PARTNERSHIPS-

CHANGES IN OWNERSHIP
STRUCTURE
UNIT 2
PRESCRIBED TEXT BOOKS
• About Financial Accounting, Volume 2, Latest Edition,
PR Berry et al, LexisNexis. CHAPTER 3
• A concept-based introduction to Financial
Accounting, Latest Edition, DL Kolitz et el. JUTA,
CHAPTER 17
• Accounting an Introduction: Latest Edition, JE
Myburgh et al, LexisNexis. CHAPTER 18
• Fundamental Accounting, Latest Edition, David Flynn
and Carolina Koornhof. CHAPTER 23
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
Learning objectives:
After studying this unit, you should be able to:
• Prepare the accounting records when a new partner is
admitted, retires, dies or resigns
• Calculate the new profit sharing ratio when a new partner
is admitted, partner retires, dies or resigns
• Calculate goodwill on admission, retirement, death or
resignation
• Prepare the revaluation/ and capital account when there is
a change in the ownership structure
• Prepare the financial statements of the partnership after
changes in ownership structures
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE

When two or more

individuals engage in an
enterprise as co-owners,
the organization is known
as a partnership.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
• The concept of dissolution of a partnership may be applied to
a wide range of events.
• It could, on the one hand, mean a small change in ownership,
for example, where a senior employee is granted status.
• In this case it would have no effect on the continuity of the
partnerships activities.
• On the other hand, it could mean the complete liquidation of
the firm.
• Under such circumstances the concepts of going concern and
continuity will no longer apply.
• Obviously it is difficult to develop a single set of rules which can
be universally applied to all possible forms of dissolutions.
• It is the nature of the events leading to the dissolution which
will determine how the dissolution should be handled, rather
than the formal legal principles of the process itself.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
• Although a partnership is dissolved from a legal point of
view when a partner dies, retires or is admitted, the
partnership in most cases simply continues, albeit with a
change in the composition of the partners.
• Interested third parties will simply be notified of the
change.
• Current accounting practice entails treating a partners’
interest as a share in a continuing business which is
transferable with the consent of the other partners.
• This approach is followed in larger partnerships.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
• From a managerial and accounting point of view, a number of
considerations are relevant to the dissolution of a partnership.
• In order to facilitate the systematic treatment of the accounting
aspects relating to the dissolution of a partnership, the subject will
now be discussed with reference to the following main categories:
• Admission of a new partner;
• Retirement or death of a partner; and
• Liquidation of the partnership
• In addition, the assumption will be that the first two cases do not
result in the liquidation (or complete dissolution) of the partnership,
but simply (from an accounting point of view) in the rearrangement of
interest amongst partners as a result of the change in composition of
the partners.
• The grouping of the first categories is not mutually exclusive. Thus,
the retirement of an existing partner and the admission of a new
partner may take place simultaneously.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
ADMISSION OF A NEW PARTNER

• On the approval of the existing partners, a new partner may be

admitted to the partnership in one of the following ways:
• By purchasing an interest directly from one or more of the present partners;
• By contributing cash and/ or assets to the partnership in order to acquire an
interest; or
• By being admitted without any form of payment
• As has already been stated, the legal position is that the old
partnership ceases to exist as soon as the new partnership is formed.
• From an economic point of view, the admission of the new partner is
unlikely to have any influence on the continuity of the partnership.
• In such a case it is not necessary to close the books of the
partnership, as the partnership entity continues to exist.
• It is necessary to make only the relevant entries to give effect to the
admission of the new partner.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
• We will examine here the issues which relate to the admission
of a partner to a partnership. In terms of common law, a
change in the members of the partnership ends the existing
partnership and a new partnership comes into existence.
• A change in composition of a partnership results in a change in
profit-sharing ratio. In addition, it is necessary to ensure that
the equity of the existing partners is fairy stated.
• This involves revaluating the assets and liabilities of the
partnership. Once the assets and the liabilities have been
revalued and the equity adjusted, a value for goodwill (if any)
needs to be determined.
• The capital contribution of the new partner is recorded and
lastly the reserve (if any) must be redistributed among the
partners.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
• The procedure to follow with the admission of a partner is
summarised as follow:

• Adjustment to the profit-sharing ratio.

