Reconstitution of Partnership

Partnership is formed through an agreement among the partners.

If the old agreement gets cancelled and a new agreement is formed, then it is called reconstitution of
partnership.

Reconstitution of Partnership takes place in following situations:

1. Change in profit sharing ratio
2. Admission of a new partner
3. Retirement of an existing partner
4. Death of an existing partner
5. Amalgamation of two or more partnership firms

Let's discuss the accounting treatment of all the above cases one by one:

Change in Profit Sharing Ratio

Accounting Treatment:
● Calculation of gain/sacrifice ratio
● Accounting treatment of goodwill
● Accounting treatment of reserves, accumulated profits and accumulated losses
● Accounting treatment of revaluation of assets and liabilities
● Comprehensive questions

In this case, partners decide to change profit sharing ratio among themselves. This may lead to gain to
few partners and loss to the others.
Gaining partners must compensate the sacrificing partners by crediting their account with goodwill
amount.
To determine what amount of goodwill shall be paid by gaining partners to sacrificing partners, we need
to calculate gain or sacrifice ratio.
Calculation of sacrifice and gain ratio:

Sacrificing Ratio is the ratio in which one or more partner(s) agree to sacrifice their share of profits in
favour of other partner(s).

Gaining Ratio is the ratio in which one or more partner(s) gain a share of profits of other partner(s).

● Sacrifice Ratio = old ratio - new ratio

● Gain Ratio = new ratio - old ratio

Accounting Treatment of Goodwill

Gaining partners compensate the sacrificing partners with the value of goodwill. For this, following entry
is to be passed.

Prepared by Arun Arora

 Gaining Partners' Capital a/c Dr
To Sacrificing Partners' capital a/c

Accounting treatment for goodwill already appearing in the books of accounts:

Old partners’ capital a/c Dr

To goodwill a/c

For example, A, B and C were partners sharing profits and losses in 3:2:1. They decided to change their
profit-sharing ratio to 1:2:3. The value of goodwill is Rs 150,000. Pass the necessary entry for goodwill.

To solve this, we first need to calculate sacrifice and gain ratio.

Sacrifice ratio = old ratio - new ratio
A = 3/6 - ⅙= 2/6 (sacrifice)
B = 2/6 -2/6 = 0 (neither sacrifice nor gain)
C = ⅙ - 3/6 = -2/6(gain) note - when sacrifice is negative, this means that partner is gaining.

So, A is sacrificing and C is gaining, C will have to compensate A with the amount of goodwill =
2/6×150000= 50,000

Date Particulars L.F Debit Credit

. (Rs) (Rs)

C's Capital A/c Dr 50,000

To A's Capital A/c 50,000
(Being the accounting treatment of
goodwill)

Questions
1. A, B and C were partners sharing profits in the ratio 2:2:1. From 1st April 2019, they decided to
share profits and losses equally. The goodwill of the firm was valued at Rs 150,000. Pass the
necessary entry.
2. A, B and C were partners sharing profits in 2:1:1. They decided to change their profit-sharing ratio
to 1:2:1. Profits of a firm for last four years were Rs 100,000, Rs 150,000, Rs 50, 000 and Rs 100,000
respectively. The goodwill of the firm is valued at 2 years purchase of average profits of last four
years. Pass the necessary journal entry for goodwill.

Accounting Treatment of Reserves, accumulated profits and accumulated losses

Note: accumulated losses include advertisement suspense, deferred revenue expenditure and profit and
loss (debit balance)

Prepared by Arun Arora

Case 1: when partners decide to distribute reserves and losses among themselves
● For distribution of reserves and accumulated profits
Reserve Fund Dr
General reserve Dr
Profit and loss (credit balance) Dr
Workmen compensation reserve Dr
Investment fluctuation fund Dr
To old partners' capital a/c
(Being the reserve and accumulated profits distributed in old ratio)

● For distribution of accumulated losses

Old partners' capital account Dr
To Profit and loss a/c (debit balance)
To advertisement suspense a/c
To deferred revenue expenditure a/c
(Being the reserve and accumulated profits distributed in old ratio)

Case 2: when partners do not want to distribute reserves, accumulated profits and accumulated losses
among themselves
Gaining Partners' Capital a/c. Dr
To Sacrificing Partners' capital a/c

Note: if nothing is given in the question, it is assumed that partners decide to distribute reserve,
accumulated profits and accumulated losses. i.e. case 1.

