Ch4 PARTNERSHIP ACCOUNTS-III

CHAPTER 4 

PARTNERSHIP ACCOUNTS-III

 

ONE WORD TO ONE SENTENCE QUESTIONS

Q.1. An increase in the value of liabilities is recorded on which side of revaluation account?

Ans. An increase in the value of liabilities is recorded on the credit side of the revaluation account.

 

Q.2. Decrease in the value of liabilities is recorded on which side of the revaluation account?

Ans. A decrease in the value of liabilities is recorded on the debit side of the revaluation account.

Q.3. An increase in the value of assets is recorded on which side of the revaluation account?

Ans. An increase in the value of assets is recorded on the debit side of the revaluation account.

 

Q.4. Unrecorded assets are shown on which side of the revaluation account?

Ans. Unrecorded assets are shown on the credit side of the revaluation account.

 

Q.5. Unrecorded liabilities are shown on which side of revaluation account?

Ans. Unrecorded liabilities are shown on the debit side of the revaluation account.

 

Q.6. Depreciation of assets is recorded on which side of the revaluation account?

Ans. Depreciation of assets is recorded on the debit side of the revaluation account.

 

Q.7. How sacrifice radio can be calculated?

Ans. The sacrifice ratio can be calculated by dividing the total number of jobs lost by the percentage reduction in the rate of inflation.

 

Q.8. What is memorandum revaluation account?

Ans. A memorandum revaluation account is a temporary account used to record adjustments in the values of assets and liabilities during a revaluation process. It serves as a record-keeping tool and does not affect the actual financial statements or accounts. The entries made in the memorandum revaluation account are later reversed, and the resulting changes are reflected in appropriate balance sheet accounts.

 

Q.9. What is revaluation account?

Ans. A revaluation account is a temporary account used to record the changes in the values of assets and liabilities during a revaluation process. It is created to adjust the carrying amounts of specific items, such as property, plant, and equipment, in the financial statements. The revaluation account reflects the increase or decrease in the value of assets or liabilities and is eventually transferred to the appropriate balance sheet accounts.

 

Q.10. What is gaining ratio?

Ans. The gaining ratio is the ratio in which the partners in a partnership share the profits and losses of the business after a change in the partnership occurs. It determines the distribution of profits among partners when a new partner is admitted, an existing partner retires, or there is a change in profit-sharing ratios. The gaining ratio is calculated based on the agreed terms and is used to determine the new profit-sharing arrangement among the partners.

 

Q.11. What is sacrificing ratio?

Ans. The sacrificing ratio is the ratio in which the existing partners in a partnership agree to give up their share of profits in favor of a new or incoming partner. It is determined when there is a change in the partnership, such as the admission of a new partner or the retirement of an existing partner. The sacrificing ratio is used to calculate the extent to which the existing partners sacrifice their share of profits and is based on their agreed terms. It helps in determining the new profit-sharing arrangement among the partners.

 

Q.12. What is new profit sharing ratio?

Ans. The new profit-sharing ratio refers to the revised distribution of profits among partners in a partnership after a change in the partnership occurs. It determines the proportion in which the partners will share the profits and losses of the business going forward. The new profit-sharing ratio is typically agreed upon when there are changes in the partnership, such as the admission of a new partner, the retirement of an existing partner, or a change in the profit-sharing arrangement.

 

Q.13. At what figure assets and liabilities to be shown in the balance sheet of reconstituted firm in case a ‘’Revaluation Account’’ is prepared?

Ans. In the balance sheet of a reconstituted firm, the assets and liabilities are generally shown at their revalued figures after the preparation of a "Revaluation Account." The purpose of the Revaluation Account is to adjust the values of assets and liabilities to reflect their fair market values. Therefore, the revalued figures are used to present a more accurate representation of the assets and liabilities in the balance sheet after the reconstitution of the firm.

 

Q.14. What is the ratio for distribution of profit or arising on account of revaluation of assets and liabilities?

Ans. The ratio for the distribution of profit or arising on account of the revaluation of assets and liabilities is typically based on the profit-sharing ratios agreed upon by the partners. These ratios determine how the revaluation gains or losses will be allocated among the partners. The distribution is proportional to the agreed profit-sharing ratios, reflecting the respective ownership interests and contributions of the partners in the partnership.

 

Q.15. State the ratio in which the old partners share all the accumulated profits, reserves and losses?

Ans. The ratio in which the old partners share all the accumulated profits, reserves, and losses is generally based on their existing profit-sharing ratios. The accumulated profits, reserves, and losses are distributed among the old partners in the same ratio in which they were sharing profits before any changes occurred in the partnership. This ensures that the distribution is proportional to their respective ownership interests and past contributions to the partnership.