• Revaluation of the assets of the partnership.
• Accounting for goodwill.
• Recording the new partner’s contribution
• Redistribution of the reserve.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
Adjustment to the profit-sharing ratio
• The profit-sharing ratio is an important aspect of a partnership
agreement because it determines how the profit remaining after
appropriations is shared among the partners. On change in
partnership composition, the existing partners must agree on
the basis of relinquishing profit share and all the partners must
agree on the profit share to be allocated to the new partner.
Three possible agreements could be reached.
• The share that the new partner will acquire is relinquished by the
existing partners according to their existing ratio. As a result, future
profits accruing to the partnership will be shared between the original
partners in their original profit-sharing ratio.
• The share that the new partner will acquire is relinquished by the
existing partners equally. As a result, future profits accruing to the
partnership will be shared between the original partners in a different
profit-sharing ratio.
• The share that the new partner will acquire is relinquished by the
existing partners according to a ratio agreed between them.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
• Adjustment to the profit-sharing ratio
• Illustration 1
• Tom and Jerry are partners sharing profits in the ratio of 4:1.
They admit Steve as a new partner for 1/5 share in the future
profits of the firm.
• Calculate new profit sharing ratio of Tom, Jerry and Steve.
• Tom 4/5 or 80%
• Jerry 1/5 or 20%
• Total 100%
• New partner will share 20% of the future profits
• Thus Tom will relinquish 1/5 of 80%=16%
• Jerry will relinquish 1/5 of 20%= 4%
• New ratio= Tom 64%, Jerry 16% and Steve 20%
 PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
Revaluation of assets

• As a new partnership comes into existence on the admission of

another partner, it is important to determine he fair value of the
partnership equity at the date of admission of the new partner.
• The underlying assets and liabilities need to be valued to determine the
consideration to be paid by the incoming partner, and to recognize any
change in the share of equity of the existing partner.
• The balance on the revaluation account is referred to as a gain or loss
on revaluation and is allocated to the existing partners in the existing
profit-sharing ratio.
• This is because the existing partners must benefit or lose from changes
in the value of equity while they controlled the business.
• The consequence of the revaluation procedure is that the new firm
begins with its assets recorded at their agreed values and the partners’
equity is adjusted to reflect the interest of the partners in the assets of
the business
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
GOODWILL
• Any trading entity strives to build up good reputation.
• As has already been stated, this reputation or good name
could be based on good management, holding of valuable
patent rights and agencies or the fact that the business is
situated in a central and convenient location.
• The ‘value’ of the intangible asset which the entity build
up, is known in accounting terminology as goodwill.
• Such goodwill is, on the whole, not reflected in the
financial statements because no price was paid for it.
• However, in cases where a business is bought and a
value placed on the goodwill, and is paid for, it is indeed
necessary to show it in the financial statements
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
Identification of goodwill
• Nature of goodwill
• The revaluation of the partnership’s tangible assets results in the net assets being
stated at their fair value.
• However, the value of the business as a whole could be greater than the sum of
the individual net assets.
• The excess of the value of a business as a whole (as indicated by the purchase
consideration) over the fair value of its identifiable net assets is known as
goodwill.
• Goodwill is an intangible asset. Goodwill represents anticipated future economic
benefits from assets that are not capable of being individually and separately
recognized. “Goodwill arises through factors such as sound management, a well-
trained workforce and loyal customers.
• Accounting practice has distinguished between internally generated goodwill and
purchased goodwill. IAS 38, entitled Intangible Assets, states that internally
generated goodwill (also known as inherent goodwill) is not recognized as an
asset because it is not an identifiable resource controlled by the entity and its cost
cannot be measured reliably. This is because internally generated goodwill could
be valued differently by different parties and could fluctuate in value as various
factors which affect the business change on a daily basis. On the other
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
Redistribution of the reserve
• A reserve, as you are now aware, is part of equity and, in
the case of a partnership, represents profits that have not
been allocated to the partners’ current accounts.
• This is to restrict the cash withdrawn from the entity.
• As the new partner is entitled to a share of the partnership
equity, an accounting entry is therefore required to
redistribute the reserve so that the equity of the existing
partners is adjusted to reflect their share of those profits.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
Retirement of a partner
• A partner may retire from a partnership by selling his
interest, with the consent of the other partners, to a new
partner.
• This will then be a personal transaction between the
retiring and the new partner, with the new partner taking
over the interest of the old partner in the firm.
• However, it is possible that the remaining partners take
over the interest of the retiring partner.
• A partner who retires from a partnership is entitled to the
repayment of his interest in the firm.
• Similarly, the estate of a deceased partner is entitled to
the settlement of his interest in the partnership.
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
A partner who retires/ or resigns from a partnership or the estate of a
deceased partner is entitled to the statement of his/her interest in the
partnership.
The interest of a partner is determined by partner’s share of equity of
the partnership. A partner’s share of equity will include:
• the balance on the partner’s capital account
• the balance on the partner’s current account
• the partner’s share of any reserves on the statement of financial
position;
• the partner’s share of any gains or losses on revaluation of assets at
date of retirement or death
• the partner’s share of any movement in the value of goodwill, as
agreed between the partners;
• a charge against the retiring partner for any assets taken over;
• the partner’s share of any costs incurred in the change in partnership
composition
PARTNERSHIPS- CHANGES IN
OWNERSHIP STRUCTURE
• The adjustments are typically made through revaluation
account, as was the case on the admission of a partner.
You may, however, come across situations where the
revaluations are allocated directly to the partners’ capital
accounts, either on retirement or on admission.
• The principles involved are similar to the admission of a
partner,