NOTES

CHAPTER 4: Change in Profit Sharing Ratio: Among Existing Partners

A firm is reconstituted in the event of:

1. Change in the profit sharing ratio among existing partners
2. Admission of a partner
3. Retirement of a partner
4. Death of a partner

Adjustments for change in profit sharing ratio

1. Determination of sacrificing and gaining ratio
2. Accounting treatment of goodwill
3. Accounting treatment of reserves, accumulated profits and losses
4. Revaluation of assets and reassessments of liabilities
5. Adjustment of capital

Sacrificing Ratio: is the ratio in which one or more partners of the firm sacrifice their share of profits in favour of one or more partners of the firm.

Gaining Ratio: in which one or more partners gain share of profits as a result of sacrificed share in profits by one or more partners of the firm.

Example 1:

A and B are partners in a firm sharing profits in the ratio of 2 : 1. It was decided by them to share profits equally. Calculate the sacrificing and gaining ratio.

Solution:

New profit sharing ratio = 1 : 1

Sacrificed share = Old share − New share

$A=\frac{2}{3}-\frac{1}{2}=\frac{4-3}{6}=\frac{1}{6}$ (i.e. sacrifice)

$B=\frac{1}{3}-\frac{1}{2}=\frac{2-3}{6}=-\frac{1}{6}$ (i.e. gain)

Accounting treatment of goodwill:

1. When goodwill is adjusted through partner’s capital accounts:
1. In case of fluctuating capital:
1. Gaining partners’ capital A/cDr.{in gaining ratio}
2. To sacrificing partner’s capital A/c {in sacrificing ratio}
2. In case of fixed capitals:
1. Gaining partner’s current A/c Dr.{In gaining ratio}
2. To sacrificing partners current A/c {in gaining ratio}
2. When goodwill is raised and written off:-
1. In case of fluctuating capitals
   Goodwill A/c Dr. {Full value of goodwill}
   To partner’s capital A/c {in old profit sharing ratio}
   Partners’ capital A/c Dr.
   To goodwill A/c {in new-profit sharing ratio}
2. In case of fixed capitals
   Goodwill A/c Dr. {Full value of goodwill}
   To partner’s current A/c {in old profit sharing ratio}
   Partner’s current A/c Dr.  {in new profit sharing ratio}
   To goodwill A/c

Example 2:

A, B & C sharing profits and losses in the ratio of 5 : 3 : 2 decide to share profits and losses equally with effect from 1^st April, 2019. Goodwill of the firm is valued at Rs. 90,000.

Pass journal entries under the following cases:

1. When goodwill does not appear in the books
2. When goodwill appears in the books at Rs. 60,000 and they agree on
1. Existing goodwill is written off
2. Existing goodwill is not written off i.e. is carried in the books of the firm.

Solution:

Date	Particulars	L.F	Debit	Credit
2019 April	Case 1 B’s capital A/c Dr. C’s capital A/c Dr. To A’s capital A/c		3,000 12,000	15,000
	Case 2 (a) When existing goodwill is written off       A’s capital A/c Dr.       B’s capital A/c Dr.       C’s capital A/c Dr.       To goodwill A/c		30,000 18,000 12,000	60,000
	B’s capital A/c $\left(\mathrm{90,000\; \times }\frac{1}{30}\right)$Dr.       C’s capital A/c $\left(\mathrm{90,000\; \times }\frac{4}{30}\right)$Dr.       To A’s capital A/c $\left(\mathrm{90,000\; \times }\frac{5}{30}\right)$		3,000 12,000	15,000
	(b) When existing goodwill is not written off:       B’s capital A/c $\left(\mathrm{30,000\; \times }\frac{1}{30}\right)$Dr.       C’s capital A/c $\left(\mathrm{90,000\; \times }\frac{4}{30}\right)$Dr.       To A’s capital A/c  $\left(\mathrm{30,000\; \times }\frac{5}{30}\right)$		1,000 4,000	5,000

Example 3:

X, Y and Z are partners sharing profits and losses in the ratio of 5 : 3 : 2. They decide to share future profits and losses in the ratio of 2 : 3 : 5 with effect from 1^st April 2019. Following items appear in the balance sheet as at 31^st March 2019.

General Reserve	Rs. 75,000	Advertisement suspense A/c(Dr.)	50,000
Workmen compensation reserve	12,000	Profit and loss Account(Cr.)	37,500

Pass the necessary journal entries.

Solution:

Date	Particulars	L.F	Debit	Credit
2019 April	General Reserve A/cDr. Workmen compensation reserve A/cDr. Profit and loss A/cDr.  To X’s capital A/c  To Y’s capital A/c  To Z’s capital A/c		75,000 12,500 37,500	62,500 37,500 25,000
	X’s capital A/cDr.  Y’s capital A/cDr.  Z’s capital A/cDr. To advertisement suspense A/c