Admission of a Partner in Partnership

When a new partner joins a partnership the old partnership is dissolved and a new partnership is formed. Accounting for admission of new partner depends on the nature of arrangement between the existing partners and the new partner. Such an arrangement can take any of the following forms:

  1. The new partner brings in new assets
  2. The new partner purchases interest in partnership from existing partners at book value
  3. The new partner pays a bonus for the partnership's goodwill; and
  4. The new partner receives a bonus for the partnership's negative goodwill.

Accounting in each of the situation is discussed separately below:

New partner brings additional assets

When the new partner brings in new assets, the assets are debited at the value agreed by the partners for the purpose and the partner's capital account is credited for the total value of those assets.

Example 1

Pluto and Sedna were partners in Kuiper Space Consulting. Their respective capital balance was $45 million and $25 million. In 2005 they agreed to admit Eris who agreed to contribute a very specialized telescope worth $20 million.

The admission through introduction of new assets is recorded by the following journal entry:

Telescope20,000,000
Eris Capital Account20,000,000

The new partner purchases his share from existing partners at book value.

New partner purchases interest in partnership from existing partners at book value

When the new partner purchases interest from existing partners at book value, the transaction is recorded by crediting the capital account of the new partner and debiting the capital account of existing partner(s). The transaction is reported in the books for the partnership at the book value of the share transferred and it has nothing to do with the price which the new partner has paid to the existing partner(s).

Example 2

Refer to Example 1 and assume that Eris purchased 25% of share of Pluto in KSC for $15 million and 45% share of Sedna for $10 million.

For the purpose of accounting for the above transaction, we have to work with book values of the transferred shares. The consideration at which the transfer is made between Pluto, Sedna and Eris is not relevant because it is the partners' personal transaction. We just need to debit Pluto's capital account by $11.25 million (25% of $45 million) and Sedna's capital account by $11.25 million (45% of $25 million) and credit Eris capital account by $22.5 million ($11.25 million worth of book value purchased from Pluto and $11.25 million worth of book value purchased from Sedna). From looking at the transaction, we see that Pluto sold the share at profit but Sedna sold it at a loss. But all this is not relevant for accounting purpose in the given arrangement.

New partner pays a bonus for goodwill

When a partnership has good reputation and a profitable client base, new partners are normally required to pay a hefty bonus for goodwill i.e. they introduce assets in excess of the book value of the share they get in the firm. In such a situation, the bonus (which equals the assets they introduce minus the book value of the share they get in the partnership) is credited to the existing partners' capital accounts.

Example 3

Refer Example 1 and assume that Eris brings in cash worth $40 million but in return it gets a capital share of only $25 million. Any payment bonus representing goodwill is shared equally by Pluto and Sedna.

The $15 million representing excess of assets introduced over the book value of the share represents the bonus paid to the existing partners. This bonus is credited to Pluto's and Sedna's capital accounts in a ratio agreed in the partnership agreement. (In their mutual profit sharing ratio if no such provision exists the agreement). It is journalized as follows

Cash40,000,000
Eris Capital25,000,000
Pluto Capital ($15 million/2)7,500,000
Sedna Capital ($15 million/2)7,500,000

New partner receives a bonus for negative goodwill

Every partnership is interested in recruiting influential partners that could prove key in business development. Existing partners might be willing to offer a bonus to a new partner i.e. they might offer him a share in the book value of the partnership's equity which is in excess of assets contributed by him. When this is the case, the existing partners share the bonus paid either in the accordance with the partnership agreement or in their profit sharing ratio or equally. The transaction is accounted for by debiting each partners' capital account by their respective shares of bonus paid and crediting the total bonus amount to the new partner's capital.

Example 4

Refer Example 1 and assume that Eris brings in cash worth $40 million but in return it gets a capital share of $60 million. Any exchange of bonus is shared equally by Pluto and Sedna.

The $20 million representing excess of the Eris's share in partnership capital over his contribution represents the bonus he receives for the 'negative goodwill'. The bonus is born by Pluto and Sedtna equally and transaction is journalized as follows:

Cash40,000,000
Pluto Capital ($15 million/2)7,500,000
Sedna Capital ($15 million/2)7,500,000
Eris Capital60,000,000

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork