How will you deal with a change in profit sharing ratio among existing partners? Take imaginary figures to ill

Long Answer Questions · Q5

Q. How will you deal with a change in profit sharing ratio among existing partners? Take imaginary figures to illustrate your answer.

Rajasthan RbseTextbookSubjective· 3mImportance★★★★★

51% · 43/84 Questions

🔒 Locked · start free trial →

You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.

Start your 14-day free trial to unlock the full solution →

Concept understanding — Partnership Capital Accounting

Partnership Capital Accounting — A First Look

Think of a partnership like a group of friends pooling money to start a roadside food stall. Each friend brings in some cash — that’s their capital. But unlike a simple piggy bank, a partnership needs a clear record of who put in how much, because profits (and losses) are shared in a fixed ratio, and partners may withdraw money, lend extra funds, or take a salary.

That record is what Partnership Capital Accounting is about.

What It Really Means

In accounting, capital is the amount a partner contributes to the firm. But it’s not just a one-time number. Over time, a partner’s capital changes due to:

Additional capital introduced
Drawings (money or goods taken out)
Share of profit or loss
Interest on capital, interest on drawings, partner’s salary, commission

The Capital Account of each partner tracks all these changes. It answers: What does the firm owe to this partner at any point?

Why It Matters

Without proper capital accounting, you cannot:

Determine each partner’s claim on the firm’s assets
Calculate interest on capital correctly
Prepare the Profit and Loss Appropriation Account
Settle accounts when a partner retires or dies

The NCERT textbook emphasises that capital accounts are personal accounts of the partners — they show the firm’s liability towards each partner.

Two Methods of Maintaining Capital Accounts

The NCERT Class 12 Accountancy textbook (Part II, Chapter 2) describes two methods:

1. Fixed Capital Method

Under this method, the capital account remains constant (except when additional capital is introduced or capital is withdrawn permanently). All other transactions — share of profit, drawings, interest, salary — are recorded in a separate Current Account.

Note

In the Fixed Capital Method, the Capital Account shows only the permanent capital. The Current Account shows the fluctuating balance.

2. Fluctuating Capital Method

Here, all transactions are recorded directly in the Capital Account. The capital balance changes every year.

Accounting Treatment — Which Account is Debited/Credited

Let’s take the most common entries. I’ll show the journal entry first, then explain.

Entry 1: Capital Introduced

When a partner brings in cash or assets:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Cash/Bank A/c	Dr.	xxx
	To Partner’s Capital A/c			xxx

Why? Cash comes in (asset increases — debit), and the firm’s liability to the partner increases (capital is a liability — credit).

Entry 2: Drawings

When a partner withdraws cash or goods for personal use:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Partner’s Capital/Current A/c	Dr.	xxx
	To Cash/Bank/Purchases A/c			xxx

Why? The firm’s liability to the partner decreases (debit the capital/current account), and cash or goods go out (credit).

Entry 3: Interest on Capital

This is an appropriation of profit. The formula (as per NCERT) is:

Interest on Capital = Capital × Rate of Time × Time (in months)/12

Journal entry:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Interest on Capital A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Then, at the end of the year, Interest on Capital is transferred to the Profit and Loss Appropriation Account:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Profit and Loss Appropriation A/c	Dr.	xxx
	To Interest on Capital A/c			xxx

Entry 4: Partner’s Salary

If the partnership deed allows a salary:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Salary to Partner A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Again, this is transferred to the Profit and Loss Appropriation Account.

Entry 5: Share of Profit

At the end of the year, after all appropriations, the remaining profit is distributed:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Profit and Loss Appropriation A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Formats as per NCERT

Format of Capital Account (Fluctuating Method)

Start your 14-day free trial to unlock the full solution →

When existing partners change their profit-sharing ratio, the adjustment is treated as if the gaining partner(s) compensate the sacrificing partner(s) for their share of goodwill. No actual payment is made; instead, the gaining partner’s capital account is debited and the sacrificing partner’s capital account is credited with the value of goodwill corresponding to the share sacrificed.

The steps are:

Calculate the sacrifice/gain of each partner: Sacrifice = Old share – New share (positive = sacrifice; negative = gain).
Value the firm’s goodwill (if not given, it must be agreed upon).
Pass the adjustment entry: Gaining partner’s capital A/c Dr. To Sacrificing partner’s capital A/c (Being adjustment for goodwill on change in profit-sharing ratio)

Illustration with imaginary figures:

A and B share profits in 3:2. They decide to share equally (1:1). Goodwill of the firm is valued at ₹1,00,000.

