RECONSTITUTION OF PARTNERSHIP FIRM-- ADMISSION OF A PARTNER & GOODWILL H.S. 2nd Year ACCOUNTANCY NOTES AHSEC ASSAM Higher secondary PART-A UNIT -3



ACCOUNTANCY
A
UNIT -3

RECONSTITUTION OF PARTNERSHIP FIRM
ADMISSION OF A PARTNER


1. What is reconstitution of partnership firm? What are the circumstances or situation in which such reconstitution take place?
Ans: Partnership is a relation arising out of an agreement among some definite persons who are involved in the agreement. Whenever any change occurs in the agreement changes the relationship between or among the partners and such change in the relationship is known as reconstitution of partnership.
                Followings are the circumstances when such reconstitution takes place:-
a. Change in the profit sharing ratio: - when any changes occurs in the profit sharing ratio of the existing partners changes the relationship among the partners and it is said to be reconstitution.
b. Admission of a new partner: - Admission of a new partner changes the relationship among the partners. A new profit sharing arrangement will take place and the partnership is said to be reconstitution.
c. Retirement of an existing partner: - When an existing partner retires from the firm due to his personal reason or business reason. After retirement a new profit sharing arrangement will take place between the remaining partners and therefore, the partnership is said to be reconstitution.
d. Death of a partner: - As in the case of retirement, death of a partner will also result in the change of relationship between surviving partners. Their profit sharing ratio will change and therefore, the reconstitution will take place.
e. Amalgamation of two firms: - When two or more separate business units carrying on business of a similar nature agree to merge together to do business jointly, it is called amalgamation. The Amalgamation causes reconstitution of the old firms.   

2. What is Sacrificing Ratio?
Ans: When a new partner is admitted in to the firm, old partners surrender some of their share of profit in favour of new partner. The ratio in which old partners surrender their share of profits is called sacrificing ratio.
Sacrificing Ratio = Old Ratio - New Ratio

3.What is Gaining Ratio?
Ans: When an existing partner retires or dies gaining ratio is calculated. The ratio in which the remaining partners acquire the retiring or deceased partner’s share is called as gaining ratio.
Gaining Ratio = New Ratio – Old Ratio

4.What is the difference between sacrificing ratio and gaining ratio?
Ans: Following are difference between Sacrificing ratio and Gaining ratio:


5. Why treatment of goodwill is necessary on admission of a new partner?
Ans: Goodwill is the reputation or fame of the business; it creates extra earning for the business. Goodwill is the result of hard working, dedication, devotion, skill etc., of the old partners. New partner had not played any role in this whole exercise. When he joins the firm, the old partners sacrifice a part of their share of profit in favour of new partner. Therefore, he compensates the old partners for the reputation built up by them in past. It is, therefore, necessary that he pays something to the old partners to compensate them for the sacrifice made by them. Hence, there is a need for treatment of goodwill on admission of a partner. 
6. Why revolution of assets and liabilities is necessary on admission of a new partner?
Ans: On the admission of a new partner, the new partner may not agree with the value of assets and liabilities of the firm shown in the balance sheet at their genuine value. With the passage of time the value of some assets and liabilities increases while the values of some others may decreases.  So, there is a need to revalue the assets and liabilities on admission of a new partner. This is mutually done by old partners and new partners.

7. What are differences between Revaluation Account and Memorandum revaluation Account?
Ans: Following are the difference between Revaluation account and Memorandum Revaluation account:

8. What is Hidden Goodwill?
Ans: Hidden goodwill means the value of goodwill that is not given at the time of admission of a partner. In other words, we can say hidden goodwill is the inferred goodwill. This is not given in the problem but is implied from brought in capital by the new partner for his share in the firm.

9. What is premium for goodwill?
Ans: Premium for goodwill is the amount bring by the new partner to compensate the old partner for sacrificing the share. Goodwill is an intangible asset that arises when one company purchases another for a premium value.
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GOODWILL

1. What is goodwill?
Ans: Goodwill is an intangible asset of the business, cannot be seen or touched. Goodwill is the reputation of the business. It is created through various activities such as quality products at reasonable price, good relations with customer, quality service provided etc. Goodwill is the extra earning capacity of the business.
According to Eric L. Kohler, “Goodwill is the present value of expected future income in excess of a normal return on the investment in tangible assets.”   

