MEANING OF KEY TERMS USED IN Profit-Sharing Ratio
1. Reconstitution of Partnership
Reconstitution of Partnership means change in relationship among the partners.
2. Change in Profit-sharing Ratio
Change in Profit-sharing Ratio means change in ratio in which profit or loss of the firm is shared by the partners.
3. Sacrificing Partners
The partners whose shares decrease as a result of change in profit-sharing ratio are known as Sacrificing Partners.
4. Gaining Partners
The partners whose shares increase due to change in profitsharing ratio are known as Gaining Partners.
5. Sacrificing Ratio
Sacrificing Ratio is the ratio with which the profit share of the partners decrease.
6. Gaining Ratio
Gaining Ratio is the ratio with which the profit share of the partners increase.
7. New Profit-sharing Ratio
It is the ratio in which all partners (including incoming partner) are to share future profits.
8. Accumulated Profits
Accumulated Profits mean profits of the firm that have not been distributed among the partners.
9. Reserve
Reserve means amount set aside out of profits to meet a contingency or to strengthen the financial position of the firm.
10. Revaluation of Assets
Revaluation of Assets means change in value of assets, i.e., present value being different from that of book value.
11. Reassessment of Liabilities
Reassessment of Liabilities means reassessing the liabilities, i.e.,whether the liability is more or less than that shown in the books of account.
Profit-Sharing Ratio Summary
• Meaning of the Reconstitution of a Firm
Any change in existing agreement of partnership amounts to the reconstitution of a firm.
• Circumstances when Reconstitution of a Firm takes Place
1. On change in the profit-sharing ratio of existing partners.
2. On admission of a new partner.
3. On retirement of an existing partner.
4. On death of a partner.
5. On amalgamation of two or more partnership firms.
• Meaning of Change in Profit-Sharing Ratio
A change in profit-sharing ratio implies a purchase of share of profit by one partner from another partner.
• Sacrificing Partners
The partners whose shares have decreased due to change in the profit-sharing ratio are known as sacrificing partners.
• Gaining Partners
The partners whose shares have increased due to change in the profit-sharing ratio are known as gaining partners.
• Sacrificing Ratio
The ratio in which one or more partners sacrifice their share in profit in favour of one of more partners is known as sacrificing ratio.
• Gaining Ratio
The ratio in which one or more partners gain in profit from the other partner or partners is known as gaining ratio.
Sacrificing/(Gaining) Share = Old Share – New Share.
• Adjustment Required at the Time of Change in Profit-Sharing Ratio
(i) Adjustment of Goodwill.
(ii) Adjustment of Gain (Profit)/Loss arising from the Revaluation of Assets and Reassessment of Liabilities.
(iii) Adjustment of the Reserves, Accumulated Profits, and Losses.
(iv) Adjustment of Capital.
• Reserves, Accumulated Profits and Losses are distributed among the existing partners in their old profit sharing ratio and will not be shown in the New Balance Sheet.
When Reserves are to be shown in the future or in the New Balance Sheet: Gaining partners compensate the
sacrificing partners for the share of reserves and profits which is proportionate to the share gained.
• Revaluation of Assets and Reassessment of Liabilities at the time of change in profit-sharing ratio
Any profit or loss arising on such revaluation is shared by the existing partners in their old profit-sharing ratio.
There are two methods of Revaluation of Assets and Reassessment of Liabilities:
1. When revised (changed) values are to be recorded in the books: The revaluation of assets and reassessment of liabilities is passed through Revaluation Account. The gain (profit) or loss on revaluation is
transferred to the old partners’ Capital (or Current) Accounts in their old profit-sharing ratio.
2. When revised (changed) values are not to be recorded: The net effect of revaluation of assets and
reassessment of liabilities is adjusted through Capital (or Current) Accounts of partners. An adjustment
entry is passed based on gain/sacrifice of the partner.
Accounting Treatment of Goodwill
A. When Goodwill is adjusted through Partners’ Capital Accounts:
In Case of Fluctuating Capitals
Gaining Partners’ Capital A/cs ...Dr.
To Sacrificing Partners’ Capital A/cs
(In sacrificing ratio)
In Case of Fixed Capitals
Gaining Partners’ Current A/cs ...Dr.
To Sacrificing Partners’ Current A/cs
(In sacrificing ratio)
B. When Goodwill is Raised and written off:
In Case of Fluctuating Capitals
Goodwill A/c ...
To Partners’ Capital A/cs
Partners’ Capital A/cs ...Dr.
To Goodwill A/c
In Case of Fixed Capitals
Dr. Goodwill A/c ...Dr.
To Partners’ Current A/cs
Partners’ Current A/cs ...Dr.
To Goodwill A/c
Accounting Treatment of Existing Goodwill
Goodwill appearing in the Balance Sheet as on the date of reconstitution is written off in the old profit-sharing ratio unless the partners decide to carry the value in the books of account.
All Partners’ Capital/Current* A/cs ...Dr. [In old ratio]
To Goodwill A/c [With existing book value of Goodwill]
*In case of Fixed Capitals
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