 

Q.16. Who is known as sacrificing partner in case of change in profit sharing ratio among existing partners?

Ans. In case of a change in the profit-sharing ratio among existing partners, the partner who agrees to give up a larger portion of their share of profits is known as the sacrificing partner. The sacrificing partner is the one who sacrifices a higher proportion of their profit entitlement to accommodate the new profit-sharing arrangement or to accommodate the entry of a new partner into the partnership. This adjustment is made to maintain equity and fairness among the partners in light of the changed circumstances or the introduction of a new partner.

 

Q.17. Who is known as gaining partner in case of change in profit sharing ratio?

Ans. In case of a change in the profit-sharing ratio among existing partners, the partner who benefits by receiving a larger portion of the profits is known as the gaining partner. The gaining partner's share of profits increases as a result of the revised profit-sharing arrangement. This can occur when a partner's profit share is increased due to their increased contribution to the partnership, the retirement of another partner, or the admission of a new partner. The gaining partner experiences a favorable change in their profit entitlement compared to the previous profit-sharing ratio.

 

Q.18. How will you calculate gaining ratio when there is change in profit sharing ratio among the existing partners?

Ans. To calculate the gaining ratio when there is a change in the profit-sharing ratio among existing partners, follow these steps:

Determine the old profit-sharing ratio: Take note of the previous profit-sharing ratio among the existing partners before the change occurred. This ratio represents the proportion in which they were sharing profits initially.

Determine the new profit-sharing ratio: Determine the revised profit-sharing ratio among the existing partners after the change. This ratio represents the new proportion in which they will share profits going forward.

Calculate the difference: Calculate the difference between the new profit-sharing ratio and the old profit-sharing ratio for each partner. This difference represents the change in their profit entitlement.

Normalize the difference: Normalize the differences obtained in step 3 by dividing each partner's difference by the sum of all the differences. This step ensures that the gaining ratios add up to 1 or 100%.

The resulting values after normalization represent the gaining ratio for each partner, indicating the extent to which their profit entitlement has increased due to the change in profit sharing ratio.

 

VERY SHORT ANSWER TYPE QUESTIONS

Q.1. What do you understand by reconstitution of partnership firm?

Ans. The reconstitution of a partnership firm refers to a change in the existing structure, rights, or obligations of the partnership. It occurs when there are alterations in the partnership agreement, such as the admission of a new partner, the retirement or death of an existing partner, the expulsion of a partner, or a change in profit-sharing ratios. Reconstitution may also involve the introduction of new terms, the dissolution of the partnership, or the formation of a new partnership. It often requires adjustments to the financial accounts, including the revaluation of assets and liabilities, the settlement of any outgoing partner's capital and profits, and the redistribution of profits and losses among the partners.

 

Q.2. State any two occasions when reconstitution of a partnership firm will take place?

Ans. Reconstitution of a partnership firm can occur in various circumstances, but here are two common occasions when it typically takes place:

 

Admission of a New Partner: When a new partner joins an existing partnership, it leads to a reconstitution of the firm. The terms of the partnership agreement, profit-sharing ratios, capital contributions, and other aspects of the partnership may need to be revised to accommodate the new partner. This change in the partnership structure necessitates a reconstitution.

Retirement or Death of a Partner: When an existing partner retires or passes away, it results in a reconstitution of the partnership. The outgoing partner's capital and share of profits need to be settled, and the remaining partners may need to adjust their profit-sharing ratios and redistribute the profits and losses among themselves. The partnership agreement undergoes changes to reflect the departure of the partner and the reallocation of rights and obligations.

These occasions require a reevaluation and adjustment of the partnership's financial and operational aspects, leading to the reconstitution of the partnership firm.

 

Q.3. Explain change in profit sharing ratio?

Ans. A change in profit sharing ratio refers to the alteration or adjustment of the proportion in which the partners in a partnership share the profits and losses of the business. It occurs when there is a modification in the agreed-upon distribution of profits among the partners. This change can result from various factors such as the admission of a new partner, the retirement or expulsion of an existing partner, or a reevaluation of the partners' contributions or responsibilities. The revised profit sharing ratio reflects the new distribution of profits and governs the allocation of financial rewards and obligations among the partners in the partnership.

 

Q.4. What is sacrificing ratio? How is it calculated?

Ans. The sacrificing ratio is the ratio in which the existing partners in a partnership agree to give up their share of profits in favor of a new or incoming partner. It represents the extent to which the existing partners sacrifice their entitlement to profits to accommodate the new partner.

