Often times the partnership firm goes through a restructure. This could be on account of admission of a partner, retirement of a partner or simply a change of terms between partners. This is known as reconstitution of a partnership firm. Let us take a look.
Reconstitution of a Partnership Firm
The partnership is an agreement between two or more persons for sharing the profits of a business carried on by all or any one of them acting for all. Any change in the existing agreement is known as reconstitution of the partnership firm. Thus, the existing agreement ends and a new agreement is formed with the changed relationship among the members of the partnership firm and its composition.
Reconstitution of a partnership firm takes place whenever there is a change in the profit sharing ratio among the partners, admission of a new partner, retirement of a partner and death or insolvency of a partner.
Forms of Reconstitution of a Partnership Firm
1. Change in the profit sharing ratio among the Existing Partners
Sometimes the partners may decide to change their profit sharing ratio due to factors like change in their roles in the firm, change in their capital contribution ratio, etc. Any change in the old profit sharing ratio will amount to a reconstitution of the partnership firm.
For example, A, B, and C were partners in a firm sharing equal profits. Due to some reasons, C shifts to another city and is therefore unable to take part in the business actively. Thus, it is decided that now the new profit sharing ratio shall be 2:2:1. This amounts to the reconstitution of a firm.
Browse more Topics under Admission Of A Partner
- Adjustment of Capital and Change in Profit Sharing Ratio Among Existing Partners
- Adjustment and Revaluation of Assets
2. Admission of a Partner
When a firm requires additional capital or managerial help it can admit a new partner in its business. As per the Partnership Act, 1932, a new partner can only be admitted unanimously unless otherwise provided in the partnership deed. When a new partner is admitted a new agreement is formed and thus the firm is reconstituted.
The new partner acquires the right to share the assets of the firm for which he brings in the capital and the right to share the future profits of the firm for which he brings Goodwill. On admission of a new partner, the profit sharing ratio changes, the assets and liabilities are revalued and goodwill is calculated and distributed among the old partners in their sacrificing ratios.
3. The Retirement of an Existing Partner
A partner may decide to retire or withdraw from the firm due to reasons such as his age, his bad health, change in firm’s nature of a business, etc. In case of Partnership at Will, a partner may retire at any time. Retirement amounts to a reconstitution of a firm where the number of partners, their capital contribution ratio and also the profit sharing ratio changes. The retiring partner is paid his share of capital, goodwill and revaluation profit or loss.
For example, X, Y, and Z are partners in the firm sharing profits in the ratio of 3:2:1. X chooses to retire and Y and Z decide to share the future profits equally. This is a reconstitution of the firm where the number of partners and their profit sharing ratio both have changed.
4. Death or Insolvency of a Partner:
Death or insolvency of a partner also results in the reconstitution of the firm when the remaining partners wish to continue the firm. In case of insolvency, all dues are paid to the insolvent partner and partnership agreement is aborted because as per the law an insolvent is incompetent to enter into a contract or an agreement.
In case of death, all dues are paid to the legal heir of the deceased partner.
Solved Question for You
Q: A, B and C are partners sharing profits in the ratio of 2:2:1. They are having a capital of 200000, 200000 and 100000 respectively. It is decided that C should bring additional capital of 100000. And then the profit sharing ratio should be calculated on the basis of their capitals. Is this a case of reconstitution of a firm and how?
Answer: Now, the new capitals are Rs.200000 each and thus the new profit sharing ratio is 1:1:1. As there is a change in the profit sharing ratio, this is definitely a case of reconstitution of a partnership.