Partner	Old Share	New Share	Sacrifice / Gain
A	3/5	1/2	3/5 – 1/2 = 1/10 (sacrifice)
B	2/5	1/2	2/5 – 1/2 = –1/10 (gain)

A sacrifices 1/10th share → entitled to 1/10 of ₹1,00,000 = ₹10,000. …

Start your 14-day free trial to unlock the full solution →

A change in profit-sharing ratio among existing partners is treated as a reconstitution of the partnership, requiring adjustments for accumulated reserves, goodwill, and revaluation of assets/liabilities. The key result is that partners' capital accounts are adjusted to reflect the new ratio, with any gain or loss compensated through a sacrifice/gain adjustment (often via a journal entry debiting gaining partners and crediting sacrificing partners).

Concept and Accounting Treatment

When existing partners decide to change their profit-sharing ratio, the partnership is reconstituted without admitting a new partner or retiring an old one. The fundamental accounting principle here is that all accumulated profits, reserves, and losses (including goodwill) belong to the partners in their old ratio. Changing the ratio means some partners sacrifice a portion of their future profits, while others gain. The accounting treatment ensures that no partner is unfairly enriched or impoverished by the change.

The key steps are:

Revalue assets and liabilities to their current fair values (if the change is effective from a date, revaluation is optional but prudent).
Adjust accumulated reserves, profits, and goodwill in the old ratio.
Compensate sacrificing partners by the gaining partners through a direct capital adjustment.

The journal entry for the sacrifice/gain adjustment is:

Debit the gaining partners' capital accounts (with their share of gain)
Credit the sacrificing partners' capital accounts (with their share of sacrifice)

This is based on the rule: "Gaining partner compensates the sacrificing partner." No cash changes hands; it's a book adjustment.

Illustration with Imaginary Figures

Let's take a simple example:

Partners: A and B

Old Ratio: 3:2

New Ratio: 1:1 (equal)

Capital Balances (before adjustment): A = ₹1,00,000; B = ₹80,000

General Reserve: ₹50,000

Goodwill (self-generated, not recorded): ₹60,000

Revaluation Loss: ₹10,000 (due to decrease in asset value)

Step 1: Calculate Sacrifice/Gain

Partner	Old Share	New Share	Difference	Nature
A	3/5 = 0.6	1/2 = 0.5	-0.1	Sacrifice
B	2/5 = 0.4	1/2 = 0.5	+0.1	Gain

A sacrifices 1/10th share; B gains 1/10th share.

Step 2: Adjust General Reserve

General Reserve of ₹50,000 must be distributed in old ratio (3:2).

Partner	Share	Amount (₹)
A	3/5	30,000
B	2/5	20,000

Journal Entry:

Particulars	Debit (₹)	Credit (₹)
General Reserve A/c Dr.	50,000
To A's Capital A/c		30,000
To B's Capital A/c		20,000
(Being reserve distributed in old ratio)

Step 3: Adjust Goodwill

Goodwill of ₹60,000 (not recorded) needs adjustment. The gaining partner (B) must compensate the sacrificing partner (A) for the goodwill.

Calculation:

A's sacrifice = 1/10 of ₹60,000 = ₹6,000
B's gain = 1/10 of ₹60,000 = ₹6,000

Journal Entry:

Particulars	Debit (₹)	Credit (₹)
B's Capital A/c Dr.	6,000
To A's Capital A/c		6,000
(Being goodwill adjusted for change in ratio)

Step 4: Revaluation of Assets/Liabilities

Assume a revaluation loss of ₹10,000 (e.g., machinery depreciated). This loss is shared in old ratio.

Partner	Share	Amount (₹)
A	3/5	6,000
B	2/5	4,000

Journal Entry:

Particulars	Debit (₹)	Credit (₹)
A's Capital A/c Dr.	6,000
B's Capital A/c Dr.	4,000
To Revaluation A/c		10,000
(Being revaluation loss transferred to partners in old ratio)

Step 5: Final Capital Accounts

Now, let's prepare the partners' capital accounts after all adjustments.

A's Capital Account …

Start your 14-day free trial to unlock the full solution →

←Previous question · questions-for-practiceQ4 — Illustrate how interest on drawings will be calculated under various s…→Next question · questions-for-practiceQ1 — Triphati and Chauhan are partners in a firm sharing profits and losses…

Q.How will you deal with a change in profit sharing ratio among existing partners? Take imaginary figures to illustrate your answer.

Concept and Accounting Treatment

Illustration with Imaginary Figures

Step 1: Calculate Sacrifice/Gain

Step 2: Adjust General Reserve

Step 3: Adjust Goodwill

Step 4: Revaluation of Assets/Liabilities

Step 5: Final Capital Accounts

🎓Unlock everything free for 14 days

Unlock everything free for 14 days