The sacrificing ratio is calculated by dividing the sacrifice made by each existing partner by the total sacrifice of all partners. Here are the steps to calculate the sacrificing ratio:

Determine the existing profit sharing ratios: Identify the profit sharing ratios of the existing partners before the change. These ratios represent the proportion in which the partners were sharing profits initially.

Calculate the sacrifice for each partner: Calculate the difference between the old profit sharing ratio and the new profit sharing ratio for each existing partner. This difference represents the amount of profit they are sacrificing.

Calculate the total sacrifice: Sum up the sacrifices made by all existing partners.

Calculate the sacrificing ratio: Divide each partner's sacrifice by the total sacrifice to obtain the sacrificing ratio for each partner. Normalize the ratios if necessary to ensure they add up to 1 or 100%.

The sacrificing ratio determines the proportion of profits that each partner sacrifices to accommodate the new partner and helps in determining the revised profit sharing arrangement among the partners.

 

Q.5. What is gaining ratio? How is it calculated?

Ans. The gaining ratio refers to the ratio in which the partners in a partnership receive an increased share of profits due to a change in the profit-sharing ratio. It represents the extent to which the partners benefit or gain from the revised profit distribution.

The gaining ratio is calculated by dividing the gain received by each partner by the total gain of all partners. Here are the steps to calculate the gaining ratio:

Determine the existing profit sharing ratios: Identify the profit sharing ratios of the partners before the change. These ratios represent the proportion in which the partners were sharing profits initially.

Calculate the gain for each partner: Calculate the difference between the new profit sharing ratio and the old profit sharing ratio for each partner. This difference represents the additional share of profits they will receive.

Calculate the total gain: Sum up the gains received by all partners.

Calculate the gaining ratio: Divide each partner's gain by the total gain to obtain the gaining ratio for each partner. Normalize the ratios if necessary to ensure they add up to 1 or 100%.

The gaining ratio determines the proportion of additional profits that each partner receives due to the change in profit sharing ratio. It helps in determining the revised profit sharing arrangement among the partners.

 

Q.6. Give any difference between gaining ratio and sacrifices ratio?

Ans. The key difference between gaining ratio and sacrificing ratio in a partnership firm is as follows:

Gaining Ratio:

Gaining ratio refers to the ratio in which partners gain an increased share of profits.

It is calculated by comparing the new profit-sharing ratio with the old profit-sharing ratio.

The gaining ratio determines the additional share of profits that partners receive due to the change in profit sharing.

The gaining ratio is used to allocate the increased profits among the partners who benefit from the change.

Sacrificing Ratio:

Sacrificing ratio refers to the ratio in which partners give up a portion of their share of profits.

It is calculated by comparing the old profit-sharing ratio with the new profit-sharing ratio.

The sacrificing ratio determines the extent to which partners sacrifice their entitlement to profits to accommodate a new partner or change in profit sharing.

The sacrificing ratio is used to adjust the profit distribution, ensuring a fair allocation of profits among the partners.

In summary, the gaining ratio focuses on the additional share of profits received by partners, while the sacrificing ratio focuses on the sacrifice made by partners to accommodate changes in the partnership. Both ratios play a crucial role in determining the revised profit sharing arrangement among the partners.

 

Q.7. What is Revaluation account?

Ans. A Revaluation account is a nominal account prepared during the revaluation process of a partnership firm. It is used to record the adjustments in the values of assets, liabilities, and capital accounts due to changes in their fair market values.

The purpose of the Revaluation account is to update the carrying amounts of specific items in the financial statements to reflect their current market values. This adjustment is necessary when there are significant changes in the value of assets and liabilities, such as appreciation or depreciation in the value of assets, revaluation of properties, or recognition of unrecorded assets or liabilities.

The Revaluation account typically consists of two sides: the debit side and the credit side. The debit side records increases in the value of assets, such as revaluation gains, while the credit side records decreases in the value of assets, such as revaluation losses. The resulting balance in the Revaluation account is eventually transferred to the capital accounts of the partners, reflecting the adjustments in their capital balances.

In summary, a Revaluation account helps in adjusting the values of assets, liabilities, and capital accounts to their fair market values, ensuring the accuracy and reliability of the financial statements.

 

Q.8. State the circumstances when revaluation account is debited?

Ans. The Revaluation account is debited in the following circumstances:

 

Revaluation Gains: When there is an increase in the value of assets or a decrease in the value of liabilities, it results in revaluation gains. These gains are recorded on the debit side of the Revaluation account to reflect the appreciation in the value of assets or the reduction in liabilities.

Recognition of Unrecorded Assets: If there are any previously unrecorded assets that are discovered during the revaluation process, their value is recognized and recorded on the debit side of the Revaluation account.

