Change in Profit sharing ratio of Partners Test - 13

Change in profit sharing ratio may also necessitate adjustments in the partner’s capital accounts with respect to undistributed profits and reserves, revaluation of assets and reassessment of liabilities, etc. The valuation of goodwill of a firm, its treatment, adjustment regarding undistributed profits and reserves and revaluation of assets and liabilities due to change in the profit sharing ratio of the partners.

Sometimes old partners may change their existing profit sharing ratio without admitting a new partner or without retirement or death of a partner. The main reason of change in existing ratio is to make ratio favorable as per the contribution of partners’ capitals and to compensate a partner who is actively participating in the management of firm.

Sacrificing ratio tells us the amount of sacrifice made by the partner. That’s why sacrificing partner is credited while prepapring journl entries so that gainer partner may compensate the sacrificing partner.

Calculation of sacrifice or gain:

1.Old Ratio 10:6:4

2.New Ratio 1:1:1

3.A’s Sacrifice (old – new share) = 10/20-1/3 = 1/6

4.B is gainer (old – new share) = 6/20 - 1/3 = (-) 1/30

5.C is gainer (old – new share) = 4/20 - 1/3 = (-) 4/30

Calculation of gain or sacrifice:

Formula : Old Share – New Share

X = 5/10 – 1/3 = 1/6 Sacrifice

Y = 4/10 – 1/3 = 1/15 Sacrifice

Z = 1/10 - 1/3 = 7/30 Gain

Adjustment of Goodwill at the time change in profit sharing ratio:

Formula : Old Share – New Share X = 3/6 – 1/3 = 1/6 Sacrifice Y = 2/6 – 1/3 = No Sacrifice/ No Gain Z = 1/6 - 1/3 = 1/6 Gain

Adjustment of goodwill at the time of change in profit sharing ratio:

Old Ratio 3:2:1 and New Ratio 1:1:1

X = 3/6 – 1/3 = 1/6 Sacrifice

Y = 2/6 – 1/3 = No Sacrifice/No Gain

Z = 1/6 – 1/3 = 1/6 Gain

Adjustment of goodwill = X’s Share = 3,00,000 × 1/6 = 50,000

At the time of reconstitution of a partnership firm some undistributed profits and reserves may exist. These undistributed profits and reserves belong to the existing partners who were the members of the firm before its reconstitution. Such undistributed profits and reserves are, therefore, distributed among the partners in their old profit sharing ratio.

The main purpose of creating investment fluctuation reserve is to meet the deficiency of investment value (if any). Partners can distribute this reserve only after meeting the requirement of this reserve.

The partner who is getting more because of change in profit sharing ratio is called a gainer partner. That is why gainer partner is debited and sacrificing partner is credited while adjustment is made for goodwill or reserves and profits etc.