One of the forms of reconstitution of the firm is Change in Profit Sharing Ratio among Existing Partners. Here there is no change in the partners carrying on the business of the firm. The only change is the profit sharing ratio among existing partners.
Change in Profit Sharing Ratio among Existing Partners
Without any admission or retirement of the partner, sometimes the partners may decide to change their existing profit sharing ratio. This may result in the gain to a few partners and loss to others. The partners who are in profit due to this change should compensate the sacrificing partner/partners in the profit sharing ratio.
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New Profit Sharing Ratio
The ratio at which the partners decide to share profits/losses in future.
The ratio in which the partners have agreed to sacrifice their share of profit in favour of other partners.
Sacrificing ratio = Old Ratio – New Ratio
The ratio in which the partners have agreed to gain their share of profit from other partners.
Gaining ratio = New Ratio – Old Ratio
Hence for this purpose, in the books of the firm, few adjustments are made. These adjustments are:-
- Revaluation of assets and liabilities;
- Adjustments of reserves accumulated profits, and losses if any etc.
- Adjustment for goodwill
Adjustment for Goodwill
At the time of reconstitution of a firm, Goodwill is also one of the special aspects which require adjustment. The gaining partner pays the sacrificing partner the proportionate share of goodwill which is equal to share gained by him
Revaluation of Assets and Liabilities
At the time of reconstitution of the firm, re-valuation of the assets and liabilities is done. Revaluation of assets and re-assessment of liabilities is done because:
- To bring the assets and liabilities at their correct values in the books
- Unrecorded assets and liabilities of the firm are brought into the books of the firm
- To ascertain the actual position of the firm.
- Profit and loss arriving on account of such revaluation up to the date of reconstitution may be adjusted in the partner’s capital accounts in their sacrificing ratio
Adjustments of Reserves, Accumulated Profits, and Losses
Any reserves or accumulated profits/losses appearing on the balance sheet should be transferred to the partner’s capital accounts. If the partners decide to leave them undisturbed it is necessary to make an adjustment entry in the books of the firm. In that case, the share gained by the gaining partner, he must compensate the sacrificing partner that share of profits and reserves which is proportionate to him.
Solved Example for You
Q: Profit and losses ratio is for 3:2:1, for A, B and C respectively. From 1st April 2018, they decide to share profit and losses equally. Value of Goodwill of the firm is Rs 24000. Calculate sacrificing and gaining ratio. Also, pass necessary journal entry.
Old ratio: 3:2:1
New ratio: 1:1:1
Sacrificing or gaining ratio= Old ratio – New ratio
A’s share= 3/6 – 1/3 = -1/6 (sacrifice)
B’s share= 2/6 – 1/3 = Nil
C’s share= 1/6 – 1/3 = 1/6 (Gain)
Goodwill of the firm= Rs 24000
A will receive for goodwill = 24000*1/6 = Rs 4000
C will give for goodwill =24000*1/6 = Rs 4000
|April 01||C’s Capital a/c||Dr.||4000|
|To A’s Capital a/c||4000|
|(being an adjustment of goodwill made on the change in profit sharing ratio)|