Adjustment for Understated Assets: If the assets of the firm were previously undervalued or understated in the books of accounts, the correction is made by debiting the Revaluation account.

Correction of Depreciation: If there were any errors or omissions in the depreciation calculations, resulting in an understatement of the asset values, the correction is made by debiting the Revaluation account.

In these circumstances, the Revaluation account is debited to reflect the increases in asset values, recognition of unrecorded assets, and adjustments for previously understated values. These adjustments are necessary to ensure the accuracy of the financial statements and reflect the true value of the assets and liabilities of the firm.

 

Q.9. State the circumstances when revaluation account is credited?

Ans. The Revaluation account is credited in the following circumstances:

Revaluation Losses: When there is a decrease in the value of assets or an increase in the value of liabilities, it results in revaluation losses. These losses are recorded on the credit side of the Revaluation account to reflect the depreciation in the value of assets or the increase in liabilities.

Adjustment for Overstated Assets: If the assets of the firm were previously overvalued or overstated in the books of accounts, the correction is made by crediting the Revaluation account.

Recognition of Unrecorded Liabilities: If there are any previously unrecorded liabilities that are discovered during the revaluation process, their value is recognized and recorded on the credit side of the Revaluation account.

Correction of Overstated Profits: If there were any errors or omissions in the calculation of profits, resulting in an overstatement of profits, the correction is made by crediting the Revaluation account.

In these circumstances, the Revaluation account is credited to reflect the decreases in asset values, recognition of unrecorded liabilities, and adjustments for previously overstated values. These adjustments are necessary to ensure the accuracy of the financial statements and reflect the true value of the assets and liabilities of the firm.

 

Q.10. Give any two differences between revaluation account and memorandum revaluation account?

Ans. The following are two differences between Revaluation Account and Memorandum Revaluation Account:

Purpose: The main purpose of a Revaluation Account is to record the increase or decrease in the value of assets and liabilities of a firm when there is a change in the profit-sharing ratio, admission, or retirement of partners. Whereas the Memorandum Revaluation Account is prepared to ascertain the profit or loss on the revaluation of assets and liabilities of the firm, which is then transferred to the Capital Accounts of the partners.

Presentation in financial statements: The balance of the Revaluation Account is transferred to the partner's capital account and is shown on the liabilities side of the balance sheet as 'Revaluation Reserve.' Whereas the balance of the Memorandum Revaluation Account is not shown in the financial statements, as it is a temporary account, and the profit or loss is directly transferred to the partners' capital accounts.

 

Q.11. What adjustments are required to be made at the time of change is profit sharing ratio between existing partners? Explain?

Ans. When there is a change in the profit-sharing ratio among existing partners in a partnership, several adjustments need to be made to ensure the accurate allocation of profits and capital among the partners. The adjustments include:

Adjustment for Revaluation of Assets and Liabilities: The assets and liabilities of the partnership need to be revalued to determine their fair market values. Any increase or decrease in the values of assets or liabilities should be recorded in a Revaluation Account. The resulting profit or loss from the revaluation is then distributed among the partners according to the new profit sharing ratio.

Adjustment for Accumulated Profits or Losses: The accumulated profits or losses in the partnership need to be redistributed among the partners based on the new profit sharing ratio. This involves transferring the existing accumulated profits or losses to the capital accounts of the partners in their old profit sharing ratio and then adjusting them according to the new ratio.

Adjustment for Capital Balances: The capital balances of the partners may need to be adjusted to reflect the changes in the profit sharing ratio. This adjustment is made by transferring any excess or deficit in the capital accounts to the partners' current accounts based on the new ratio.

Admission or Retirement of Partners: If the change in the profit sharing ratio is due to the admission or retirement of partners, additional adjustments are required. The retiring partner's capital, as well as their share of accumulated profits or losses, needs to be settled. The incoming partner's capital and share of profits need to be introduced and recorded.

By making these adjustments, the partnership ensures that the new profit sharing ratio is reflected accurately in the financial accounts, the allocation of profits and losses is fair, and the capital accounts of the partners are adjusted accordingly.

 

Q.13. Why it is necessary to revalue the assets and liabilities if there is a change in the profit sharing ratio among the existing partners?

Ans. It is necessary to revalue the assets and liabilities when there is a change in the profit sharing ratio among existing partners for the following reasons:

Reflecting Fair Market Values: Revaluing the assets and liabilities helps in determining their fair market values at the time of the change in profit sharing ratio. This ensures that the financial statements of the partnership accurately reflect the current worth of the assets and the obligations of the firm.

