C. Reconstitution of Partnership

When a partner joins or leaves, the agreement among the partners changes and the firm is reconstituted. This part covers the admission of a partner, the retirement of a partner and, finally, the dissolution of the firm itself.

The section is organised in three blocks. Admission of a Partner explains why firms admit partners and the adjustments that follow: a new profit-sharing ratio, the sacrificing ratio, goodwill, revaluation of assets and liabilities, and capital adjustments. Retirement of a Partner covers the reasons for retiring and the matching adjustments, built around the gaining ratio and the settlement of the amount due to the retiring partner. Dissolution of a Partnership Firm explains how dissolution differs from retirement, the modes of dissolution, the order of settlement under Section 48 of the Indian Partnership Act, 1932, and the accounts prepared to close the books.

Reconstitution means a change in the relationship among the partners while the firm carries on. Every such change alters the profit-sharing ratio, so the same questions come up each time: who gains, who sacrifices, what is the goodwill worth, and do the books show the assets and liabilities at their true values? The section ends with dissolution, where the firm itself comes to an end.

I. Admission of a Partner (sub-lessons: Reasons for Admission, Accounting Adjustments on Admission, Capital Accounts Adjustment)

• Reasons: the firm needs more capital, a partner with special skills, or support to expand.
• New profit-sharing ratio and sacrificing ratio: for each old partner, Sacrificing share = Old share − New share.
• Goodwill: the premium the new partner brings for his share of goodwill is credited to the old partners in their sacrificing ratio.
• Revaluation: assets and liabilities are restated at current values through a Revaluation Account, and the profit or loss on it belongs to the old partners in their old ratio.
• Capital adjustment: capitals may be brought into line with the new profit-sharing ratio, with partners bringing in or withdrawing cash.

A quick check: A and B share profits 3 : 2 and admit C for a 1/5 share, which C takes from A and B in their old ratio. A's new share is 3/5 × 4/5 = 12/25, B's is 2/5 × 4/5 = 8/25 and C's is 5/25, so the new ratio is 12 : 8 : 5. A gives up 15/25 − 12/25 = 3/25 and B gives up 10/25 − 8/25 = 2/25, a sacrificing ratio of 3 : 2.

II. Retirement of a Partner (sub-lessons: Reasons for Retirement, Accounting Adjustments)

• Reasons: age or health, personal reasons, or disagreement with the other partners.
• Gaining ratio: for each continuing partner, Gain = New share − Old share.
• Goodwill: the retiring partner is credited with his share of goodwill, and the continuing partners are debited in their gaining ratio.
• Revaluation of assets and liabilities, with the profit or loss shared by all the partners, including the retiring one, in the old ratio.
• Settlement: the amount due to the retiring partner is paid in cash or transferred to his loan account.

III. Dissolution of a Partnership Firm (sub-lessons: Dissolution vs. Retirement, Modes of Dissolution, Settlement of Accounts, Preparation of Accounts)

• Dissolution of the firm ends the business and the relation among all the partners, whereas retirement ends only one partner's membership while the business goes on.
• Modes (Indian Partnership Act, sections 40 to 44): by agreement of the partners; compulsorily, for example when all the partners, or all but one, are declared insolvent, or when the business becomes unlawful; on the happening of certain contingencies, such as the expiry of the term, the completion of the venture, or the death or insolvency of a partner; by notice, in a partnership at will; and by order of a court.
• Settlement under Section 48: the assets are realised and the money is used first to pay the firm's debts to outsiders, then partners' loans to the firm, then partners' capital, and any surplus is divided in the profit-sharing ratio. The expenses of dissolution are met out of the amounts realised.
• Accounts prepared: the Realisation Account, the Partners' Capital Accounts and the Cash or Bank Account.