Hello! Welcome to our next lesson.
In our previous lessons, we've covered the essential adjustments for revaluation of assets and liabilities, goodwill, and the distribution of accumulated profits and reserves. These steps are crucial to determine the true capital balances of the old partners right before the new partner joins. Today, we build directly on that foundation to tackle the final major adjustment to the partners' capital accounts.
This lesson focuses on how to adjust old partners' capitals based on the new partner's capital and new profit-sharing ratio. Often, after a new partner is admitted, the firm decides that all partners' capital balances should be proportionate to their new profit-sharing ratio. This ensures fairness and aligns each partner's investment with their stake in the firm's future profits.
The Rationale for Capital Adjustment
Imagine a firm where Partner A has a capital of ₹1,00,000, Partner B has ₹50,000, but they share profits equally. After admitting Partner C, their new profit-sharing ratio becomes 1:1:1. It might seem more equitable for all three partners to have the same amount of capital invested. This is the core idea behind capital adjustment.
A problem will explicitly tell you when to perform this adjustment. The instruction will look something like this: "The capitals of the old partners are to be readjusted on the basis of the new partner's capital contribution."
To understand the basic concept, watch this short introductory clip.
Adjustment of capital | Case 1. Admission of a partner class 12 Accounts Part 12 Concept & Questions
The video 'Adjustment of capital' from Sunil Panda-The Educator starts with a simple analogy to explain why partners might want to adjust their capital to align with a new ratio.
Watch the segment from 00:53 to 05:40. The instructor explains the concept of capital adjustment and, importantly, highlights the specific phrases in a question that signal this adjustment is required.
The Three-Step Method for Capital Adjustment
When the new partner's capital is given and used as the base, the adjustment process follows three logical steps. This is the most common scenario you will encounter.
Let's start by reading a concise summary of these steps.
Adjustment of Partner's Capital Account: Admission of a ...
The article 'Adjustment of Partner's Capital Account' on GeeksforGeeks provides a clear, step-by-step breakdown of the calculation. We'll focus on their 'Case 2', which matches our learning outcome.
Read the section titled 'Case 2: Calculation of capital of the old partner on the basis of a new partner'. Focus on the four steps outlined, which we will consolidate into a three-step process.
Based on the resources, here is the consolidated three-step process:
Step 1: Calculate the Total Capital of the New Firm
Use the new partner's capital and their profit share to determine the total capital of the reconstituted firm.
Logic: If a new partner invests ₹50,000 for a 1/5th share, it implies the total capital (5/5th share) of the firm should be ₹50,000 × 5 = ₹2,50,000.
Step 2: Determine the New "Required" Capital for Each Partner
Divide the total capital calculated in Step 1 among all partners (including the new one) in their new profit-sharing ratio.
The amounts you calculate here will be the closing balances (To Balance c/d) in the Partners' Capital Accounts.
Step 3: Find the Surplus or Deficit and Make Adjustments
Compare each old partner's existing adjusted capital (their capital after all adjustments for goodwill, revaluation, and reserves) with their new required capital from Step 2.
- If Existing Capital > Required Capital, there is a surplus. The partner will withdraw the excess cash.
- If Existing Capital < Required Capital, there is a deficit. The partner must bring in additional cash.
The journal entry for a surplus is:Partner's Capital A/c Dr.
 To Cash/Bank A/c
The journal entry for a deficit is:Cash/Bank A/c Dr.
 To Partner's Capital A/c
Sometimes, the question may state that adjustments should be made through Current Accounts instead of cash. In that case, you would debit or credit the Partner's Current Account instead of Cash/Bank.
Test your understanding!
A and B are partners. They admit C for a 1/4th share. C brings in ₹1,00,000 as capital. The new profit-sharing ratio is 2:1:1. After all adjustments, A's existing capital is ₹1,80,000 and B's is ₹1,10,000.
Calculate the surplus or deficit for A and B.
Show answer
Step 1: Total Capital of the New Firm
Total Capital = C's Capital × (1 / C's Share) = ₹1,00,000 × 4/1 = ₹4,00,000
Step 2: Required Capital for Each Partner
- A's Required Capital = ₹4,00,000 × (2/4) = ₹2,00,000
- B's Required Capital = ₹4,00,000 × (1/4) = ₹1,00,000
- C's Required Capital = ₹4,00,000 × (1/4) = ₹1,00,000 (matches his contribution)
Step 3: Find Surplus or Deficit
- For A: Required = ₹2,00,000, Existing = ₹1,80,000.
This is a deficit of ₹20,000 (A needs to bring in cash). - For B: Required = ₹1,00,000, Existing = ₹1,10,000.
This is a surplus of ₹10,000 (B can withdraw cash).
Applying the Method: A Worked Example
Now, let's see these steps in action. The following video works through a problem where the existing adjusted capitals are given, allowing you to focus purely on the capital adjustment calculation.
Adjustment of capital | Case 1. Admission of a partner class 12 Accounts Part 12 Concept & Questions
Let's return to the Sunil Panda video. The instructor will now apply the methodology to a practical example, walking you through each step of the calculation.
Watch from 07:25 to 16:27. This segment first recaps the three steps and then applies them to a question involving partners X, Y, and Z. Pay close attention to how the new required capital is calculated and then compared with the actual capital to find the cash to be brought in or withdrawn.
The image below summarizes the kind of calculation you just saw, showing how the new capital is determined and how the resulting cash surplus/deficit is recorded.
Capital Adjustment in a Comprehensive Problem
In a full exam problem, you won't be given the "existing adjusted capital." You will have to calculate it yourself by preparing the Revaluation Account and the Partners' Capital Accounts, incorporating all adjustments for reserves, goodwill, etc. The capital adjustment is one of the final steps in preparing the capital accounts.
Let's watch a video that demonstrates this entire process.
24. Admission Of Partner - "Adjustment Of Capitals"
The video 'Admission Of Partner - "Adjustment Of Capitals"' by Devika's Commerce & Management Academy solves a comprehensive problem. We'll focus on the parts that deal with our topic today.
First, watch from 07:12 to 10:36. This is where the instructor performs the capital adjustment calculation (Steps 1 & 2). Next, watch from 15:47 to 20:30. Here, you'll see how the 'Required Capital' is entered as 'To Balance c/d' in the Capital Account. The account is then balanced to find the surplus/deficit ('To Cash' or 'By Cash'), which is our Step 3.
As you saw, the "Required Capital" that we calculate becomes the closing balance (Balance c/d) of the capital account. The balancing figure, which used to be the Balance c/d, now becomes the cash brought in or withdrawn.
Conclusion
Great work today! You have now learned the final and often most complex adjustment in the admission of a partner. Mastering this technique is crucial for correctly preparing the final capital accounts and the new firm's balance sheet.
Key Takeaways:
- Capital adjustment is performed to make partners' capital balances proportionate to their new profit-sharing ratio.
- This adjustment is only done when explicitly stated in the problem.
- The three-step process is:
- Calculate Total Firm Capital from the new partner's contribution.
- Calculate the Required Capital for each partner in the new PSR.
- Compare existing capital with required capital to find the surplus (cash withdrawn) or deficit (cash brought in).
- In the Partners' Capital Account, the "Required Capital" becomes the
To Balance c/d, and the balancing figure is the cash adjustment.
Preview of the Next Lesson:
In our next lesson, we will consolidate everything you've learned. We will focus on preparing comprehensive Partners' Capital Accounts that incorporate all adjustments—goodwill, revaluation, reserves, and the capital adjustment we covered today. This will prepare you to tackle full-length problems on partner admission.