2. What are the features of goodwill? 
Ans: Following are the features of goodwill:
(i) Goodwill is an intangible asset; it cannot be seen or touched.
(ii) Goodwill is the extra earning capacity of the business.
(iii) The value of goodwill fluctuates from time to time.
(iv) The value of goodwill is created by various factors.

3. What are the needs for valuation of Goodwill?
Ans: Following are the needs for valuation of goodwill:
(i) When there is a change in profit sharing ratio of existing partners.
(ii) On the admission of a new partner.
(iii) On the retirement of a partner.
(iv) On the death of a partner.
(v) When two or more partnership firms are amalgamated.

4. What are the factors effecting the value of goodwill?
Ans: Following the factors affecting the value of goodwill:
(i) Location of Business: - If the business is situated at a centrally located convenient place , it can attract more customers and hence its goodwill will be more .
(ii) Quality of the Product: - In case the firm produces or deals in products of better quality it will have more goodwill.
(iii) Risk Involved: - When the risk is less in the business it creates more goodwill but if the risk is more, it creates less goodwill.
(iv) Efficiency of Management:- If the firm is managed and controlled by the experienced and efficient people, there will be economics in production , higher demand for goods as a result its profit will go on increasing consequently the value of goodwill will also increase .
(v) Reputation of the Owner:- If the owners of the firm are known for their financial soundness , honesty, sincerity , customer friendliness and are socially conscious the business will earn super profit due to its popularity which will add to the value of goodwill.

5. What are the methods for valuation of goodwill?
Ans: Following are the methods for valuation of goodwill:
(i) Average profit method:-
(a) Simple average profit method.
(b) Weighted average profit method.
(ii) Super Profit method.
(iii) Capitalization method:-
(a) Capitalization of average profit.
(b) Capitalization of super profit.

6. How would you calculate goodwill under average profit method?
Ans: The average profit of given number of past years multiplied by an agreed number is considered to be the value of goodwill.
Steps for calculating the value of goodwill under average profit method:
(i) Calculate the total profits of the agreed number of years.
(ii) Calculate the average total profit divided by number of years.
(iii) Calculate the value of goodwill = Average Profit x Number of Years Purchase.

7. How would you calculate goodwill under weighted average profit method?
Ans: Under this method, each year’s profit is multiplied by the respective number of weights example, 1, 2,3,4,5 etc. in order to find out value of product. The sum of the product is then divided by the total weights to get weighted average profits; the weighted average profit is then multiplied by number of year’s purchase.

8. How would you calculate goodwill under super profit method?
Ans: This method is based on the super profit earned by a firm. Super profit is the excess of actual profit over the normal profit of a firm.
Under this method, the Value of Goodwill = Super Profit x Number of year’s Purchase or Number of years the Super Profit is Expected.
Following steps are involved in the valuation of goodwill under super profit method:
(i) Calculation of average profit.
(ii) Calculation of normal profit on capital employed on the basis of normal rate of return.
(iii) Calculation of super profit deducting the normal profit from average profit.
(iv) Calculation of goodwill by multiplying the super profits by the given number of year’s purchase.

9. How would you calculate goodwill under capitalization of super profit method?
Ans. Under this method, the capitalized value of super profit is taken as the value of goodwill. Capitalized value is calculated by taking into account the normal rate of return.



Value of Goodwill = Capitalized value of super profit

 10. How would you calculate goodwill under capitalization of average profit method?
Ans: Under this method, the average profits are capitalized on the basis of normal rate of return. The figure ascertained is known as value of business. From this the net assets of business is deducted, the balance left is called goodwill.



Capital Employed = Total Assets – Outside Liabilities.
Goodwill = Capitalized Value of Business – Net Assets or Capital Employed.

11. What are the difference between Average Profit and Super Profit?
Ans. Following are the differences between average profit and super profit:



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