CHANGE IN PROFIT SHARING RATIO

 ACCOUNTING FOR PARTNERSHIP FIRMS

LESSON - 10

CHANGE IN PROFIT SHARING RATIO

   

           As discussed in the previous lesson, we have understood that the partnership deed is to be prepared new when certain major changes take place among the partners agreement. Each and every major change that leads for preparation of new partnership deed has to be discussed in detail. Lets start with the first change in this lesson.

PROFIT SHARING RATIO AMONG PARTNERS  

           When the partnership is formed the partners would have already decided about their profit or loss sharing ratio (the percentage of sharing among each partners). This ratio may be changed due to some reasons like capital contribution, increase in responsibilities, new partners admission etc. This makes them to prepare a new deed according to the changes they have made. When the ratio among the partners is changing then there are two possibilities that may arise 

        a) A partner may get more percentage of profit share than his previous share or 

        b) He may get less percentage of profit share than his previous share.

            When a partner is getting more percentage of share than his previous share then he is gaining more percentage of share, as his profit ratio is gaining it is called 'gaining ratio'. If the partner is getting less percentage of share than his previous share then his share has decreased from his previous share of profit, as his profit ratio is sacrificed it is called 'sacrificing ratio'. Based on this two situations Sacrificing ratio and Gaining ratio is calculated.

FORMULA:

Sacrifice Share Ratio = Old Share Ratio - New Share Ratio

Gaining Share Ratio = New Share Ratio - Old Share Ratio

          

              

            As a partner's gain in profit share is because of an another partner's sacrifice made in his profit share. In other words, if share of one or more partners increases then the share of other one or more partners decreases. What is the benefit for the sacrificing partner?  The partner who has sacrificed his share in favor of the gaining partner should be compensated by the gaining partner in the form of 'goodwill'.

            Formulas should be used to find the sacrificing and the gaining partners and the amount of compensation. The reason for finding the sacrificing and the gaining partner is to find the amount of compensation the gaining partner has to pay to the sacrificing partner for the sacrifice he has made in his share of profit. The gaining partner will pay the compensation amount according to the share gained by him.

JOURNAL ENTRY

        Gaining partner capital a/c Dr.                         XXX

            To sacrificing partner's capital a/c                              XXX

       (being gaining partner compensated the sacrificing partner)

OTHER FACTORS RELATED TO PROFIT SHARING RATIO:

            There are certain things which are interlinked with the profit sharing ratio of the partners so a change in profit sharing ratio might bring a change in the following things also. While changing the profit ratio of the partners look for the changes in the following things.

a) Gaining or Sacrificing ratio will be determined

b) Goodwill has to be treated

c) Treatment of Reserves, accumulated profits or losses

d) Assets and liabilities should be revalued

e) Partner's capital accounts should be adjusted

            Each of these headings will be discussed individually in detail in the further lessons.