# Accounting: Admission of a Partner: Adjustments in Profit Sharing Ratio (For CBSE, ICSE, IAS, NET, NRA 2022)

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• Every business wants to do expansion/diversification in order to get more momentum. In that case it may require additional capital or managerial help. To get managerial help or additional capital firm may admit additional partners.
• According to the Partnership Act 1932, a person can be admitted into partnership only with the consent of all the existing partners unless otherwise agreed upon.
• Admission of new partners brings not only capital but also Good will. Therefore, required adjustments need to make in accounting entries. The following adjustments become necessary:

## Adjustments in Profit Sharing Ratio

First thing need to adjust is ratios of profit sharing. As new partner will contribute new capital he will get share of profit. Because of this existingpartner profit ratios will change and the existing partners sacrifice a share of their profit in favour of new partner.

Sacrificing Ratio = Existing Ratio – New Ratio

### Only the New Partner՚s Share is Given

In this case new partner՚s ratio will be decided first. Existing partners continue to share remaining profit in the same ratio as they did earlier.

Ex: Deepak and Vivek are partners sharing profit in the ratio of 3: 2. They admit Ashu as a new partner for 1/5 share in profit. Then Ashu share will be 1/5 and the remaining 4/5 will be shared by Deepak and Vivek. New ratios will be (3/5 of 4/5) : (2/5 of 4/5) : (1/5) i.e.. 12: 8: 5

### The New Partner Purchases His/Her Share of the Profit from the Existing Partner in a Particular Ratio

In this case the new partner will purchase part of share from both the existing partners.

Ex: A and B are partners sharing profit in 5: 3 ratio. They admit C for 1/6 share and C acquires 1/8 from A and 1/24 from B. New profit ratios will be

(5/8 - 1/8) : (3/8 - 1/24) : (1/8 + 1/24) i.e.. 3: 2: 1

And Sacrifice Ratio will be 1/8: 1/24 i.e.. 3: 1

### Existing Partners Surrender a Particular Portion of Their Share in Favour of a New Partner

Goodwill: Meaning, Factors Affecting Goodwill and Valuation

Goodwill represents the reputation of a firm. It helps in many ways to firm in acquiring additional profits. Admission of new partner brings Goodwill along with capital. The value of Goodwill can be measured in different ways.

#### Factors Affecting the Goodwill

• Location: If the firm is located at a central place, resulting in good sale, the goodwill tends to be high.
• Nature of Business: A firm that produces high value products or having a stable demand is able to earn more profits and therefore has more goodwill.
• Efficient management: A well-managed firm earns higher profit and so the value of goodwill will also be high.
• Quality: Quality in products and services brings more Goodwill to the firm.
• Market Situation: If it is Monopoly it earns more profits and has higher Goodwill.
• Special Advantages: Firms with Patents and Trademarks will have more Goodwill.

### Methods of Valuation of Goodwill

#### Average Profit Method

• Simple Average Method:

Value of goodwill = Average Profit × Number of year of purchase

Where, Average Profit = Total Profit/No. of Years

• Weighted Average Method:

In this method each year profit is assigned a weight i.e.. 1,2, 3,4 etc. Thereafter each year profit is multiplied by the weight and find product. This method is used when we observe that there is a tendency to increase the annual profits. Latest year profit is assigned the highest weight.

Weighted average profit = Total product of profit/Total of weights

Value of goodwill = Weighted average profit × number of year of purchase

Ex: The profit of firm for past years was as follow: Profit ₹

2002 2005

2003 2006

2004

The weight to be used is 1, 2,3, 4, and 5 for the years from 2002 - 2006. Calculate the value of goodwill on the basis of two year՚s purchase of weighted average profit.

Solution:

 Year Profit Weight Products 2002 1 2003 2 2004 3 2005 4 2006 5 15

#### Super Profit Method

Normal profit = Capital employed × normal rate of return/100

Actual Profit: These are the profit earned during the year or it is also taken as the average of the last few years profit.

Super Profit = Actual Profit – Normal Profit

Value of Goodwill = Super Profit × Number of years of purchase

Ex: A firm earns profit of ₹ On a capital of ₹ and the normal rate of return in similar business is 10 % . Then the normal profit is ₹ the actual profit is ₹ 65,000. Thus, Super profit = Actual profit – Normal profit

=

=

If value of Goodwill is calculated by 3 years՚ purchase of super profit then

#### Capitalisation Method

Optimum utilization of capital is very important to any business. Two firms may acquire same profit but one firm uses less capital to get that profit. The amount of capital saved by the firm is termed as Goodwill.

### Capitalisation of Average Profit

In this method, the value of goodwill is assumed to be excess of the capital value of average profit over the actual capital employed.

Capital employed = Total assets – outsider liabilities

Capitalised value of profit = (Average Profit/Normal rate of profit) × 100

Goodwill = Capitalised value of profits – Capital employed

#### Capitalisation of Super Profit

Goodwill = (Super profit/normal rate of profit) × 100

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