Accountancy · Ch 6 — Reconstitution of a Partnership Firm — Admission of a Partner
Change in Profit Sharing Ratio among the Existing Partners
Change in Profit Sharing Ratio among the Existing Partners
Change in Profit Sharing Ratio Among Existing Partners
A change in profit sharing ratio can happen even when no partner is admitted or retires. The partners simply agree to a new ratio for sharing future profits and losses. This is a form of reconstitution of the firm — the old partnership ends and a new one begins, even though the same persons remain as partners.
When the ratio changes, some partners gain a larger share of future profits and others lose a part of theirs. The partner who gains is effectively buying a portion of the profit share from the partner who sacrifices. This calls for a compensating adjustment, usually through goodwill.
The Sacrifice and Gain
Consider three partners A, B and C sharing profits in the ratio 8:5:3 (total 16). They decide to change to 5:6:5 (total 16).
- A's old share = 8/16, new share = 5/16 → A loses 3/16 (sacrifice)
- B's old share = 5/16, new share = 6/16 → B gains 1/16
- C's old share = 3/16, new share = 5/16 → C gains 2/16
The partner who sacrifices must be compensated by the partners who gain. This compensation is calculated on the basis of the firm's goodwill.
Accounting Treatment for Goodwill Adjustment
The gaining partners are debited and the sacrificing partners are credited with their respective shares of goodwill. The journal entry is:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Gaining Partner's Capital A/c | Dr. | xxx | ||
| To Sacrificing Partner's Capital A/c | xxx | |||
| (Goodwill adjusted on change in profit sharing ratio) |
The amount is calculated as: Gain/Sacrifice in share × Value of goodwill of the firm
Other Adjustments Required
A change in profit sharing ratio also requires the same adjustments as in the case of admission of a partner:
- Revaluation of assets and liabilities — through a Revaluation Account
- Transfer of accumulated profits and reserves — to partners' capital accounts in the old ratio
- Transfer of accumulated losses — to partners' capital accounts in the old ratio
- Adjustment of partners' capitals — if agreed, to make them proportionate to the new profit sharing ratio
All these are done exactly as in the case of admission of a partner.
Key Points to Remember
When profit sharing ratio changes among existing partners, the accounting treatment is identical to that on admission of a partner — revaluation, transfer of reserves, goodwill adjustment, and capital adjustment are all done in the same manner. …