Your Cart

CHANGE IN PROFIT SHARING RATIO AMONG THE EXISTING PARTNERS

 

financial accountInG (class-xIi)

CHAPTER-3     (CHANGE IN PROFIT SHARING RATIO

AMONG THE EXISTING PARTNERS)

 

Partnership agreement defines the relationship among the partners and whenever there is a change in relationship, it results in reconstitution of a firm. In other words, any change in existing agreement of partners is reconstitution of the firm. As a result, existing agreement comes to an end and new agreement comes into existence. But the firm continues.

A firm is reconstituted, whenever there is a

(i)         Change in the profit-sharing ratio among the existing partners.

(ii)        Admission of a new partner.

(iii)       Retirement of an existing partner.

(iv)       Death of a partner

(v)        Amalgamation of two partnership firms.

Change in the profit sharing ratio among the existing partners means it is reconstitution of the firm without admission of new partner(s) or retirement or death of a partner. A change in the profit sharing ratio in a partnership firm means, one (or more) partner(s) acquire share of profit in the business from another partner(s). Therefore the aggregate amount of gain of one (or more) partner(s) is equal to the aggregate amount of sacrifice made by the other partner(s).

Example :

Ram and Shyam are partners in a firm sharing profits in the ratio of 3 : 2. They have decided to share profits equally in future. It means, Ram sacrifies and Shyam gains. The sacrifice or gain is calculated as follows:

Sacrificing/(Gaining) share = Old Ratio – New Ratio.

Ram      i.e. sacrifice made.

Shyam  being negative result, it is a gain.

+ve result means old share was more and – ve result means new share is more.

Adjustment for change in profit sharing ratio. The issue that needs to be dealt with at the time of change in the profit sharing ratio are :

(i)         Determination of sacrificing ratio and gaining ratio

(ii)        Accounting treatment of Goodwill

(iii)       Accounting treatment of reserves and accumulated profit or losses, and

(iv)       Revaluation of assets and reassessment of liabilities.

(i)         Determination of sacrificing ratio and gaining ratio :

It is important to determine sacrificing ratio and gaining ratio because the gaining partner compensates the sacrificing partner by paying goodwill.

Example :

X, Y and Z are partners sharing profits in the ratio of 5 : 3 : 2. They decide to share the future profits and losses equally.Calculate sacrificing or gaining ratio.

Sacrificing,/Gaining share = Old Ratio – New Ratio

 

 

 

Y gains by 1/30th share, Z gains by 4/30th.Share of Y and Z have increased and X sacrifices by 5/30th share. Gaining ratio between Y and Z  or 1 : 4.

(ii)        Accounting Treatment of Goodwill

If the partners decide to change their profit sharing ratio, gaining partner should compensatethe sacrificing partner by payment of goodwill to him in the gaining ratio. When there is a change in the profit sharing ratio, journal entry passed to adjust goodwill is :

  • In case of Fluctuating Capitals :

Gaining Partner[s]Capital A/c – Dr

To Sacrificing Partner[s] Capital A/c (with share of goodwill).

In case of Fixed Capitals :

Gaining Partner[s] Current A/c, Dr. [ In gaining ratios]

To Sacrificing Partner(s) Current A/c [In sacrificing ratio]

 

 

Example :

A and B shared profit and losses in the ratio of 3 : 2.With effect from 1st April, 2014, they agreed to share profit equally.  The goodwill of the firm was valued at ` 30,000. Pass necessary Journal entry for the accounting treatment of goodwill.

Working Note :

Calculation of share of profitssacrificed/gained. Sacrificing/(Gaining) Share = Old Ratio – New Ratio.

, i.e. sacrifice made

(being negative result, it is a gain).

B’s Capital A/c Dr 3,000

To A’s Capital A/c = 3,000

Treatment of Existing Goodwill

Goodwill (if any) appearing in the books of the firm must be written off by debiting it to the existing Partners’Capital Accounts in their old profit sharing ratio and by crediting Goodwill Account. The entry is :

All Partners Capital/Current A/c_________________ Dr.

