Reconstitution of a Partnership Firm

Reconstitution of a Partnership Firm

It means building partnership in a new way. If there is a change in the partnership agreement, it brings to an end of the existing partnership and a new agreement comes into force, because partnership is the result of an agreement between persons for a business. This change also changes the relationship of partners. In that case partnership continues with reconstitution. It may happen due to following circumstances:

·        When partners decide to change their profit sharing ratio.

·        When a new partner is admitted to the firm.

·        When an existing partner decides to take retirement from the firm.

·        When a partner dies.

·        When two or more firms decide to amalgamate.

In all these cases, the profit sharing ratio of partners changes from their existing ratio. Firm continues its business but with a different agreement. Let’s discuss in detail.

Change in the Profit Sharing Ratio among the existing Partners

Sometimes the existing partners decide to change their profit sharing ratio. This change results in sacrifice or gain for partners. Some partners may acquire extra share in Profit i.e. gain and some partners may have to lose their share i.e. sacrifice. The reasons for change in profit sharing ratio can be change in capital contribution, active participation in the management of business of the firm etc.in that case equity is maintained among the partners. So it is necessary to make some adjustments in assets & liabilities, profit & losses etc.

Some adjustments which are required at that time are:

·        Determination of Sacrificing or Gaining ratio

·        Accounting for Goodwill

·        Accounting treatment of Reserves and Accumulated Profits

·        Accounting for Revaluation of Assets & Liabilities

·        Adjustment of Capitals

When a new partner is admitted to the firm:

Admission of a new partner into the existing firm is possible only when all the existing partners are ready for it. It is one of the modes of reconstitution of the firm. A new partnership deed is prepared at that time because the old one comes to an end. Due to following reasons a new partner is needed into the business:

·        When more capital is needed for the expansion of the business.

·        When a competent and experienced person is needed for the efficient running of the business.

·        To encourage a capable employee by taking him into the partnership.

·        To increase the Goodwill and reputation of the business by taking a reputed and renowned person into partnership.

At the time of admission, the new partner also brings his share of goodwill along with his capital. Therefore, old partners have to sacrifice a share of their profits in favour of the new partner. New partner gets a share in the future profits of the firm.

Some adjustments are needed at the time of the admission of a new partner. These are:

·        Calculation of new profit sharing ratio of the partners

·        Accounting treatment of goodwill

·        Accounting treatment for revaluation of assets and liabilities

·        Accounting treatment of reserves and accumulated profits

·        Adjustment of capitals on the basis of new profit sharing ratio