Achieving Equity and Transparency: A change in the profit sharing ratio means that partners will have different rights and entitlements to the partnership's assets and profits. By revaluing the assets and liabilities, any appreciation or depreciation in their values can be recognized and accounted for, ensuring fairness and transparency in the allocation of resources and risks among the partners.

Adjusting Capital Accounts: Revaluing the assets and liabilities impacts the capital accounts of the partners. Any increase or decrease in the values of the assets and liabilities will result in changes to the partners' capital balances. By revaluing, the capital accounts can be adjusted to reflect the new profit sharing ratio and the revised values of the assets and liabilities.

Determining Revaluation Gains/Losses: Revaluation of assets and liabilities allows the partnership to determine any revaluation gains or losses that arise due to the change in their values. These gains or losses need to be appropriately recognized and accounted for in the financial statements and distributed among the partners based on the new profit sharing ratio.

By revaluing the assets and liabilities, the partnership ensures that the financial statements provide an accurate representation of the partnership's financial position, and the partners' capital accounts and profit sharing ratios are adjusted to reflect the changes in their rights and entitlements.

 

Q.14. How will you calculate the amount of good will to be paid by gaining partners to the sacrificing partner?

Ans. The calculation of the amount of goodwill to be paid by the gaining partners to the sacrificing partner can be done using the following steps:

Determine the Sacrificing Partner's Share of Goodwill: Calculate the sacrificing partner's share of the total goodwill of the partnership. This is done by multiplying the total goodwill of the partnership by the sacrificing partner's sacrificing ratio. The sacrificing ratio is the proportion in which the sacrificing partner has given up their share of future profits.

Sacrificing Partner's Share of Goodwill = Total Goodwill × Sacrificing Ratio

Determine the Gaining Partners' Share of Goodwill: Calculate the total amount of goodwill to be distributed among the gaining partners. This is done by subtracting the sacrificing partner's share of goodwill from the total goodwill of the partnership.

Gaining Partners' Share of Goodwill = Total Goodwill - Sacrificing Partner's Share of Goodwill

Allocate the Gaining Partners' Share of Goodwill: Distribute the gaining partners' share of goodwill among them based on their gaining ratio. The gaining ratio represents the proportion in which the gaining partners will benefit from the revised profit sharing arrangement.

Goodwill Payment for Each Gaining Partner = Gaining Partner's Share of Goodwill × Gaining Ratio

The resulting calculations will provide the amount of goodwill to be paid by the gaining partners to the sacrificing partner. It is important to note that the sacrificing partner receives their share of goodwill as a lump sum payment from the gaining partners as compensation for their sacrifice in the revised profit sharing ratio.

 

Q.15. What adjustment entry is usually passed for goodwill when there is change in the profit sharing ratio among the existing partners?

Ans. When there is a change in the profit sharing ratio among existing partners, the adjustment entry for goodwill typically involves the following steps:

Calculate the value of the existing goodwill based on the old profit sharing ratio.

Determine the difference between the old goodwill and the recalculated value of goodwill based on the new profit sharing ratio.

Pass the adjustment entry to account for the change in goodwill. The specific entry will depend on whether there is an increase or decrease in the value of goodwill:

Increase in Goodwill: If the recalculated value of goodwill is higher than the existing goodwill, the entry will involve debiting the Goodwill account and crediting the capital accounts of the partners in their old profit sharing ratio. This records the increase in goodwill and adjusts the capital accounts accordingly.

Decrease in Goodwill: If the recalculated value of goodwill is lower than the existing goodwill, the entry will involve debiting the capital accounts of the partners in their old profit sharing ratio and crediting the Goodwill account. This reflects the reduction in goodwill and adjusts the capital accounts accordingly.

The adjustment entry ensures that the value of goodwill is aligned with the new profit sharing ratio among the partners. It helps maintain the accuracy of the financial statements and reflects the revised distribution of profits and ownership interests within the partnership.

 

Q.16. Why ‘’memorandum revaluation account’’ is opened?

Ans. A "Memorandum Revaluation Account" is opened in certain circumstances to keep a record of the revaluation of assets and liabilities during the reconstitution of a partnership. Here are the reasons why a Memorandum Revaluation Account is opened:

Determining the Gains or Losses: The purpose of opening a Memorandum Revaluation Account is to calculate the gains or losses arising from the revaluation of assets and liabilities. This account helps in ascertaining the total impact of the revaluation process on the partnership's financial position.

Temporary Nature: The Memorandum Revaluation Account is considered a temporary account. It is not shown in the financial statements or reflected in the partners' capital accounts. Instead, the profit or loss derived from the revaluation is directly transferred to the partners' capital accounts.