To Goodwill A/c.

Example :

A, B and C at present share profits and losses in the ratio of 5 : 3 : 2. They decided to share future profit and losses equally with effect from 1st April, 2014. Goodwill of the firm has been valued at ` 90,000. On that date, the goodwill appeared in the books at
` 45,000.Show journal entries.

Solution :

(i)         B’s Capital A/c ____________________ Dr. 3,000

C’s Capital A/c ____________________ Dr 12,000

To A’s Capital A/c                                           15,000

(Being the adjustment made for goodwill on change in the profit sharing ratio).

(ii)        A’s Capital A/c ___________________ Dr 22,500

B’s Capital A/c ___________________ Dr 13,500

C’s Capital A/c ___________________ Dr 9,000

To Goodwill A/c                                              45,000

(Being the existing goodwill written off in old profit sharing ratio)

 

Working Note :

Calculation of sacrificing/gaining (Rate of Partners) sacrificing ratio = old share – new share.

 

 

 

One should make sure that sacrifice = gain as

 

Accounting Treatment of Reserves and Accumulated Profit or Losses.

Treatment-I

If at the time of change in profit sharing ratio, reserves or accumulated profits/losses exist in the books of the firm, they are transferred to the partners’ capital accounts (if capitals are fluctuating) or the current accounts (if capitals are fixed) in their old profit sharing,. The reason for transfer is that the partners should not be placed at an advantage or disadvantage. The reserves and accumulated profit/losses as on the date of change in profit sharing ratio were earned before the reconstitution of the firm. Therefore, reserves and accumulated profits/losses are transferred to Partners’ capital accounts or current accounts in their old profit sharing ratio. The journal entries passed are :

(i)         For transfer of reserves and accumulated profits.

Reserve/Profit and Loss A/c __________________ Dr

Workmen Compensation Reserve A/c _________________ Dr

Investment Fluctuation Reserve A/c __________________ Dr

To All Partners’Capital/Current A/c’s (in old Ratio)

(ii)        For transfers of accumulated losses.

AllPartner’sCapital/Current A/c’s _________________ Dr

To Profit and Loss A/c

To Deferred Revenue Expenditure A/c (In old ratio)

Treatment-II

Sometimes the partners may decide that existing profit and loss account or reserve should continue to appear at the same amount in the balance sheet of the reconstituted firm, in such a situation, an adjustment is made directly in partners’ capital accounts. The gains or sacrifice of partner(s) is calculated and an adjusting entry for the same is passed. This is because at present the partners are entitled to share such reserves and profits in the old ratio whereas in future they will be entitled to share such reserves and profits in the new profit sharing ratio.

Adjusting Entry :

In case of Fluctuating Capitals :

Gaining Partners’Capital A/c _______________ Dr

To Sacrificing Partners’Capital A/c ___________

In case of fixedcapitals :

Gaining Partners’Current A/c ______________ Dr

To Sacrificing Partners’Current A/c.

Example :

X, Y and Z are partners in a firm sharing profit in the ratio of 3 : 3 : 2. They decided to share profit equally w.e.f. 1st April 2014. On that date,  Profit and Loss Account showed credit balance of ` 36,000. Instead of closing the Profit and Loss Account, it was decided to record an adjustment entry reflecting the change in profit sharing ratio. Pass Journal entry to give effect to the same.

Working Note :

            Calculation of gaining/sacrificing share of partners due to change in the profit sharing ratio :

 

 

(being negative result, it is a gain)

Profit and Loss Account ` 36,000

` 1,500

` 1,500

` 3,000

Adjusting Journal Entry

                        Z’s Capital A/c _______________ Dr 3,000

To X’s Capital A/c ______________ 1,500

To Y’s Capital A/c ______________1,500

(Being the adjustment of profit and loss accounts balance due to change in the profit sharing ratio)

Revaluation of Assets and Reassessment of Liabilities :