Questions:
● A, B and C were partners sharing profits in the ratio 2:2:1. From 1st April 2019, they decided to
share profits and losses equally. The firm had general reserve of Rs 150,000 at that date. Pass
the necessary entry.
● A, B and C were partners in a firm sharing profits and losses equally. From 1st April 2019, they
decided to share profits and losses in the ratio 3:2:1. At that date, the firm had a debit balance
in profit and loss a/c amounting to Rs 60,000. Pass the necessary journal entry.
● A, B and C were partners in a firm sharing profits and losses in 3:2:1. From 1st April 2019, they
decided to share profits and losses in the ratio 2:1:1. At the date firm had credit balance in profit
and loss a/c amounting to Rs 150000 and advertisement suspense of Rs 30,000. Pass the
necessary journal entry.
● A, B and C were partners sharing profits in the ratio 2:2:1. From 1st April 2019, they decided to
share profits and losses equally. The firm had general reserve of Rs 150,000 at that date.
Partners do not want to distribute reserves, accumulated profits and losses. Pass the necessary
entry.
● A, B and C were partners in a firm sharing profits and losses equally. From 1st April 2019, they
decided to share profits and losses in the ratio 3:2:1. At that date, the firm had a debit balance
in profit and loss a/c amounting to Rs 60,000. Partners do not want to distribute reserves,
accumulated profits and losses. Pass the necessary journal entry.
● A, B and C were partners in a firm sharing profits and losses in 3:2:1. From 1st April 2019, they
decided to share profits and losses in the ratio 2:1:1. At the date firm had credit balance in profit

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 and loss a/c amounting to Rs 150000 and advertisement suspense of Rs 30,000.Partners do not
want to change the value of reserves, accumulated profits and losses. Pass the necessary journal
entry.

ACCOUNTING TREATMENT OF REVALUATION OF ASSETS AND LIABILITIES

Revaluation Account is prepared to record the change in values of assets and liabilities at the time of
change in profit sharing ratio, admission of a partner, retirement or death of a partner.

Nature of Revaluation account in nominal. (Rule- losses are recorded on debit side and gains are
recorded on credit side)

Format of Revaluation A/c:

Particulars Amount Particulars Amount

To increase in liabilities By increase in assets

To decrease in assets By decrease in liabilities
To profit on revaluation By loss on revaluation

Total Total

Journal:
a. For increase in assets
Assets a/c Dr
To Revaluation a/c
b. For decrease in assets
Revaluation a/c Dr
To Assets a/c

c. For increase in liabilities

Revaluation a/c Dr
To liabilities a/c

d. For decrease in liabilities

Assets a/c Dr
To Revaluation a/c

Case 1: When partners decide to record new values of assets and liabilities.

i. For profit on revaluation

Revaluation a/c Dr
To Partners’ capital a/c
ii. For loss on revaluation
Partners’ capital a/c Dr

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 To Revaluation a/c

Case 2: When partners decide to record new values of assets and liabilities.

When partners do not want to record revalued values of assets and liabilities, old values are
recorded in the balance sheet and an adjustment entry is passed.

For revaluation profit:

Gaining partners’ capital a/c Dr

To sacrificing partners’ capital a/c

Questions:
1. X, Y and Z are partners sharing profits and losses in 5:3:2. With effect from 1st April 2019, they
agree to share profits and losses 2:3:5. On that day, profit on revaluation was Rs 100,000. Pass
the necessary entry.
2. X, Y and Z are partners sharing profits and losses in 5:3:2. With effect from 1st April 2019, they
agree to share profits and losses 2:3:5. On that day, profit on revaluation was Rs 100,000.
Partners do not want to record new values of assets and liabilities in books of accounts. Pass the
necessary entry.
3. Prepare revaluation account from the following information. Also, calculate profit / loss on
revaluation.
● value of stock has been reduced by Rs 1000
● Provided 10% depreciation in machinery of Rs 200,000.
● Building of Rs 500,000 has been appreciated to Rs 550,000.
4. Prepare revaluation account from the following information. Also, calculate profit/ loss on
revaluation.
● Creditors of Rs 20000 allowed discount of 5%.
● Prepaid wages Rs 500
● Building of Rs 400,000 appreciated by 10%.
(Answers: 1. Profit on revaluation Rs 29000, 2. Profit on revaluation Rs 41,500)

COMPREHENSIVE QUESTION

1. A and B are partners in XYZ Ltd. sharing profits and losses in 2:1. Following is the balance sheet
of XYZ Ltd. as at 1st April 2018.

Liabilities Amount Assets Amount

Capital 150,000 Building 100,000

A- 100,000 Debtors 20,000
B- 50000 Machine 65000
Creditors 20,000 Cash in hand 15000

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 General reserve 30,000

200,000 200,000

Additional Information:
● Partners decide to share profits and losses in 1:2 from 1st April 2018.
● Goodwill of the firm is valued at Rs 50,000.
● Machinery is depreciated by 10%.
● Building to be appreciated at Rs 120,000.
You are required to prepare revaluation a/c, partners’ capital a/c and new balance sheet.

(Answer: Revaluation profit Rs 13,500, Partners’ capital A- Rs 145667, B- 47,833, Balance Sheet Total Rs
213500)

Prepared by Arun Arora