Partner's Capital Adjustment: The Memorandum Revaluation Account facilitates the adjustment of partners' capital accounts based on their share of the revaluation gains or losses. The calculated gains or losses are allocated among the partners in their new profit sharing ratio.

Ensuring Equity: Opening a Memorandum Revaluation Account helps in ensuring fairness and equity among the partners. It enables the proper distribution of revaluation gains or losses, which aligns with the revised profit sharing ratio and maintains the partners' respective capital interests.

In summary, the Memorandum Revaluation Account serves as an internal record-keeping tool during the revaluation process. It helps in determining the gains or losses from the revaluation, adjusting the partners' capital accounts, and ensuring equitable distribution of the revaluation impacts among the partners.

 

Q.17. Why are ‘’Reserves and surplus’’ distributed at the time of reconstitution of the firm?

Ans. Reserves and surplus are distributed at the time of reconstitution of a firm for the following reasons:

Adjustment of Accumulated Profits/Losses: Reserves and surplus represent the accumulated profits or retained earnings of the firm over time. During the reconstitution of the firm, the partners may decide to adjust the accumulated profits or losses among themselves based on the new profit sharing ratio. This ensures that the partners' capital accounts reflect their respective entitlements to the profits generated by the firm.

Equitable Distribution of Reserves: Reserves and surplus are often considered as collective assets of the firm. By distributing these reserves, the partners ensure a fair and equitable distribution of the firm's accumulated profits among themselves. This helps to align the capital interests of the partners with their respective contributions and rights in the reconstituted firm.

Capital Adjustment: The distribution of reserves and surplus also facilitates the adjustment of partners' capital accounts. By distributing these accumulated profits, the capital accounts of the partners are appropriately adjusted to reflect their revised profit sharing ratio and capital contributions in the reconstituted firm.

Smooth Transition and Clarity: Distributing reserves and surplus at the time of reconstitution provides clarity and transparency in the financial arrangements of the firm. It helps in maintaining a smooth transition from the previous partnership structure to the new arrangement, ensuring that the partners are aware of their respective entitlements and the financial position of the reconstituted firm.

Overall, the distribution of reserves and surplus during the reconstitution of a firm ensures that the accumulated profits or losses are allocated among the partners in a fair and equitable manner, and the partners' capital accounts reflect their revised profit sharing ratio and capital contributions.

 

Q.18. How will you deal with reserves and accumulated profit at the time of change in the profit sharing ratio among existing partners?

Ans. At the time of a change in the profit sharing ratio among existing partners, the treatment of reserves and accumulated profits can be handled in the following ways:

Distribution of Reserves: The partners may decide to distribute the reserves among themselves based on the new profit sharing ratio. This involves allocating the reserves in proportion to each partner's revised entitlement to future profits. The distribution of reserves can be done by transferring the respective shares to the partners' capital accounts or current accounts, depending on the agreement among the partners.

Adjustment of Accumulated Profits/Losses: Accumulated profits or losses in the partnership need to be adjusted to reflect the new profit sharing ratio. The existing profits or losses are transferred to the capital accounts of the partners in their old profit sharing ratio. Then, these balances are adjusted according to the new ratio. Any excess or deficit is either distributed among the partners or transferred to their current accounts.

Retention of Reserves: In some cases, the partners may decide to retain the reserves within the partnership. This can be done to strengthen the financial position of the reconstituted firm or to provide a cushion for future business activities. In such instances, the reserves remain as part of the partnership's retained earnings and are not distributed among the partners.

The specific treatment of reserves and accumulated profits will depend on the agreement among the partners and the objectives of the reconstitution. It is essential for the partners to discuss and agree upon the allocation or retention of reserves, ensuring transparency and consensus in the distribution of accumulated profits or losses.

 

SHORT ANSWER TYPE QUESTIONS

Q.1. Under what circumstances Reconstitution of partnership firm can take place?

Ans. The reconstitution of a partnership firm can take place under various circumstances, including:

Change in Profit Sharing Ratio: When the partners agree to revise the existing profit sharing ratio among themselves, a reconstitution of the partnership firm occurs. This change can happen due to factors such as changes in the partners' roles, contributions, or capital interests in the firm.

Admission of a New Partner: When a new partner joins the existing partnership, it leads to a reconstitution. The terms and conditions of the partnership are typically renegotiated, and the profit sharing ratio is adjusted to accommodate the new partner's investment and contribution to the business.

Retirement of a Partner: When a partner decides to retire from the partnership, it results in a reconstitution. The retiring partner's share of the firm's assets, liabilities, and profits needs to be settled, and the remaining partners often agree to a new profit sharing ratio to reflect the change in ownership and management.