Treatment – I

Assets are revalued and the liabilities are reassessed at the time of change in profit sharing ratio and the profit or loss arising from it is credited or debited  Partners’Capital Accounts in their old profit sharing ratio. For revaluation of assets and reassessment of liabilities, an account titled ‘Revaluation Account’ or Profit and Loss Adjustment Account is opened. Increase in the value of assets and decrease in liabilities is credited to this account while decrease in the a value of assets and increase in liabilities is debited. Unrecorded assets, if any, are credited and unrecorded liabilities are debited. The balance in the account is profit, if total of credit side is larger than the total of debit side and loss, if total of debit side is larger than the total of credit side. Profit or loss on revaluation and reassessment is credited or debited to partners capital account in their old profit sharing ratio.

 

Specimen of Revaluation Account :

 

Revaluation Account

Particulars ` Particulars `
To Assets  (Individually) Decreases in value on revaluation)   By Assets (Individually)Increase in valuation on revaluation.  
To Liabilities-Increase in reassessment   By Liabilities-Decrease on reassessment  
To Partners’Capital Accounts gain on revaluation (in old ratio)   By Partners’Capital Account (in old ratio)Loss on Revaluation  

 

Note :

WhenRevaluation account is prepared, assets and liabilities appear in the balance sheet of the reconstituted firm at their revised values.

Example :

X, Y and Z are partners in a firm sharing profit and losses in the ratio of 3 : 3 : 2. Their balance sheet on at 31st March, 2014 was :

Liabilities ` Assets `
Sundry Creditors 24,000 Cash at Bank 27,000
General Reserve 36,000 Sundry Debitors 50,000
Capital A/Cs   Stock 1,20,000
X                      2,00,000   Machinery 1,59,000
Y                      2,00,000   Building 2,00,000
Z                      1,00,000 5,00,000 Advertisement Suspense (DeferredRevenue) 4,000
  5,60,000   5,60,000

 

Example :

Partners decided that with effect from 1st April, 2014, they would share profits and losses in the ratio of 4 : 3 : 2. It was agreed that :

(i)         Stock is to be valued at ` 1,10,000.

(ii)        Machinery is to be depreciated by 10%.

(iii)       A Provision for Doubtful Debts is to be made on [email protected]%.

(iv)       Building to be appreciated by 20%

(v)        A liability for `3,000 included in Sundry Creditors is not like to arise.

Partners agreed that revised values of assets and liabilities are to be recorded in the books. They do not want to distribute the General Reserve. Give the necessary accounting entries to be made in the books of the firm on account of change in profit-sharing ratio.

Solution :

Date Particulars L.F. Dr. (`) Cr (`)
2014

April 1

Revaluation A/c                                                           …..Dr

To Stock A/c

To Machinery A/c

To Provision for Doubtful Debts A/c

(Being the decrease in the value of assets and provision made for doubtful debts)

  28,400  

10,000

15,900

2,500

April 1 Building A/c    …..Dr

Sundry Creditors A/c   …..Dr

To Revaluation A/c      …..Dr

(Being the increase in the value of building and decrease in creditors)

  40,000

3,000

 

 

43,000

April 1 Revaluation A/c                       …..Dr

To X’s Capital A/c

To Y’s Capital A/c

To Z’s Capital A/c

(Being the transfer of profit on revaluation to the Capital Accounts of Partners in old profit-sharing ratio) (WN 1)

  14,600  

5,475

5,475

3,650

April 1 X’s Capital A/c (` 36,000 × 5/72)                     …..Dr

To Y’s Capital A/c                               (` 36,000 × 3/72)

To Z’s Capital A/c                   (` 36,000 × 2/72)

(Being the adjustment of general reserve on change in profit-sharing ratio) (WN 2)

  2,500  

1,500

1,000

 

April 1 X’s Capital A/c

Y’s Capital A/c

Z’s Capital A/c

To Advertisement Suspense

(Being the transfer of advertisement expenditure to all partners in old profit-sharing ratio)

  1,500

1,500

1,000

 

 

 

