Question

A and B share the profits of a business in the ratio of 5 : 3. They admit C into the firm for a `1/4`th share in the profits to be contributed equally by A and B. On the date of admission of C, the Balance Sheet of the firm was as follows:

Liabilities	₹	Assets	₹
A’s Capital	3,00,000	Machinery	2,60,000
B’s Capital	2,00,000	Furniture	1,60,000
Workmen’s Compensation Reserve	40,000	Stock	1,20,000
Bank Loan	1,20,000	Debtors	80,000
Creditors	15,000	Bank	60,000
Outstanding Expenses	5,000
	6,80,000		6,80,000

Terms of C’s admission were as follows:

1. C will bring ₹ 3,30,000 for his share of capital and goodwill.
2. Goodwill of the firm has been valued at 4 years’ purchase of the average super profits of the last three years. Average profits of the last three years are ₹ 2,20,000 while the normal profits that can be earned with the capital employed are ₹ 1,40,000.
3. Furniture is to be appreciated by ₹ 60,000 and the value of stock is to be reduced by ₹ 20,000.
4. Outstanding Expenses will be paid off.

Prepare Revaluation Account, Partners’ Capital Accounts and the new Balance Sheet of A, B and C.

Answer 1

Dr.	Revaluation Account				Cr.
Particulars	Amount (₹)	Amount (₹)	Particulars	Amount (₹)	Amount (₹)
To Stock A/c		20,000	By Furniture A/c		60,000
To Gain on Revaluation transferred to:		40,000
A’s Capital A/c	25,000
B’s Capital A/c	15,000
		60,000			60,000

 

Dr.	Partners’ Capital Accounts						Cr.
Particulars	A (₹)	B (₹)	C (₹)	Particulars	A (₹)	B (₹)	C (₹)
To Balance c/d	3,90,000	2,70,000	2,50,000	By Balance b/d	3,00,000	2,00,000
				By Revaluation A/c	25,000	15,000
				By Workmen’s Comp. Reserve	25,000	15,000
				By Bank A/c			2,50,000
				By Premium for Goodwill A/c	40,000	40,000
	3,90,000	2,70,000	2,50,000		3,90,000	2,70,000	2,50,000

 

New Balance Sheet of A, B, and C
Liabilities	Amount (₹)	Amount (₹)	Assets	Amount (₹)	Amount (₹)
Bank Loan		1,20,000	Machinery		2,60,000
Creditors		15,000	Furniture (₹ 1,60,000 + ₹ 60,000)		2,20,000
Capital Accounts:		9,10,000	Stock (₹ 1,20,000 − ₹ 20,000)		1,00,000
A	3,90,000		Debtors		80,000
B	2,70,000		Bank		3,85,000
C	2,50,000
		10,45,000			10,45,000

Working Notes:

1. Sacrificing Ratio:

C’s share is `1/4`, contributed equally by A and B.

A’s sacrifice = `1/4 xx 1/2`

= `1/8`

B’s sacrifice = `1/4 xx 1/2`

= `1/8`

Sacrificing Ratio A and B = `1/8 : 1/8` or 1 : 1

New Profit-Sharing Ratio:

A’s new share = `5/8 - 1/8`

= `4/8`

= `2/4`

B’s new share = `3/8 - 1/8`

= `2/8`

= `1/4`

C’s new share = `1/4`

= `(1 xx 2)/(4 xx 2)`

= `2/8`

= `1/4`

New Ratio of A, B, and C = `2/4 : 1/4 : 1/4` or 2 : 1 : 1

Valuation of Goodwill:

Super Profits = Average Profits − Normal Profits

= 2,20,000 − 1,40,000

= 80,000

Firm’s Goodwill = Super Profits × 4 years’ purchase

= 80,000 × 4

= 3,20,000

C’s share of Goodwill = `3,20,000 xx 1/4`

= 80,000

Amount for C’s Capital = Amount brought by C − Amount for Goodwill

= 3,30,000 − 80,000

= 2,50,000