Death or Insolvency of a Partner: In the unfortunate event of the death or insolvency of a partner, the partnership undergoes reconstitution. The legal procedures associated with the departure of the partner are followed, and the remaining partners may choose to restructure the firm, adjust profit sharing ratios, or admit new partners.

Amalgamation or Merger: When two or more partnership firms decide to merge or amalgamate, it necessitates the reconstitution of the firms involved. The terms of the merger or amalgamation are agreed upon, and the partners determine the new profit sharing ratio, capital contributions, and other relevant aspects of the combined entity.

These circumstances highlight some of the common situations that trigger the reconstitution of a partnership firm. Each scenario requires careful consideration, negotiation, and formal agreement among the partners to ensure a smooth transition and the continued operation of the firm.

 

Q.2. Why revaluation of assets and liabilities is necessary when there is change in profit sharing ratio among existing partners?

Ans. Revaluation of assets and liabilities is necessary when there is a change in the profit sharing ratio among existing partners for the following reasons:

Reflecting the Fair Value: A change in the profit sharing ratio often implies a change in the partners' ownership interests and capital contributions. Revaluing the assets and liabilities helps in determining their fair value and adjusting the partnership's financial position accordingly. It ensures that the revised profit sharing ratio aligns with the updated valuation of the partnership's resources.

Ensuring Equity and Accuracy: Revaluing the assets and liabilities helps in maintaining equity among the partners. It ensures that each partner's capital account reflects their proportionate share in the partnership's net assets. By adjusting the values based on fair market value, the partners' capital accounts are updated to reflect their revised ownership interests accurately.

Resolving Unrecorded Assets/Liabilities: Revaluation also helps in identifying any unrecorded assets or liabilities that may have been previously overlooked. By reassessing the assets and liabilities, any hidden or unrecognized resources or obligations can be properly accounted for, ensuring the completeness and accuracy of the financial statements.

Facilitating Capital Adjustment: The revaluation process allows for a smooth adjustment of the partners' capital accounts. The revised values of assets and liabilities are used to compute the partners' capital balances, taking into account their new profit sharing ratio. This ensures that the partners' capital accounts reflect their revised ownership interests and the changes in the partnership's financial position.

In summary, revaluation of assets and liabilities is necessary when there is a change in the profit sharing ratio among existing partners to establish a fair and accurate representation of the partnership's financial position. It helps in ensuring equity among the partners, resolving any unrecorded items, and facilitating the adjustment of capital accounts to reflect the revised ownership interests.

 

Q.3. What is the procedure of showing effect of change in the value of assets and liabilities without opening revaluation account?

Ans. When there is a change in the value of assets and liabilities, and a revaluation account is not opened, the effect can be shown directly in the partners' capital accounts. Here is the procedure for showing the effect of the change without opening a revaluation account:

Determine the Revised Values: Assess the fair value of the assets and liabilities that have changed. This can be done through professional valuation or other appropriate methods.

Calculate the Revaluation Gain or Loss: Find the difference between the original values and the revised values of the assets and liabilities. This will determine the revaluation gain or loss.

Allocate the Revaluation Gain or Loss: Allocate the revaluation gain or loss among the partners based on their profit sharing ratio. Multiply the gain or loss by each partner's respective share.

Adjust the Capital Accounts: Make the necessary entries in the partners' capital accounts to reflect the revaluation. Increase or decrease the capital accounts of each partner according to their share of the revaluation gain or loss.

If there is a revaluation gain, credit the capital accounts of the partners proportionately.

If there is a revaluation loss, debit the capital accounts of the partners proportionately.

Reflect Accumulated Profits/Losses: Consider any accumulated profits or losses in the partnership. If there are any undistributed profits or accumulated losses, transfer them to the capital accounts based on the partners' profit sharing ratio.

By following this procedure, the effect of the change in the value of assets and liabilities can be shown directly in the partners' capital accounts without opening a separate revaluation account. The capital accounts will reflect the revised values and the partners' revised ownership interests in the partnership.

 

Q.4. Explain the accounting treatment treatment on the adjustment of accumulated profits, reserves and losses?

Ans. The accounting treatment for the adjustment of accumulated profits, reserves, and losses during a reconstitution of a partnership firm depends on the specific circumstances and agreements among the partners. However, here are some general guidelines for the accounting treatment:

Accumulated Profits:

If the partners decide to distribute accumulated profits among themselves, the amounts will be transferred from the retained earnings or profit and loss account to the partners' capital accounts based on their profit sharing ratio.

The accumulated profits are typically credited to the capital accounts of the partners, increasing their capital balances.