4,000

Working Notes :Revaluation Account

Particular ` Particular `
To Stock A/c 10,000 By Building A/c 40,000
To Machinery A/c 15,900 By Sundry Creditors A/c 3,000
To Provision for Doubtful Debts A/c 2,500    
To Profit on Revaluation transferred to :      
X’s Capital A/c (3/8)                    5,475

Y’s Capital A/c (3/8)                    5,475

Z’s Capital A/c (2/8)                    3,650

 

 

14,600

   
  43,000   43,000

 

 

Calculation of Sacrifice/Gain in share of partners :

                       Gaining Partner

Sacrificing Partner

Sacrificing Partner

 

Treatment-II

Adjustment of Profits/Losses on Revaluation of Assets and Reassessment of liabilities through the capital accounts only.

 

If partners decide to record the net effect of revaluation of assets and liabilities without effecting the old amount of assets and liabilities, a single adjusting entry involving the capital account of gaining partners and sacrificing partners is passed.

In this regard, we take the following steps :

Step-I :Calculation of the net effect of revaluation :

`

(i)         Increase in the value of Assets                        ________________

(ii)        Add decrease in amount of liabilities   ________________

(iii)       Less decrease in amount of assets       ________________

(iv)       Less increase in value of liabilities      ________________

Net effect on Revaluation                    ________________

Step-II :To find share of Sacrifice/Gain by partners

(i)         Old Share – New share

Step-III :Calculation of proportional amount of net effect of revaluation.

Step-IV :Pass the following Journal entry :

(a)        For Profit on Revaluation

Gaining Partners’Capital A/c – Dr

To Sacrificing Partner’s Capital A/c

 

(b)        For Loss of Revaluation

Sacrificing Partners’Capital A/ c                                  ___________ Dr

To Gaining Partners(s)Capital A/c

Example :

X, Y and Z are s haring profit and losses in the ratio of 5 : 3 : 2. They decided to share future profit and losses in the ratio of 2 : 3 : 5 with effect from 1st April 2014. They also decide to record the followingrevaluations without affecting the book values of the assets and liabilities by passing a single adjusting entry :

 

  Book Value ` RevaluedValue `
Land and Building 5,00,000 5,50,000
Plant and Machinery 2,50,000 2,40,000
Trade Creditors 60,000 55,000
Outstanding Expenses 60,000 75,000

Pass necessary single adjusting entry.

Solution : Step-I Calculation of net effect of Revaluation :

  Particulars `
(i) Increase in value of Land and Building 50,000
(ii) Decrease in amount of Trade Creditors 5,000
(iii) Decrease in value of Plant and Machinery –          10,000
(iv) Increase in the amount of Outstanding Exp. –          15,000
  Profit in Revaluation 30,000

 

Calculation of Sacrifice/Gain of share :

(Sacrifice)

Nil

(Gain)

Step-III :Calculation of Proportionate Amount of Share of Profit on Revaluation.

For A

For C

Step-IV :         C’sCapital A/c ___________              Dr. 9,000

To A’s Capital A/c                         9,000

 

 

ASSIGNMENT

Practice Questions

 

  1. X, Y and Z are presently sharing profits and losses in the ratio of 2 : 2 : 1. Calculate the New Profit Sharing Ratio and the Sacrificing Ratio if Z acquires 1/5th share from Y.

 

  1. X, Y and Z are presently sharing profits and losses in the ratio of 2 : 2 : 1. Calculate the New Profit Sharing Ratio and the Sacrificing Ratio if Z acquires 1/5th share equally from X and Y.

 

  1. X, Y and Z are presently sharing profits and losses in the ratio of 2 : 2 : 1. Calculate the New Profit Sharing Ratio and the Sacrificing Ratio if X, Y and Z decide to share future profits and losses equally.

 

  1. X, Y and Z who are presently sharing profits and losses in the ratio of 5 : 3 : 2, decide to share future profits and losses equally with effect from 1st April, 2014. The goodwill of the firm has been valued at `1,08,000. Goodwill already appearing in the books is at `18,000. Show the necessary accounting treatment.

