Hello! Welcome to our next lesson.
In our previous session on hidden goodwill, we saw how adjustments for revaluation profit or loss were a crucial step in finding the old partners' correct capital balances. Today, we're going to dive deep into that process.
This lesson is dedicated to learning how to prepare a Revaluation Account for assets and liabilities upon a partner's admission and distribute the resulting profit or loss. This is a fundamental step in reconstituting a partnership, ensuring that the financial changes that occurred before a new partner joins are accounted for fairly.
Why Do We Need a Revaluation Account?
When a new partner is admitted, the firm's assets and liabilities may have values that are different from what is recorded in the books. For example, a piece of land bought ten years ago for ₹5,00,000 might be worth ₹20,00,000 today. This ₹15,00,000 increase in value is a gain that belongs to the old partners who were with the firm during that period. It would be unfair for the new partner to get a share of this past gain.
The Revaluation Account is prepared to:
- Bring all assets and liabilities to their current market values.
- Calculate the net profit or loss arising from these changes.
- Distribute this profit or loss exclusively among the old partners in their old profit-sharing ratio.
To get a clear picture of this logic, let's start with a short video.
Revaluation Account | Admission of Partner#9 |12Accounts
The video 'Revaluation Account | Admission of Partner#9' by Accounts Funda provides an excellent example using land appreciation to explain why revaluation is necessary. It sets the foundation for everything we will cover.
Watch the first 5 minutes and 27 seconds of the video. Focus on understanding the argument that the profit from the land's revaluation should only go to the old partners (A and B) and why.
The Structure and Rules of the Revaluation Account
The Revaluation Account is a Nominal Account. This is the key to understanding how it works. As you know from your Grade 11 basics, the rule for nominal accounts is:
- Debit all expenses and losses.
- Credit all incomes and gains.
Applying this to revaluation:
- A loss occurs when an asset's value decreases or a liability's value increases.
- A gain occurs when an asset's value increases or a liability's value decreases.
Therefore, the rules for posting to the Revaluation Account are:
Debit Side (Losses):
- To Decrease in the value of Assets (e.g., Stock, Furniture)
- To Increase in the value of Liabilities (e.g., Creditors, Bills Payable)
- To Unrecorded Liabilities (a new liability discovered)
Credit Side (Gains):
- By Increase in the value of Assets (e.g., Land, Buildings)
- By Decrease in the value of Liabilities (e.g., Creditors)
- By Unrecorded Assets (a new asset discovered)
Here is the standard format:
To see these rules explained with more examples, including how to handle unrecorded items, continue with the video you started.
Revaluation Account | Admission of Partner#9 |12Accounts
This next segment of the 'Revaluation Account' video details the format and explains what goes on the debit and credit sides, item by item. It directly follows the nominal account rules we just discussed.
Watch from 05:27 to 12:15. The instructor clearly explains how increases/decreases in assets and liabilities, as well as unrecorded items, are treated as gains or losses and placed on the appropriate side of the account.
Journal Entries for Revaluation
Behind every ledger account are journal entries. Understanding them solidifies the logic. For a comprehensive overview of the accounting treatment, including all the necessary journal entries, please review the following text.
Accounting Treatment of Revaluation of Assets and Liabilities
The article 'Accounting Treatment of Revaluation of Assets and Liabilities' from GeeksforGeeks provides a structured breakdown of the journal entries for each type of adjustment. It's a great reference to have.
Read the sections 'What is Revaluation Account?', 'Nature', and 'Accounting Treatment' (Case 1). Pay close attention to the journal entries provided for increase/decrease in assets/liabilities and for unrecorded items.
Calculating and Distributing the Final Profit or Loss
After you have posted all the revaluation adjustments:
- Total the Debit side and the Credit side.
- If the Credit side > Debit side, the difference is a Profit on Revaluation.
- If the Debit side > Credit side, the difference is a Loss on Revaluation.
This profit or loss is then transferred to the Old Partners' Capital Accounts in their Old Profit-Sharing Ratio.
The journal entry for transferring a profit would be:Revaluation A/c Dr.
To Old Partner 1's Capital A/c
To Old Partner 2's Capital A/c
The entry for a loss is the reverse:Old Partner 1's Capital A/c Dr.Old Partner 2's Capital A/c Dr.
To Revaluation A/c
Test your understanding!
A and B are partners sharing profits 3:2. On C's admission, the following revaluations occur:
- Machinery (Book Value ₹50,000) is now valued at ₹45,000.
- Creditors (Book Value ₹30,000) are to be paid only ₹28,000.
- Where will these items be recorded in the Revaluation Account?
- What is the net profit or loss and how will it be distributed?
Show answer
- Machinery: The value decreased by ₹5,000. This is a loss, so it will be debited to the Revaluation Account.
- Creditors: The liability decreased by ₹2,000. This is a gain, so it will be credited to the Revaluation Account.
Calculation:
- Total Debits = ₹5,000
- Total Credits = ₹2,000
- Net Result = Debit side is greater by ₹3,000. This is a Loss on Revaluation of ₹3,000.
Distribution:
- A's Share of Loss = ₹3,000 × 3/5 = ₹1,800 (Debited to A's Capital A/c)
- B's Share of Loss = ₹3,000 × 2/5 = ₹1,200 (Debited to B's Capital A/c)
A Comprehensive Example
Now, let's put it all together by preparing a full Revaluation Account from a problem.
Revaluation Account | Admission of Partner#9 |12Accounts
The final part of the 'Accounts Funda' video walks through a complete problem. This will show you the practical application of all the rules we've discussed.
Watch from 15:37 to 21:40. Follow along as the instructor takes each adjustment from the problem, posts it to the Revaluation Account, calculates the net gain, and distributes it to the old partners in their old ratio.
For another detailed example, you can review the solved numerical question from the NCERT solutions. It's an excellent resource that shows the Revaluation Account, Capital Accounts, and the final Balance Sheet.
NCERT Solution for Class 12 Accountancy Chapter 3
This solved problem from the BYJU'S NCERT solutions is a perfect comprehensive exercise. It demonstrates how revaluation fits into the larger process of a partner's admission.
Scroll down to 'Long Questions for NCERT Accountancy Solutions Class 12 Part 1 Chapter 3' and find Question 27. Carefully study the question and its solution, focusing on how each adjustment is posted to the Revaluation Account and how the final profit of ₹27,000 is calculated and transferred to A and B.
Conclusion
You have now mastered a critical component of accounting for partnership admissions. The Revaluation Account ensures fairness by quarantining all profits and losses from asset and liability value changes to the period before the new partner joins.
Key Takeaways:
- The Revaluation Account is a nominal account used to record changes in the value of assets and liabilities.
- Gains (increase in assets, decrease in liabilities, unrecorded assets) are credited.
- Losses (decrease in assets, increase in liabilities, unrecorded liabilities) are debited.
- The final balance, whether a profit or loss, is distributed only among the old partners in their old profit-sharing ratio.
Preview of the Next Lesson:
The profit or loss on revaluation is not the only historical item that belongs to the old partners. Firms often have accumulated profits (like a General Reserve) or losses sitting in their Balance Sheet. In our next lesson, we will learn how to adjust for accumulated profits, reserves, and losses on the admission of a partner. This is the next logical step in preparing the firm's books for the new partnership structure.