Key Points - Reconstitution of Partnership

Meaning of Reconstitution:
Any change in agreement of partnershipis called reconstitution of partnership firm. In following circumstances a partnership firm may be reconstituted:

1. Change in Profit Sharing Ratio

2. Admission of a partner

3. Retirement/Death of a partner

Change in profit sharing ratio among the existing partners

Meaning:
When all the partners of a firm agree to change their profit sharing ratio, the ratio may be changed. In this case one profit is purchasing a share of partner from another one. In other words, share of one partner may increase and share of another partner may decrease.
Accounting treatment of goodwill:
In case of change in profit sharing ratio, the gaining partner must compensate the sacrificing partner by paying the proportionate amount of goodwill.

Accounting treatment of Reserves and Accumulated Profits:
Case (i) When reserves and accumulated profits/losses are to be distributed
At the time of change in profit sharing ratio, if there are some reserves or accumulated profits/losses existing in the books of the firm, these should be distributed to partners in their old profit sharing ratio.

Case (ii) When accumulated profits/losses are not be distributed at the time of change in ratio
Partners may decide that reserves and accumulated profits/losses will not be affected and remains in the books with same figure. In this case, the gaining partner must compensate the sacrificing partner by the share gained by him i.e.
Gaining Partner's Capital A/c
Dr.
To Sacrificing Partner's Capital A/c.


Accounting treatment for Revaluation of Assets and reassessment of Liabilities on change in Profit sharing ratio:
At the time of change in profit sharing ratio of existing partners, Assets and liabilities of a firm must be revalued because actual realizable value of assets and liabilities may be different from their book values. Change in the assets and liabilities belongs to the period prior to change in profit sharing ratio and therefore it must be shared in old profit sharing ratio.
 

Revaluation of assets and liabilities may be treated in two ways: (i)
When revised values are to be shown in the books. (ii) When revised values are not to be shown in the books
When revised values are to be shown in the books:
In this case revaluation of assets and liabilities is completed with the help of "Revaluation
Account”. This account is also known as “Profit and Loss Adjustment Account”. All losses due to revaluation are shown in debit side of this account and all gains due to revaluation are shown in credit side of this account.
Note : (1) Increase in the value of an Asset and decrease in the value of a liability result in profit. (2) Decrease in the value of any asset and Increase in the value of liability gives loss.

When revised values are not to be shown in the books.

In illustration 6, Partners agreed that the revised value of assets and liabilities are not to be shown in the books. You are required to record the effect by passing a single journal entry. Also prepare the revised value balance sheet.
Gain due to revaluation
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