Admission of a New Partner

The admission of a new partner to an existing partnership can occur in one of two ways. Either the new partner can purchase an existing partners share or the new partner can invest additional capital into the partnership.

In the first case, the arrangement is a private one between the new partner and the existing partner and other than the reallocation of capital accounts, no accounting journal entries are required in the records of the partnership.

Providing the remaining partners agree the new partner simply makes a payment to the existing partner based on an agreed valuation, and the total capital of the partnership remains the same.

The main purpose of this post is to show what happens in the second case when the new partner invests additional capital into the existing partnership and the partnership capital changes.

Admission of a New Partner – Investment at Book Value

Providing the amount invested by the new partner is equal to the book value of the percentage of the partnership purchased, the new partners capital account is simply credited with the amount invested.

Suppose for example a partnership has two existing partners A and B with total combined capital of 65,000. The admission of a new partner C is agreed on the basis that C provides additional capital in return for a 20% share.

Required investment calculation

The first step is to calculate the investment required by calculating the book value of the partnership share the new partner is purchasing.

If the new partner is to purchase 20%, then the existing partners will be left with 80% of the partnership. Since their 80% share of the partnership capital must still be equal to 65,000 after the admission of a new partner, it follows that the new partner investment can be calculated as follows.

Capital before admission of a new partner = 65,000
Required capital after admission of a new partner = 65,000 / 80% = 81,250
New partner investment = 81,250 - 65,000 = 16,250

The new partner must invest 16,250 for a 20% share in the partnership. To check this we can calculate the new partner capital as follows.

Capital after admission of a new partner = 81,250
New partner share = 20%
New partner capital = 81,250 x 20% = 16,250

Investment at book value journal entry

The journal entry to reflect the admission of a new partner is as follows.

Admission of a new partner at book value
Account Debit Credit
Cash 16,250
Capital – Partner C 16,250
Total 16,250 16,250

Cash increases by 16,250 as the new partner invests in the partnership. Since the investment was made at book value the capital account of the new partner is also credited with the amount.

Admission of a New Partner – Investment Not at Book Value

If the admission of a new partner is not carried out at book value, then there will be a difference between the amount invested by the new partner and the value of the percentage of the partnership purchased. This difference is normally accounted for using one of two methods.

  1. Goodwill Method
  2. Bonus method

The accounting treatment of the admission of a new partner will vary depending on which accounting method is adopted.

Admission of a New Partner – Goodwill Method

Using the goodwill method the capital allocated to the new partner must not be less than the amount invested, and the capital accounts of the existing partners must not be reduced.

Two situations can arise.

  1. The investment is greater than the book value of the percentage of the partnership purchased.
  2. The investment is less than the the book value of the percentage of the partnership purchased.

Goodwill Method – Investment at Greater than Book Value

In the example above the existing Partners A and B had combined capital of 65,000. The admission of a new partner C was agreed on the basis that C provides additional capital at book value in return for a 20% share.

Suppose now that the new partner is instead required to make an investment of 30,000 for the 20% share.

Valuation calculation

The investment by the new partner for a percentage share in the partnership implies a valuation calculated as follows.

Amount invested = 30,000
New partner share = 20%
Implied partnership valuation = 30,000 / 20% = 150,000

Goodwill calculation

The investment implies the partnership is worth 150,000, hence the required capital is also 150,000. However, the total paid in capital is only 95,000 (65,000 + 30,000). Using the goodwill method, the difference between the required capital and the paid in capital is treated as goodwill and is calculated as follows.

Existing partner capital = 65,000
New partner investment = 30,000
Paid in capital = 95,000
Required capital = 150,000
Goodwill = 150,000 - 95,000 = 55,000

Allocation of goodwill to existing partners

The new partner has paid more than the existing book value of the partnership would suggest. The goodwill belongs to the existing partners and is shared between them in proportion to their profit sharing ratio.

Suppose the profit sharing ratio between existing partners A and B was 70:30. The goodwill is allocated between them as follows.

Profit sharing ratio A:B = 70:30
Partner A goodwill share = 70% x 55,000 = 38,500
Partner B goodwill share = 30% x 55,000 = 16,500

Goodwill Journal Entry

The admission of a new partner for an amount in excess of book value results in the following goodwill journal entry.

Admission of a partner journal entry – Goodwill method
Account Debit Credit
Cash 30,000
Goodwill 55,000
Capital – Partner A 38,500
Capital – Partner B 16,500
Capital – Partner C 30,000
Total 85,000 85,000

The new partner invests cash of 30,000 for a 20% share in the partnership. The investment implies a valuation of 150,000 resulting in goodwill of 55,000. The new partner is allocated capital equal to their investment of 30,000, and the goodwill is shared between the existing partners in proportion to their profit share with partner A getting 38,500 and partner B getting 16,500.

Goodwill Method – Investment at Less than Book Value

A similar approach can be adopted when the investment is at less than book value. Suppose in the above example the new partner invested only 14,000 instead of 30,000 for the 20% share in the partnership.

Valuation calculation

In this instance the amount is invested at below book value. In order to preserve the existing partners capital, which is required by the goodwill method, the valuation needs to be based on the share retained by the existing partners.