 

  1. A, B and C are partners sharing profits in the ratio of 3 : 2 : 1 respectively. From 1 April, 2014 they decided to share profits in the ratio of 2 : 3 : 1. The Partnership Deed provides that in the event of any change in profit-sharing ratio, the goodwill should be valued at three years purchase of the average of five years profits. The profits and losses of the preceding five years are :

Profit : 2009-10 :         `72,000

2010-11 :         `80,000

Loss :   2011-12 :         `2,04,000

Profit : 2012-13 :         `2,28,000

Loss :   2013-14 :         (`84,000)

 

 

Showing the working clearly, give the necessary Journal entry to record the above change.

  1. X, Y and Z are partners sharing profits & losses in the ratio of 5 : 3 : 2. From 1stApril 2014, they decide to share profits and losses in the ratio of 2 : 5 : 3. The Partnership deed provides that in the event of any change in profit sharing ratio, the goodwill should be valued at two years purchase of the average profits of the preceding 5 years. The profits and losses of the preceding years are

Profit : 2009-10 :         `39,000

Profit : 2010-11 :         `57,000

Profit : 2011-12 :         `24,000

Profit : 2012-13 :         `27,000

Loss :   2013-14 :         (`12,000)

 

            Pass the necessary single adjusting entry to record the above transactions.

 

  1. A, B and C were partners in a firm sharing profits in the ratio of 5 : 3 : 2. On 1stApril, 2014, they decided to share the profits equally. It was also agreed that the change be carried out retrospectively for the last 4 years. The profits for the last 5 years were :

            Year ended                 Profit(`)

Profit : 2009-10 :         `50,000

Profit : 2010-11 :         `40,000

Loss :   2011-12 :         `10,000

Profit : 2012-13 :         `60,000

Profit : 2013-14 :         `1,00,000

            Pass the necessary adjustment entry.

 

  1. Suman and Poonam were partners in a firm sharing profits in 3 : 2 ratio. From 1stApril, 2014 they decided to change it to 3 : 1. For this purpose the goodwill of the firm was valued at
    `1,20,000.

            Pass the necessary Journal entry for the treatment of goodwill.

 

  1. X, Y and Z were sharing profits and losses in the ratio of 5 : 3 : 2. They decided to share future profits and losses in the ratio of 2 : 3 : 5 with effect from 1st April, 2014. They decided to record the effect of the following, without affecting their book values; Profit & Loss A/c `24,000. Advertisement Suspense A/c `12,000. Pass the necessary Journal entry.

 

  1. P, Q and R are partners sharing profits and losses in the ratio of 5 : 3 : 2. From 1stApril, 2014, they decided to share profits and losses in equal proportions. The Partnership Deed provides that in the event of any change in profit-sharing ratio, the goodwill should be valued at three year’s purchase of the average of five years profits. The profits and losses of the preceding five years were :

Profit : 2009-10 :         `60,000

Profit : 2010-11 :         `1,50,000

Profit : 2011-12 :         `1,70,000

Profit : 2012-13 :         `1,90,000

Loss :   2013-14 :          (`70,000)

Pass the necessary Journal entry to record the above change.

 

  1. X, Y and Z are sharing profits and losses in the ratio of 5 : 3 : 2. They decide to share future profits & losses in the ratio of 2 : 3 : 5 share with effect from 1st April, 2014. The following items appear in the Balance Sheet as at 31st March, 2014 :

                        General Reserve                                                          `18,000

Contingencies Reserve                                                 `3,000

Profit & Loss A/c (Cr.)                                                `9,000

Advertisement Suspense A/c (Dr.)                               `12,000

Required :Pass the necessary Journal Entries.

 

  1. X, Y and Z who are presently sharing profits and losses in the ratio of 5 : 3 : 2, decide to share future profits and losses in the ratio of 2 : 3 : 5 with effect from 1st April, 2014. Workmen Compensation Reserve appears at `72,000 in the Balance Sheet as at 31st March, 2014.

            Required :Show the accounting treatment in each of the following alternative cases :

            Case-I : If there is no other information.

Case-II : If a claim on account of Workmen’s Compensation is estimated at `90,00 only.

