A mid-year change in a partnership typically involves the admission of a new partner, the retirement of an existing partner, or adjustments in the profit-sharing ratio. Such changes require careful accounting to ensure fair distribution of profits and proper adjustments to capital accounts. The following example illustrates how to account for a mid-year partnership change.
Scenario:
XYZ Partners consists of three partners: Alice, Bob, and Carol, sharing profits in a 3:2:1 ratio. On July 1st, Carol retires, and David is admitted as a new partner. The new profit-sharing ratio between Alice, Bob, and David is 4:3:3. Goodwill is valued at $12,000, and the firm’s total annual profit is $60,000.
Step 1: Calculate Profits Before and After the Change
- Total Annual Profit: $60,000
- Profit for the First Half of the Year (before Carol’s retirement): $60,000 ÷ 2 = $30,000
- Profit for the Second Half of the Year (after David’s admission): $30,000
Step 2: Distribute Profits Before the Change
Old Profit-Sharing Ratio (3:2:1):
- Alice’s Share: 3/6 × $30,000 = $15,000
- Bob’s Share: 2/6 × $30,000 = $10,000
- Carol’s Share: 1/6 × $30,000 = $5,000
Step 3: Goodwill Adjustment on Carol’s Retirement
Goodwill is valued at $12,000. Carol’s share of goodwill is 1/6 of $12,000, which equals $2,000. The remaining partners compensate Carol for her share of goodwill.
Goodwill Adjustment:
- Alice’s Contribution: 3/5 of $2,000 = $1,200
- Bob’s Contribution: 2/5 of $2,000 = $800
Journal Entry:
- Debit: Alice’s Capital Account $1,200
- Debit: Bob’s Capital Account $800
- Credit: Carol’s Capital Account $2,000
Step 4: Distribute Profits After the Change
New Profit-Sharing Ratio (4:3:3):
- Alice’s Share: 4/10 × $30,000 = $12,000
- Bob’s Share: 3/10 × $30,000 = $9,000
- David’s Share: 3/10 × $30,000 = $9,000
Step 5: Final Capital Account Adjustments
The following table summarizes the adjustments to the partners’ capital accounts after accounting for profit distribution and goodwill.
| Partner | Profit Before Change ($) | Profit After Change ($) | Goodwill Adjustment ($) | Total Capital Adjustment ($) |
|---|---|---|---|---|
| Alice | 15,000 | 12,000 | (1,200) | 25,800 |
| Bob | 10,000 | 9,000 | (800) | 18,200 |
| Carol | 5,000 | – | 2,000 | 7,000 |
| David | – | 9,000 | – | 9,000 |
Step 6: Settlement of Carol’s Capital Account
Carol’s total entitlement upon retirement is $7,000 (profit share + goodwill). This amount is settled through the partnership’s bank account.
Journal Entry:
- Debit: Carol’s Capital Account $7,000
- Credit: Bank Account $7,000
Managing Mid-Year Partnership Changes
This example demonstrates how to account for a change in partnership in mid-year, including profit distribution before and after the change, goodwill adjustments, and settlement of a retiring partner’s capital. Proper accounting ensures fairness and transparency, fostering trust among partners and ensuring smooth business operations.