Q.Radhika, Bani and Chitra were partners in a firm sharing profits and losses in the ratio of 2 : 3 : 1. With effect from 1st April, 2018 they decided to share future profits and losses in the ratio of 3 : 2 : 1. On that date their Balance Sheet showed a debit balance of ₹ 24,000 in Profit and Loss Account and a balance of ₹ 1,44,000 in General Reserve. It was also agreed that :
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Start your 14-day free trial to unlock the full solution →Journal entries are passed to adjust accumulated profits (General Reserve and debit balance of Profit & Loss A/c) and to record the revaluation of Land and the adjustment for goodwill arising from the change in profit-sharing ratio among Radhika, Bani, and Chitra.
When partners change their profit-sharing ratio, all accumulated reserves, accumulated losses, and revaluation gains/losses must be adjusted in the old ratio. Goodwill is also adjusted because the gaining partner compensates the sacrificing partner for the increased share of future profits.
Let's break down the treatment for each item:
1. Accumulated Profits and Losses
The General Reserve (₹1,44,000) is an accumulated profit, and the debit balance of Profit & Loss A/c (₹24,000) is an accumulated loss. These belong to the partners in their old profit-sharing ratio (2:3:1). Since the ratio is changing, these balances must be transferred to the partners' capital accounts in the old ratio. The net effect is:
- Total credit to be distributed: ₹1,44,000 (Reserve) - ₹24,000 (Loss) = ₹1,20,000.
- This ₹1,20,000 is credited to the partners in the old ratio.
2. Revaluation of Land
The Land's value increases from ₹3,00,000 to ₹4,80,000, a gain of ₹1,80,000. This gain belongs to the partners in the old ratio (2:3:1) because it arose before the change in the profit-sharing arrangement. We record this by increasing the asset's value and crediting the partners' capital accounts.
3. Goodwill Adjustment
The firm's goodwill is valued at ₹1,80,000. When the profit-sharing ratio changes, the partner whose share increases (the gaining partner) must compensate the partner whose share decreases (the sacrificing partner). We first calculate the sacrifice or gain for each partner.
Old Ratio: Radhika 2/6, Bani 3/6, Chitra 1/6
New Ratio: Radhika 3/6, Bani 2/6, Chitra 1/6
Sacrifice/Gain = Old Share - New Share
- Radhika: 2/6 - 3/6 = -1/6 (Gain)
- Bani: 3/6 - 2/6 = 1/6 (Sacrifice)
- Chitra: 1/6 - 1/6 = 0 (No change)
Only Bani sacrifices (1/6th), and only Radhika gains (1/6th). Therefore, Radhika must pay Bani for the goodwill she gains. The amount of goodwill to be adjusted is:
- Value of firm's goodwill: ₹1,80,000
- Share of goodwill gained by Radhika: 1/6 of ₹1,80,000 = ₹30,000
- Share of goodwill sacrificed by Bani: 1/6 of ₹1,80,000 = ₹30,000
The journal entry will be: Radhika's Capital A/c Dr. to Bani's Capital A/c.
SOLUTION: Journal Entries in the books of the firm
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| 2018 April 1 | General Reserve A/c Dr. | 1,44,000 | ||
| To Radhika's Capital A/c | 48,000 | |||
| To Bani's Capital A/c | 72,000 | |||
| To Chitra's Capital A/c | 24,000 | |||
| (Being General Reserve distributed among partners in old ratio 2:3:1) | ||||
| April 1 | Radhika's Capital A/c Dr. | 8,000 | ||
| Bani's Capital A/c Dr. | 12,000 | |||
| Chitra's Capital A/c Dr. | 4,000 | |||
| To Profit and Loss A/c | 24,000 | |||
| (Being debit balance of Profit & Loss A/c written off among partners in old ratio 2:3:1) | ||||
| April 1 | Land A/c Dr. | 1,80,000 | ||
| To Radhika's Capital A/c | 60,000 | |||
| To Bani's Capital A/c | 90,000 | |||
| To Chitra's Capital A/c | 30,000 |
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