What is Meant by Adjustment of Capitals?
An adjustment of capital indicates the adjustment which is made in an account to adjust for the effect of inflation as there will be a change in the prices of goods or services that are used by the business on their day-to-day basis. In this case, stocks are being excluded but items like prepaid expenses, receivable bills, and the trade debtors are included.
At times, in situations of admission, the partners agree that their capitals are required to be adjusted to make them proportionate to their profit-sharing ratio. In this situation, with the capital of the new partner been given, the same is to be used as a base for estimating the new capital of the old partners.
The capitals after which partners can ascertain and thus be able to compare their old capitals after all the adjustments relating to goodwill reserves and revaluation of assets and liabilities, etc. are done. The partner whose capital drops short is required to bring in the necessary amount to cover up the shortage and the partner who has a surplus amount will need to withdraw the excess amount of the capital.
Capital Adjustment in Admission
During the time of admission of a new partner, capital rearrangements are to be made on the basis of the partners’ decision. The capital rearrangement takes place in this way – the contribution of partners towards the capitals is rearranged on the basis of their new profit-sharing ratio. For this, the Capital Accounts of the old partners are to be first adjusted with the Goodwill, Revaluation Account, to adjust the past profits if any.
After this, the capitals of all the partners who are continuing in the firm are rearranged in any of the following ways:
The calculation of the amount of capital is required to be made on the basis of the New Partners’ Capital contribution done.
The calculation is done of the amount of the capital which is made on the basis of Old Partners’ Capital Account.
The Capital Accounts of all partners are then re-adjusted on the basis of the new Profit-Sharing Ratio.
How to Calculate Adjusted Capitals of all Partners?
After the admission of the new partner, s/he acquires his own share in profits from the old partners who continue to exist in the firm. So, on the admission of a new partner in the firm, the other old partners are required to sacrifice a share of their profit in favour of the new partner. The main question is - What will be the share of the new partner and how will s/he acquire it from the existing partners if they decide mutually among the old partners together with the new partner? While, if nothing is specified as to how will the new partner should acquire his own share from the old partners, this may be assumed that he will get it from them in their agreed profit-sharing ratio.
On admission of a new partner in the firm, the profit-sharing ratio that will be shared among the old partners will change keeping in view the respective contribution of the profit-sharing ratio of the incoming partner. Hence, there is a definite need to ascertain the new profit-sharing ratio among all the partners. This again depends upon how does the new partner acquires his own share from the old partners for which there exist many possibilities.
Capital Adjustment in Retirement
During the retirement of the partners, the remaining partners decide to adjust their own capital contribution which is to be done in their profit-sharing ratio.
The capitals of all the continuing partners are required to be adjusted in the following three cases:
First Case: When the total capital of the new firm is given in the partnership deed.
Second Case: When the total capital of the new firm is not given in the partnership deed.
Third Case: When the outgoing partner is to be paid through cash which is brought by the continuing partners in such a ratio so as to make their capitals proportionate with their new profit-sharing ratio.
FAQs on Capital Adjustments in Partnership
1. What are capital adjustments in a partnership firm as per the CBSE Class 12 Accountancy syllabus for 2025-26?
Capital adjustments in a partnership firm refer to the process of realigning the capital accounts of all partners to be in proportion to their new profit-sharing ratio. This is typically done during significant events like the admission of a new partner or the retirement or death of an existing partner. The goal is to ensure that each partner's capital contribution reflects their share in the future profits of the firm.
2. Why is it necessary to make capital adjustments during the admission or retirement of a partner?
It is necessary to adjust capitals to ensure fairness and equity among the partners. When the profit-sharing ratio changes, an unadjusted capital structure may lead to a situation where a partner with a smaller profit share has a disproportionately large capital, or vice versa. Adjusting capitals ensures that the financial stake of each partner (their capital) is directly aligned with their claim on the firm's future profits, as specified in the new partnership deed.
