Change in Profit Sharing Ratio of Partners

Change in Profit Sharing Ratio of Partners

This is the basic topic which serves as the foundation of all other topics under Reconstitution of the firm.

(1) Sacrifice Ratio / Gaining ratio:

Sacrifice or gain can be calculated by comparing old profit sharing ratio and new profit sharing ratio.

If new share is in excess of the old share of a partner, the result is gain and vice-versa.

Following formula can be used for calculating Sacrifice/gain:

Sacrifice ratio = Old ratio - New ratio (gain, if result is negative).

Gaining Ratio = New ratio - Old ratio (sacrifice, if result is  negative).

Note: Total sacrifice = Total gain.

(2) Treatment of Goodwill:

Upon change in profit sharing ratio, the gaining partner must compensate the sacrificing partner, with respect to sacrifice/gain of the partners and the value of goodwill, by passing the following journal entry:

Gaining Partner’s Capital account           Dr. (Gain x Goodwill of the firm)

           To Sacrificing Partner’s capital Account   (Sacrifice x Goodwill of the firm)

(Being the adjustment of Capital accounts for goodwill)

Note: Total sacrifice = Total gain

Existing Goodwill if any should be completely written off by passing the following journal entry:

All Partners’ Capital accounts         Dr. (in old profit sharing ratio)

           To Goodwill (Goodwill of the firm existing in the balance sheet)

The above two journal entries are basic journal entries, that are used in all cases of Reconstitution i.e. Change in profit sharing ratio, Admission of a partner, Retirement as well as Death of a partner.

(3) Treatment of Accumulated profits/losses

(1) Unless otherwise agreed or mentioned in question, the existing profits/losses will be distributed among all the partners in Old Ratio, following journal entry is to be passed:

Accumulated Profits account          Dr. (by the name of the account)

        To All Partners’ Capital accounts (in their old profit sharing ratio)

(Being the accumulated profits shared by the partners in their profit sharing ratio)

Reverse entry is to be passed in case of Accumulated losses.

(2) If the partners decide not to share these profits

or

they don’t want to disturb the existing profits

or

they want to pass an adjusting entry regarding these profits;

following adjusting entry is passed similar to that in case of treatment of goodwill valued on the date of change in profit sharing ratio i.e.

Gaining Partner’s Capital account           Dr. (Gain x Accumulated Profits of the firm)

        To Sacrificing Partner’s capital Account   (Sacrifice x Accumulated Profits of the firm)

(Being the adjustment of Capital accounts for Accumulated profits)

Reverse entry is to be passed in case of Accumulated losses.

List of Common items under Accumulated Profits and Losses.

Employees’ Provident Fund is not part of Accumulated profits, but a liability, to be paid by the firm.

(4) Revaluation of Assets/Liabilities

(1) Unless otherwise agreed or mentioned in the question, the Revaluation profit will be shared by all the partners in Old Ratio.

If partners want to change the values of assets and liabilities

or

they want to show the revised values in the new balance sheet,

Following journal entry is to be passed:

Revaluation account          Dr. (with the amount of profit)

        To All partners’ Capital accounts (in their Old profit sharing ratio)

(Being the revaluation profit shared by the partners in their profit sharing ratio)

Reverse entry is to be passed in case of Revaluation loss.

(2) If the partners decide not to share the revaluation profits

or

they don’t want to change the values of assets and liabilities

or

they want to keep the values of assets and liabilities same

or

they want to pass an adjusting entry regarding these revaluation profits;

following adjusting entry is passed similar to that in case of treatment of goodwill valued on the date of change in profit sharing ratio i.e.

Gaining Partner’s Capital account           Dr. (Gain x Revaluation Profit of the firm)

          To Sacrificing Partner’s capital Account   (Sacrifice x Revaluation Profit of the firm)

(Being the adjustment of Capital accounts for Revaluation profits)

It may be noted that reverse entry is to be passed in case of Revaluation loss.

(5) Capital Adjustment

On change in profit sharing ratio, partners sometimes decide to adjust their capital accounts according to their profit sharing ratio. In this case, take the following steps:

(1) capitals of all the partners after adjustments are totalled and then

(2) capitals of all the partners are calculated by multiplying with their new share and

(3) show as closing capitals,

(4) the balance if any on Dr. Side or Cr. side may be transferred to bank or Current account as specified in the question.

Change in Profit Sharing Ratio/Reconstitution of Firm

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