Modes of Reconstitution of a Partnership Firm

A partnership is a type of business organisation. The Indian Partnership Act 1932 govern partnership firms. A partnership is formed when people (two or more) start a business and divide profits according to the agreed-upon ratio. There are many reasons behind the reconstitution of any partnership firm, like an admission of a new partner, death of a partner, change in profit sharing ratio, retirement etc. These people who start the business are the partners who sign a partnership deed to start the partnership business.

Modes of Reconstitution of a Partnership Firm

There are three ways by which a firm can be reconstituted. They are:

• Change in profit sharing ratio
• Admission of a new partner
• Retirement of a partner
• Death of a partner

Change in Profit Sharing Ratio

When the company’s existing partners decide to change the profit sharing ratio of the partnership firm, the old partnership deed comes to an end, and a new deed is enforced with the necessary changes. This results in the reconstitution of a partnership firm. When the profit-sharing ratio changes, some partners lose their share of profit, and others earn a profit percentage. When this happens, some altercations are made in the partnership deed through which the gaining partner can compensate the sacrificing partner.

Certain adjustments take place when the profit-sharing ratio changes. Those are:

1. Determining the Sacrificing Ratio
2. Determining the Gaining Ratio
3. Treatment of Goodwill
4. Accounting treatment of reserves and Accumulated Profits
5. Accounting for Revaluation of Assets and Liabilities.
6. Adjustment of capitals

Determining the Sacrificing Ratio

Sacrificing Ratio= Old Ratio – New Ratio

Determining the Gaining Ratio

Gaining Ratio= New Ratio- Old Ratio

(It is the opposite of Sacrificing Ratio)

Treatment of Goodwill

Goodwill is an intangible asset. It is valued as per the image of the business. It helps in earning higher profits. There are three methods for the valuation of goodwill:

1. Average Profit Method
2. Super Profit Method
3. Capitalization Method

Accounting Treatment of Reserves and Accumulated Profits

The existing partners earn the reserves and profits and distribute amongst them in the old profit-sharing ratio.

Accounting for Revaluation of Assets and Liabilities

A revaluation account is made for determining the current state of assets and liabilities of a company. An increase in value of Assets and decrease in value of Liability are credited in the revaluation account. A decrease in the value of assets and an increase in the value of the liability is debited in the revaluation account.

Adjustment of Capitals

Adjustment of capital is sharing the wealth between the partners as per the new profit-sharing ratio of the firm.

Admission of a new partner

According to the Partnership Act 1932, a partnership can only be formed between two or more people. If a new person wants to enter the partnership firm, then it is necessary to have the approval of all the existing partners to let him in the business. If a new partner joins the firm, then the change in profit sharing ratio also occurs with the admission of a new partner. The old partnership deed comes to an end when the admission of a new partner takes place and a new agreement is made between the partners of a partnership firm.

For instance, Swati and Manishika are partners sharing profits in the ratio of 3:2. On the 1st of April 2022, they admitted Sonakshi as a replacement partner with a 5/6 share in the firm’s profits. With the admission of a new partner, now the firm is reconstituted.

Retirement of a partner

If an existing partner ends all his connections with the firm and leaves the firm, he is considered a retiring partner. The old partnership deed comes to an end when the retirement of a partner takes place, and a new agreement is made between the partners of a partnership firm.

Death of a partner

The death of a partner does not affect the partnership deed unless the deceased partner is one of the firm’s two partners or a provision in the partnership deed revokes the deed after the death of a partner. The death of a partner is not accountable for any events which might happen after his death. For example, A,B, and C are partners in a company. This company shares profits in the ratio 3:2:1. ‘A’ passed away on the 30th of May, 2015. B and C are liable to bear the business equitably, sharing future profits. Thus, as the business continues when B and C continue to share future profits equitably, it results in the company’s reconstitution.

Conclusion

Thus, we see that often a partnership firm can experience restructuring. There are a lot of reasons for this change. Some of the reasons behind the reconstitution of a partnership firm include the admission of a new partner, change in profit sharing ratio, retirement or death of a partner, etc. These people who start the business are the partners who sign a partnership deed to begin the partnership business. However, if there is a case of death and insolvency, the firm may be dissolved due to the absence of a contract.