Adjustment for Accumulated Profits, Losses and Capital

Adjustment for Accumulated Profits and Losses –

A partnership firm, instead of transferring its profit to capital accounts of partners at the end of a year generally accumulates its profit earned or loss incurred to various reserves maintained by it. These reserves could take the form of General reserve and/or Profit and Loss Account.

Since these have been accumulated over the years, the new partner who is admitted has no right on such reserves. The old partners are the rightful owners of such accumulated profits.

Therefore, these accumulated profits (credit balance of Profit and loss account or General Reserve) should be divided between the old partners in their old profit sharing ratio so as to ensure that their interest in the firm is not sacrificed.

Further, any accumulated losses (debit balance of profit and loss account and/or deferred revenue expenditure) are also transferred to the old partners’ capital accounts in their old profit sharing ratio.

This is done so as to make sure that the new partner does not have to contribute for the losses incurred by the old partners.

Adjustment of Capitals

When a new partner is admitted to a partnership firm, all the partners together might agree that their capital accounts might also be in the same ratio as that of their profit sharing ratio.

This basically implies that the capital of old partners requires some adjustments as the amount that new partner will bring to the firm remains pre-determined.

So to make capitals proportionate to the new profit sharing ratio, new partner’s capital balance is taken as the base by which old partner’s new capital amount is calculated.

The old partners old capitals are then adjusted with respect to any revaluation of assets/ liabilities or any goodwill reserves. This revised capital amount is then compared with the new capital amount derived from taking the new partners capital as the base.

If the difference between the old capital and new capital results in surplus, the old partner withdraws the excess amount contributed by him and if it results in shortage, the old partner introduces additional amount to meet the shortfall.

Chapter 3 Reconstitution of a Partnership Firm – Admission of a Partner

1. Modes of Reconstitution of a Partnership Firm
2. Admission of a New Partner
3. New Profit Sharing Ratio
4. Sacrificing Ratio
5. Goodwill
6. Adjustment for Accumulated Profits and Losses and Capitals
7. Revaluation of Assets and Reassessment of Liabilities
8. Change in Profit Sharing Ratio among the Existing Partners