0In a partnership firm, whenever there is any change in terms of partnership deed, there is a need for reconstitution of the partnership firm. A change in a partnership deed can be due to various reasons like:
a) Change in Profit Sharing Ratio
b) Admission/ Retirement of Partner
c) Death of Partner
Mostly, admission of a new partner is the main criteria on which, reconstitution of partnership firm happens. While the admission of a new partner, the following points need to be taken down by the students:
a) New Profit Sharing Ratio b) Sacrificing Ratio c) Valuation & Adjustment of Goodwill
d) Revaluation of Assets & Reassessment of Liabilities
e) Distribution of Accumulated Profits
f) Adjustment of Partner's Capital
Point D to F is only possible if points A to C is correctly recorded. Sacrificing Ratio & Goodwill Valuation forms the basic concept to learn admission/retirement/death of partners, in general. So in this lesson, I will present you the essence of Sacrificing Ratio & Adjustment of Goodwill
A. Sacrificing Ratio
Sacrificing ratio is the ratio at which existing partners contribute or surrender their share of profit for the new admission of partner(s). For instance, A & B are partners sharing profit equally (1:1) for ABC Traders. They decide to admit C as a partner, for which A sacrifices 1/4th of his share & B sacrifices 2/4th of his share, thus, sacrificing ratio for A: B is 1:2. The formula for Sacrificing Ratio= Old Ratio - New Ratio
Note: 1. The base of the denominator of the ratio MUST be the same. Read the question correctly. If the base is not the same, you cannot conclude the answer correctly.
Note 2. Sometimes, only one partner makes the sacrifice of his/her share of profit. Thus, if that is the scenario, directly apply the formula to the partner who sacrificed his/her share.
Note 3. If there is no specific information given related to NEW RATIO or contribution made by the partners, it is implied and assumed that SACRIFICING RATIO = OLD PARTNER'S RATIO
Note 4. 75% of the times, new partners profit is the 1/nth (n= numbers) of the partner's shares. Dont rush to apply formula. Multiple with their ratio & then according to the information in the problem, solve it.
VALUATION OF GOODWILL
As per AS26, Intangible Assets are invisible & non-monetary assets which help to build the reputation of the company due to which it attains extra profit. Goodwill is the most used asset by any business organisation.
Goodwill is the reputation of the firm, on which it is recognised as brand equity. It helps an individual to attain SUPER profit over normal profit. For instance, ABC Diary is well known for its milk. Without branding or advertisement, if its selling price is INR 22/- per litre, while another substitute cost is INR 20/-, then that EXTRA INR 2/- it earned due to their GOODWILL in the market.
Goodwill can be calculated using three methods:
a) Average Profit Method
b) Super Profit Method
c) Capitalisation Method
Usually, university dont ask sums to solve based on goodwill, but the theory is critical. While solving problems related to Treatment of Goodwill, keep in mind the following points:
Note 1. Always note whether the new partner brings goodwill or not. It will help you to ascertain whether to transfer Goodwill amount to Partners Capital account or Partners Current Account.
Note 2. The Sacrificing ratio is used for distribution of goodwill,when new partner brings in the amount calculated for goodwill.
Note 3. In case, the goodwill account already exists in books of accounts. First, we need to write off in Partners Capital Account, in their old profit sharing ratio, and then account for goodwill brought by a new partner in sacrificing ratio.
Note 4. In case, the new partner doesn't bring goodwill, then the amount calculated for his/her share of goodwill will be distributed to old partners capital account in their sacrificing ratio.
Note 5. Always take care of Hidden Goodwill. 95% of the times, goodwill is brought by the new partner. In case it is not mentioned, we need to inferred it from the capital & profit sharing ratio
