some amount which is generally referred to as his share of goodwill or he may also bring the capital share to be contributed by him.
Withdrawal of a Partner
The withdrawal of a partner from the partnership firm is done by serving a notice to other partners of the firm in advance stating the reason for the withdrawal. The partnership agreement usually mentions the time frame within which the notice period is required to be served. There are two kinds of withdrawal.
- Voluntary Withdrawal: It takes place when a partner chooses to discontinue the partnership and serve a notice for the same on the other existing partners in the firm. The voluntary withdrawal usually happens in the case of the retirement of a partner.
- Involuntary Withdrawal: It is a kind of withdrawal wherein the partner is disassociated from the existing partnership firm without his consent and all other existing partners jointly serve a notice for his withdrawal. The partnership agreement so drafted mentions the condition under which a partner may be involuntarily discontinued from the firm. This kind of withdrawal usually happens in case of death of a partner, incompetence, incapacity of a partner to carry on in the firm or owing to his/her criminal conviction.
Methods to admitted new Partner to the Partnership Firm
A partner is admitted in two ways in a partnership firm:
By Purchasing interests from Current Partners
In this scenario when the new partner comes in, he is generally allocated some portion in the existing shares of old partners. The ratio in which the new partner is entitled to the existing shares is generally pre-defined.
For example, A and B are partners in the partnership firm in XYZ company. They decide to share 1/3rd of their existing shares with C. The net asset of the partnership firm is valued at $75,000. The capital balance of A is $30,000 and that of B is $45,000. The journal entries are as follows will be:
|Date||Description||Debit ($)||Credit ($)|
|April 1||A, Capital||$10,000 (1/3rd of $30,000)|
|B, Capital||$15,000 (1/3rd of $45,000)|
|C, Capital||$25,000 ($10,000+ $15,000)|
|The transfer of interest between existing partners and new partners.|
Adjusted Partnership Interest after Admission: (Journal Entries)
|Pre-Admission Capital Balance||30,000||45,000||0||75,000|
|Post-Admission Capital Balance||20,000||30,000||25,000||75,000|
|New adjusted partnership interest||26.67%||40%||33.33%|
When a new partner joins in, he usually brings with him certain amount of cash (goodwill) which in turn increases the capital strength of the partnership and accordingly the ratio of the partnership interest gets changed. For example, C contributes $25,000 cash to join the ABC company as a new partner, the journal entry for the same would be.
|Date||Description||Debit ($)||Credit ($)|
|Contribution of assets by a new partner.|
Adjusted Partnership Interest after Cash Contribution
|Pre- admission capital||$30,000||$45,000||$0||$75,000|
|Adjustment made to the capital account||$0||$0||$25,000||$25,000|
|New partnership interest||30%||45%||25%|
Revaluation of Assets
In case when there is an entry of a new partner into the partnership firm, the balance of the partnership assets account is required to be stated at its current value and any changes in the current value of the assets is to be divided amongst the current partners' capital account in the ratio as stated in the partnership agreement. For example, if the inventory balance of the company is $10,000, but its current market value is $20,000, and partners A and B share the profits equally, then in such case the capital account of each partner shall be credited with $5,000, being revaluation value of the assets.
However, in the case where the asset that is being revalued is fixed, then in such case it is revalued at its current value after the accumulated depreciation is removed. The revaluation of assets is necessary because it prevents the new partner from income sharing and bearing the loss as recorded on the books before the entry of a new partner into the partnership.
For example, a company has machinery worth $30,000 with accumulated depreciation of $5,000. When the new partner C was admitted the value of the machinery was $20,000. The $5,000 decrease in the value of the machinery ($25,000 minus the current market value of $20,000) will be debited from the capital accounts of the existing partners A and B.
Treatment of Bonuses in Case of Admission of a New Partner
- In the case where a new partner joins the firm, he/she may pay other partners a bonus or there might also be a situation where the other partners pay the partner coming in, a certain amount of bonus for joining in.
- The amount of bonus usually depends on the income-generating potential of the new or existing partners for the firm.
- The partnership agreement is amended with the joining of the incoming partner and constitutes a clause which states in what amount and ratio, the bonus is going to be divided.
- If the incoming partner's ownership interest is less than the amount paid by him, then the other partners receive a bonus which is credited to their capital accounts as per their profit sharing ratio, however, in the case where the ownership interest of the incoming partner is more than the amount paid by him/her, he receives a bonus and the amount shall be a credit to his/her capital account.
Effects of Withdrawal of Partner from the Partnership Firm
- As per the partnership agreement, when an existing partner decides to retire or withdraw from a partnership firm, the interest of the withdrawing partner is sold off to the existing partners and the entries for the sale and purchase of the interest is recorded in the books as the sale and purchase of the individuals, wherein the withdrawing partner's capital account is debited and the capital balances of the existing partners who purchase the additional interest is credit with the same amount.
- The partner who is retiring also has the right to receive his share in the assets from the partnership along with an option to see them off to the existing partners.
- However, in the case where a partner dies, it is also mandatory to close the books of accounts on the date of death.
- The net income of the firm is then determined and distributed among the existing partners in the ratio as stated in the partnership agreement.
- The assets are generally adjusted as per the current market value on the death of a partner and in case if there is any revaluation, the same is distributed amongst the partners in their income sharing ratio.
- After all the required entries are made in the books of accounts, the final journal entry is passed to close the books of accounts of the deceased partner, whereby the capital account of the deceased partner is debited and any liability with regards to his share in the income of the firm, is credited as payable to the deceased partner's heir or estate.
- The remaining partners thereafter can accordingly decide to liquidate the firm or continue the business with new capital balance and adjustments.
The care must be taken while computing the share of goodwill contributed by the incoming partner and also while passing the journal entries for the same in the books. The retirement or death of an existing partner also requires revaluation of assets, the entry for which is to be recorded properly in the journal books. The mistakes which are mostly observed relates to the calculation of profit sharing, goodwill valuation, etc which needs to be taken care of.
Context and Applications
This topic is significant in the professional exams for both undergraduate and graduate courses, especially for:
- B.com (Honors) (Bachelor of Commerce).
- M.com (Master of Commerce).
- Chartered Accountants (CA).
- Company Secretary (CS).
- Liquidation of Partnership.
- Goodwill and its valuation.
- Partnership Accounting.
- Death of a partner.
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