Case-III : If a claim on account of Workmen’s Compensation is estimated at `1,35,000.

 

  1. X, Y and Z who are presently sharing profits & losses in the ratio of 5 : 3 : 2, decide to share future profits and losses in the ratio of 2 : 3 : 5 with effect from 1st April, 2014. An extract of their Balance Sheet as at 31st March, 2014 is as follows :                
Liabilities ` Assets `
Investment Fluctuation Reserve 900 Investments (at cost) 12,000

            Required :Show the accounting treatment in each of the following alternative cases :

            Case-I : If there is no other information is given.

Case-II : If the market value of investments is `12,000.

Case-III : If the market value of investments is `11,400.

Case-IV : If the market value of investments is `10,800.

Case-V : If the market value of investments is `12,300.

 

  1. X and Y are partners in a firm sharing profits in the ratio of 2 : 3. The balance Sheet of the firm as at March 31, 2014 is given below :
Liabilities ` Assets `
Capitals   Land 3,00,000
X 4,80,000 Buildings 3,60,000
Y 7,20,000 Plant 4,80,000
Creditors 1,86,000 Furniture 72,000
Outstanding Expenses 42,000 Stock 1,08,000
    Debtors 90,000
    Cash 18,000
  14,28,000   14,28,000

The partners decided to share profits in equal ratio w.e.f. April 1, 2014. The following adjustments were agreed upon :

  • The goodwill of the firm was valued at `2,40,000 but it was not to appear in books.
  • Land was valued at `4,80,000, Plant at `4,32,000 and Furniture at `60,000 and were to appear at revalued amounts in the balance sheet.

Required : Pass the necessary Journal entries to give the above and prepare the balance sheet.

 

  1. B and C are partners in a firm, sharing profits or losses in the ratio 5 : 3. Their Balance Sheet on 1.4.2014 was as follow :
Liabilities ` Assets `
B’s Capitals 32,000 Goodwill 8,000
C’s Capital 34,000 Machinery 38,000
General Reserve 4,800 Furniture 5,000
Bank Loan 6,000 Debtors 23,000
Creditors 5,000 Stock 7,000
Employees’ Provident Fund 1,000 Bank 5,000
Workmen Compensation Reserve 4,000 Advertisement Suspense A/c 800
  86,800   86,800

They decided to change their profit sharing ratio to 3 : 5 and decided that :

  • Goodwill be valued on the basis of 2 years purchase of the average profits of the last three years. Average Profits of the last three years are `
  • Machinery and Stock be revalued at `45000 and `8000 respectively.
  • Goodwill is not to be shown in the books of the new firm.

Required : Prepare Revaluation Account and partners’ Capital Accounts and the Balance Sheet of the new firm.

 

  1. X, Y and Z who are presently sharing profits and losses in the ratio of 5 : 3 : 2, decide to share future profits and losses in the ratio of 2 : 3 : 5 w.e.f. 1st April, 2014. Workmen Compensation Reserve appears at `1200 in the Balance Sheet as at 31st March, 2014.

Required : Show the accounting treatment in each of the following alternative cases :

Case-I: If there is no other information.

            Case-II :If a claim on account Workmen’s Compensation is estimated at `150 only.

Case-III :If a claim on account of Workmen’s Compensation is estimated at `2,250.

 

  1. X, Y and Z who are presently sharing profits & losses in the ratio of 5 : 3 : 2, decide to share future profits & losses in the ratio of 2 : 3 : 5 with effect from 1st April, 2014. An extract of their Balance Sheet as at 31st March, 2014 is as follows :                
Liabilities ` Assets `
Investment Fluctuation Reserve 1,500 Investments (at cost) 20,000

 

            Required :Show the accounting treatment in each of the following alternative cases :

            Case-I : If no other information is given.

Case-II : If the market value of investments is `20,000.

Case-III : If the market value of investments is `19,000.

Case-IV : If the market value of investments is `18,000.

Case-V : If the market value of investments is `20,500.

 

Leave a Reply

Your email address will not be published.

X