Existing partner capital = 65,000
Existing partner share = (1-20%) = 80%
Implied partnership valuation = 65,000 / 80% = 81,250

Goodwill calculation

The calculation above implies a partnership valuation of 81,250, hence the required capital is also 81,250. However, the total paid in capital is only 79,000 (65,000 + 14,000). Using the goodwill method, the difference between the required capital and the paid in capital is treated as goodwill and is calculated as follows.

Existing partner capital = 65,000
New partner investment = 14,000
Paid in capital = 79,000
Required capital = 81,250
Goodwill = 81,250 - 79,000 = 2,250

New partner capital account

The capital allocated to the new partner is calculated as follows.

Required capital = 81,250
New partner share = 20%
New partner capital = 81,250 x 20% = 16,250

Allocation of goodwill to partners

The new partner has paid less than the existing book value of the partnership would suggest and therefore the goodwill belongs to the new partner.

Goodwill journal entry

The admission of a new partner for an amount less than book value results in the following goodwill journal entry.

Admission of a partner journal entry – Goodwill method
Account Debit Credit
Cash 14,000
Goodwill 2,250
Capital – Partner C 16,250
Total 16,250 16,250

The new partner invests cash of 14,000 for a 20% share in the partnership. The share retained by the existing partners implies a valuation of 81,250, resulting in a capital allocation to the new partner of 16,250 including goodwill of 2,250.

Admission of a New Partner – Bonus Method

Using the bonus method the capital of the partnership after the admission of a new partner must be equal to the existing partnership capital plus the amount invested by the new partner.

As before, the investment can either be greater than or less than the book value of the percentage of the partnership purchased.

Bonus Method – Investment at Greater than Book Value

In the example above the existing Partners A and B had combined capital of 65,000. The admission of a new partner C was agreed on the basis that C provides additional capital in return for a 20% share.

Suppose that the new partner is again required to make an investment of 30,000 for the 20% share.

Partnership capital calculation

The partnership capital after the admission of a new partner is calculated as follows.

Existing partner capital = 65,000
New partner investment = 30,000
Paid in capital after admission of a new partner = 95,000

New partner capital account

The new partner invested in return for a 20% share of the partnership. The new partners capital is calculated as follows.

Paid in capital = 95,000
New partner share = 20%
New partner capital = 95,000 x 20% = 19,000

Bonus calculation

The partner invested 30,000 in return for a capital allocation of 19,000. The difference of 11,000 is treated as a bonus, calculated as follows.

New partner investment = 30,000
New partner capital allocation = 19,000
Bonus = 30,000 - 19,000 = 11,000

Bonus allocation

The partner invested 30,000 in return for a capital allocation of 19,000. The difference of is treated as a bonus calculated as follows.

New partner investment = 30,000
New partner capital allocation = 19,000
Bonus = 30,000 - 19,000 = 11,000

The bonus is allocated to the existing partners in proportion to their profit share ratio.

Profit sharing ratio A:B = 70:30
Partner A bonus share = 70% x 11,000 = 7,700
Partner B bonus share = 30% x 11,000 = 3,300

Bonus journal entry

The admission of a new partner for an amount in excess of book value results in the following journal entry.

Admission of a partner journal entry – Bonus method
Account Debit Credit
Cash 30,000
Capital – Partner C 19,000
Capital – Partner A 7,700
Capital – Partner B 3,300
Total 30,000 30,000

The new partner invests 30,000 and receives a capital allocation of 19,000 equal to 20% of the paid in capital of the partnership. The difference of 11,000 is treated as a bonus and allocated to the existing partners in proportion to their profit share, with partner A getting 7,700 and partner B getting 3,300.

Bonus Method – Investment at Less than Book Value

A similar approach can be adopted when the investment is at less than book value. Suppose in the above bonus example the new partner invested only 14,000 instead of 30,000 for the 20% share in the partnership.

Partnership capital calculation

The partnership capital after the admission of a new partner is calculated as follows.

Existing partner capital = 65,000
New partner investment = 14,000
Paid in capital = 79,000

New partner capital account

The new partner invested in return for a 20% share of the partnership. The new partners capital is calculated as follows.

Paid in capital = 79,000
New partner share = 20%
New partner capital = 79,000 x 20% = 15,800

Bonus calculation

The partner invested 14,000 in return for a capital allocation of 15,800. The difference of 1,800 is treated as a bonus, calculated as follows.

New partner investment = 14,000
New partner capital allocation = 15,800
Bonus = 14,000 - 15,800 = -1,800

The bonus is allocated to the existing partners in proportion to their profit share ratio.

Profit sharing ratio A:B = 70:30
Partner A bonus share = 70% x -1,800 = -1,260
Partner B bonus share = 30% x -1,800 = -540

It should be noted that the bonus is this case is a negative amount as the new partner invested less than the capital allocated. The existing partners must effectively absorb the bonus allocated as capital to the new partner.

Bonus journal entry

The admission of a new partner for an amount less than book value results in the following journal entry.

Admission of a partner journal entry – Bonus method
Account Debit Credit
Cash 14,000
Capital – Partner C 15,800
Capital – Partner A 1,260
Capital – Partner B 540
Total 15,800 15,800

The new partner invests 14,000 and receives a capital allocation of 15,800 equal to 20% of the paid in capital of the partnership. The difference of 1,800 is treated as a bonus and allocated to the existing partners in proportion to their profit share, with partner A getting 1,260 and partner B getting 540.

Admission of a New Partner August 10th, 2017Team

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