Change in Profit Sharing Ratio of Partners Test - 4

Calculation of sacrifice or gain:

Formula = Old Share – New Share

Vinod = 7/10 – 6/10 = 1/10 Sacrifice

Pandey = 3/10 – 4/10 = -1/10 Gain

Sometimes, the partners of a firm may agree to change their existing profit sharing ratio. As a result of this, some partners will gain in future profits while others will lose. In such a situation, the partner who gains by change in profit sharing ratio must compensate the partner who has made the sacrifice. In simple words, it is also known as purchase of shares of profit by one partner form another partner.

Whenever there is change in the existing profit sharing ratio, a gainer partner will compensate the sacrificing partner, for this purpose these steps should be followed by the partners:

1.Find out the Gainer due to change in existing profit sharing ratio

2.Find out the Sacrificing partner

3.Now, Debit the gainer partner and credit the sacrificing partner

Any change in the relationship of partners amounts to reconstitution of the partnership firm. A change in the partnership agreement brings to an end the existing agreement and a new Agreement comes into being. This new agreement changes the relationship among the members of the partnership firm. Hence, whenever there is a change in the partnership agreement, the firm continues but it amounts to the reconstitution of the partnership firm.

Reconstitution of the firm can take place on the following occasions:

1.Change in the profit sharing ratio of the existing partners

2.Admission of a new partner

3.Retirement of an existing partner

4.Death of a partner

In this case adjustment will be made as follows:

1.Goodwill of the firm Rs.30,000 (given)

2.A’s Gain share in goodwill 30,000 × 1/6 = 5,000

3.B’s Sacrifice share of goodwill 30,000 × 1/6 = 5,000

Now, Debit the gainer and credit the sacrificing partner

All accumulated profits, reserves, losses and fictitious assets will be distributed by the old partners in their old ratio at the time of reconstitution of partnership firm.

Calculation of Sacrificing ratio:

1.A = 5/10 – 1/3 = (+)5/30 Sacrifice

2.B = 3/10 – 1/3 = (-)1/30 Gain; - sign indicate Gain

3.C = 2/10 – 1/3 = (-)4/30 Gain; - sign indicate Gain

In the above question only A is sacrificing.

1. Mainly sacrificing ratio is calculated at the time of Change in existing profit sharing ratio and admission of new partner.

2. Total of each old partner's Sacrifice will be equal to new ratio of new admitted partner or a gainer partner in case of change in existing profit sharing ratio.

3. Goodwill will be adjusted at the time of admission of a partner in sacrifice ratio.

4. Formula : Old share – New share

Change in profit sharing ratio is essential in the following circumstances:

1. When existing partners have decided to change their existing profit sharing ratio to new ratio.

2. When a new partner is admitted

3. When a partner gets retirement from the firm

4. At the time of death of a partner

As we know, in case of fixed capital method, all adjustments has to be done through current account and capital accounts remains fixed. In case of charge of profit sharing ratio,  no actual cash will be brought or withdraw by partners as a premium for goodwill for the loss or gain in profit sharing ratio.  Therefore,  adjustments has to be done through capital /current accounts.  Hence,  gaining partner's current account will be debited and sacrificing partner's current account will be credited. 

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

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.

A sacrificing partner is one who has given or surrendered his share in favour of a new partner. That’s why a sacrificing partner is compensated by a new partner in the form of premium for goodwill.

Due to change in the profit sharing ratio among the partners, the share of one or more partner may increase and consequently share of one or more partner may decrease. therefore, gaining partner should compensate to sacrificing partner by paying goodwill to him. amount of goodwill of the firm will be paid to the sacrificing partner, which will be called as compensation, to the extent of share in profit sacrificed by him.

Gaining Ratio is calculated at the time of retirement or death of partner. It is the excess of new ratio over old ratio of old partners except retired or deceased partner. Formula : Gaining Ratio = New Ratio - Old

1.X will be credited because his share has been reduced from 5/10 to 1/3, X's sacrifice = 5/10-1/3 = 15/30-10/30=5/30 (Sacrificed)

2.Y will be debited because his share has been increased from 3/10 to 1/3, Y's gain = 3/10-1/3=9/30-10/30= -1/30 (Gained)

3.Z will be debited because his share also increased from 2/10 to 1/3, Z's gain = 2/10-1/3=6/30-10/30 = -4/30 (Gained)
Now, Y and Z debited and X will be credited.