Reserves:

Reserves such as general reserve, specific reserves, or any other retained earnings can be distributed among the partners according to their agreed-upon terms.

The reserves are typically transferred from the reserves or retained earnings account to the partners' capital accounts in proportion to their profit sharing ratio.

The reserves are credited to the capital accounts of the partners, increasing their capital balances.

Accumulated Losses:

If there are accumulated losses in the partnership, the partners may decide to transfer them to the capital accounts or current accounts of the partners in their old profit sharing ratio.

The accumulated losses are debited to the capital accounts or current accounts of the partners, reducing their capital balances or increasing their current account liabilities.

It's important to note that the specific treatment may vary depending on the partnership agreement and the decision of the partners. The adjustments are made to ensure that the partners' capital accounts reflect their revised profit sharing ratio and their entitlement to accumulated profits, reserves, and losses.

It is recommended to consult with a professional accountant or refer to the partnership agreement to determine the exact accounting treatment and ensure compliance with accounting standards and regulations.

 

Q.5. How adjustment of capital is carried out on reconstitution of a partnership firm?

Ans. The adjustment of capital during the reconstitution of a partnership firm involves modifying the partners' capital accounts to reflect the changes in their ownership interests and the terms of the reconstitution. The specific steps for adjusting the capital accounts may vary based on the circumstances and agreements among the partners, but here are some general guidelines:

Determine the Revised Profit Sharing Ratio: The partners need to agree on the new profit sharing ratio based on the terms of the reconstitution. This ratio determines the proportion of profits and losses that each partner will be entitled to going forward.

Calculate the Adjusted Capital Balances: Adjust the capital balances of the partners to reflect their revised ownership interests. This can be done by multiplying the partners' original capital balances by their respective shares in the new profit sharing ratio.

Make Journal Entries:

If there are additional capital contributions by the partners, credit the capital accounts of the contributing partners and debit the corresponding asset or bank accounts.

If partners are withdrawing capital, debit their capital accounts and credit the corresponding asset or bank accounts.

If there are any adjustments for accumulated profits, reserves, or losses, make the necessary debits or credits to the capital accounts based on the agreed-upon terms.

Adjust for Revaluation:

If there is a revaluation of assets and liabilities, adjust the capital accounts to reflect the changes in the fair values of the partnership's resources. This is typically done by transferring the revaluation gain or loss to the capital accounts in proportion to the partners' revised profit sharing ratio.

Update the Capital Accounts: After making the necessary journal entries, update the capital accounts of each partner with the adjusted capital balances.

It is important to note that the adjustment of capital should be done in accordance with the partnership agreement and applicable accounting standards. It is recommended to consult with a professional accountant to ensure accurate and compliant adjustments of the capital accounts during the reconstitution of the partnership firm.

 

Q.6. Explain the main objectives behind reconstitution of partnership firm?

Ans. The reconstitution of a partnership firm is undertaken to achieve various objectives, depending on the specific circumstances and goals of the partners involved. The main objectives behind the reconstitution of a partnership firm include:

 

Change in Profit Sharing Ratio: One common objective is to revise the existing profit sharing ratio among the partners. This may be necessary due to changes in the partners' roles, contributions, or capital interests in the firm. The reconstitution allows for a realignment of the profit sharing ratio to reflect the partners' updated agreement on the distribution of profits and losses.

Admission of New Partners: Another objective is to admit new partners into the existing partnership. This may be driven by the need for additional capital, expertise, or resources. The reconstitution facilitates the inclusion of new partners and establishes the terms and conditions of their participation, including their capital contribution and profit sharing ratio.

Retirement or Withdrawal of Partners: The reconstitution is carried out when a partner decides to retire or withdraw from the partnership. This objective involves settling the retiring partner's capital, profit sharing, and any outstanding claims. The reconstitution ensures a smooth transition by redistributing the retiring partner's share among the remaining partners.

Death or Insolvency of a Partner: In unfortunate circumstances such as the death or insolvency of a partner, the reconstitution aims to address the legal and financial consequences. It involves determining the partner's share in the partnership, settling their capital, and adjusting the profit sharing ratio accordingly.

Restructuring or Expansion of the Firm: Sometimes, a reconstitution is undertaken to restructure or expand the partnership firm. This may involve a change in the partnership agreement, including modifications to profit sharing ratios, capital contributions, and decision-making authority. The reconstitution enables the partners to redefine their roles, responsibilities, and goals.

Overall, the objectives behind the reconstitution of a partnership firm are to ensure fairness, accommodate changes in ownership and capital, facilitate the admission or withdrawal of partners, address legal and financial issues, and align the partnership structure with the partners' current requirements and aspirations.