3. What are the two main methods for adjusting partners' capitals upon the admission of a new partner?
When a new partner is admitted, there are two primary methods for adjusting capitals based on the new profit-sharing ratio:
- Method 1: Adjusting Old Partners' Capitals based on the New Partner's Capital. Here, the new partner's capital is used as a base to calculate the total capital of the firm. The old partners must then bring in or withdraw cash to make their capital balances proportionate.
- Method 2: Determining the New Partner's Capital based on the Old Partners' Adjusted Capitals. In this case, the combined adjusted capitals of the old partners serve as the base to determine the firm's total capital. The new partner is then required to bring in a proportionate amount of capital.
4. How does the treatment of goodwill and revaluation profit affect the final capital adjustment calculation?
The treatment of goodwill and revaluation profit or loss is a crucial step that must be completed before making the final capital adjustments. The profit or loss from the Revaluation Account and the adjustments for goodwill are credited or debited to the old partners' capital accounts in their old profit-sharing ratio. This ensures their capital accounts reflect the true, up-to-date value before calculating the new proportionate capitals.
5. How is the new partner's capital used as a base to calculate the total capital of the firm and adjust old partners' capitals?
To use the new partner's capital as a base, you follow these steps:
- Step 1: Determine the total capital of the new firm by taking the new partner's capital and multiplying it by the reciprocal of their profit share. For example, if a new partner brings in ₹50,000 for a 1/4th share, the total capital is ₹50,000 x 4/1 = ₹2,00,000.
- Step 2: Calculate the new required capital for each old partner by multiplying the total capital (₹2,00,000) by their respective new profit-sharing ratios.
- Step 3: Compare this required capital with their actual adjusted capital (after revaluation, goodwill, etc.). Any shortfall is brought in as cash, and any surplus is withdrawn.
6. What journal entries are passed to record a surplus or deficit in a partner's capital account after adjustments?
The journal entries depend on whether there is a surplus (excess capital) or a deficit (shortfall):
- For a deficit (Partner brings in cash):
Cash/Bank A/c Dr.
To Partner's Capital A/c
(Being the amount of deficit brought in by the partner) - For a surplus (Partner withdraws cash):
Partner's Capital A/c Dr.
To Cash/Bank A/c
(Being the excess amount withdrawn by the partner)
7. What is the key difference between adjusting capital through cash accounts versus current accounts?
The primary difference lies in the method of settlement. When adjustments are made through cash accounts, partners physically bring in or withdraw cash to settle the surplus or deficit. When adjustments are made through current accounts, the surplus or deficit is transferred to the respective partner's current account instead of an immediate cash settlement. This method is often used when the partnership deed specifies that fixed capitals will be maintained.
8. In what situations are capital adjustments made on the retirement or death of a partner?
On the retirement or death of a partner, the remaining (or continuing) partners may decide to adjust their capitals for two main reasons:
- To make their capitals proportionate to their new profit-sharing ratio after the partner leaves.
- To arrange the necessary cash to pay out the amount due to the retiring or deceased partner. The continuing partners may bring in cash in a manner that not only clears the dues but also adjusts their own capitals to the new ratio.
9. What happens if a continuing partner's existing capital (after all adjustments for goodwill, revaluation, etc.) is more than their new proportionate capital?
If a continuing partner's existing adjusted capital is more than their newly calculated proportionate capital, they have a surplus. As per the partnership agreement, this partner is entitled to withdraw the excess amount from the firm. The journal entry would be to debit that partner's capital account and credit the cash or bank account, reducing their capital to the required proportionate level.
10. Is it mandatory to adjust capitals in proportion to the new profit-sharing ratio every time a partner is admitted or retires?
No, it is not mandatory. Capital adjustments are made only if it is explicitly stated in the partnership deed or if all partners mutually agree to do so at the time of admission or retirement. If there is no such agreement, the capital accounts of the continuing partners will remain at their balances after all other adjustments for goodwill, reserves, and revaluation are made.
