Topic - 1 | DETERMINATION OF SACRIFICING & GAINING RATIO:
Video Lectures [1]
Study Material & Notes
Study Material & Notes for the Chapter 3
Partnership – Change in Profit Sharing Ratio
I. DETERMINATION OF SACRIFICING & GAINING RATIO
A. Definitions
B. Sacrificing/(Gaining) Ratio
Sacrificing/(Gaining) Share = Old Share – New Share
If a Partner’s Old Share – New Share is Positive (+) figure then the partner has made a sacrifice
If a Partner’s Old Share – New Share is Negative (-) figure then the partner has made a gain
Topic - 2 | ACCOUNTING FOR GOODWILL:
Video Lectures [1]
Study Material & Notes
Study Material & Notes for the Chapter 3
Partnership – Change in Profit Sharing Ratio
II. ACCOUNTING FOR GOODWILL
If Partners decide to change their profit-sharing ratio, the gaining partner must compensate the sacrificing partner
The compensation by gaining partner to the sacrificing partner is payment of Goodwill in the gaining ratio
If Partner B gained 1/10 of the share and Partner A scarified 1/10 of the share and goodwill of the Firm is Rs. 5,00,000/- then Partner B should compensate Partner A for: Rs. 5,00,000 X (1/10)= Rs. 50,000/-
Case-1 Goodwill is not appearing in the books of accounts
Method-1 Goodwill is raised and then written off
Method-2 Goodwill is adjusted through Partners’ Capital Accounts
Important to Note: If question is silent, treat Capital Accounts as Fluctuating
Case-2 Goodwill is appearing in the books of accounts
Method-1 Existing Goodwill is written off
Important to Note: If question is silent, Method-1 is the preferred treatment
Method-2 Effect is given to the net increase or decrease in goodwill
III. ACCOUNTING OF RESERVES, ACCUMULATED PROFITS / LOSSES
On reconstitution of partnership Firm, the partners scans Firm’s Financial position (Balance Sheet) i.e. Reserves, Accumulated Losses, Assets & Liabilities
The logic behind this exercise is the new relationship should not get undue benefit due to previously earned/unearned profits or suffer loss due to previous earned/unearned losses.
During this scanning process Partners may find Free Reserves like General Reserve, P&L (Cr), these are distributed among partners in their existing profit-sharing ratio.
Specific purpose reserves like (a) Workmen Compensation Reserve are compared with any workmen claim (b) Investment Fluctuation Reserve is compared with market value of Investments and any excess reserve is distributed to existing partners in their current PSR and any short reserve is taken to Revaluation A/c.
Partners may also find Undistributed Losses or Fictitious Assets, these are written off and charged to the existing Partners in their current Profit Sharing Ratio.
Partners reevaluate market value of Fixed Assets and remeasure Current Assets and Current Liabilities. Any change in the value of Assets/Liabilities is dealt via Revaluation Account and the resultant gain/loss is shared amongst the existing partners in their current profit-sharing ratio.
A. Accounting treatment of Accumulated Losses
Accumulated Losses include
Debit balance in Profit & Loss A/C
Deferred revenue Expenses
Preliminary Expenses
Advertisement Suspense A/C
Method-1 Accumulated Losses are written off
Important to Note: If question is silent, Method-1 is the preferred treatment
Method-2 Accumulated Losses are carried forward
B. Accounting treatment of Free Reserves
Free Reserves include
Credit balance in Profit & Loss A/C
General Reserve
Accumulated Profits
Contingency Reserve
Method-1 Reserves are distributed amongst partners
Important to Note: If question is silent, Method-1 is the preferred treatment
Method-2 Accumulated Losses are carried forward
C. Workmen Compensation Reserve
All good firms take necessary safety precautions and train their workmen to avoid any accidents
At the factories/workplace despite all safety precautions and training there may be a situation wherein a worker might meet an accident resulting into medical treatment or disability.
Since the accident taken place at the Firm’s premises, there is a claim from the workmen/employee
To meet such contingencies, good firms generally set aside funds and create specific reserve Workmen Compensation Reserve
Any claim from workmen is paid out of the Workmen Compensation Reserve
Accounting Treatment under various scenarios
D. Investments Fluctuation Reserve
In case a firm has surplus funds, which are not be used in business immediately, invests these funds.
The Market value of the investments is not static and keeps on varying (higher/lower) due to various economic conditions
To protect from the risk of any loss due to fall in the value of investments, Good firms set aside reserve out of profits and create Investment Fluctuations Reserve
In case of a permanent fall in the value of Investments, Firm utilize Investment Fluctuation Reserve
Any excess Investment Fluctuation Reserve at the time of change in PSR is distributed amongst Partners’ in their old PSR
Accounting Treatment under various scenarios
Topic - 4 | REVALUATION OF ASSETS / LIABILITIES:
Video Lectures [1]
Study Material & Notes
Study Material & Notes for the Chapter 3
Partnership – Change in Profit Sharing Ratio
IV. REVALUATION OF ASSETS / LIABILITIES
Partners reevaluate market value of Fixed Assets and remeasure Current Assets and Current Liabilities. Any change in the value of Assets/Liabilities is dealt via Revaluation Account and the resultant gain/loss is shared amongst the existing partners in their current profit-sharing ratio.
Case-1 When Partners decide to show the effect of Revaluation in the Balance Sheet
A. Accounting Treatment under various scenarios
Important to Note:
Language in the question: AT/To means new value of the Asset/Liability.
Language in the question: By means difference between existing value and new value of the Asset/Liability.
B. Preparation of Revaluation Account
On the Revaluation of Assets and Reassessment of Liabilities, a new account is opened Revaluation Account
Revaluation Account is a nominal account. As per nominal rule all the expenses & losses are debited and all the incomes/gains/profits are credited
Revaluation Account
* Only one will appear at a time
When Revaluation Account is prepared, assets and Liabilities appear in the Balance Sheet of the reconstituted firm at their revised (changed) values
C. Expenses on reconstitution of the Firm
Firm gives contract to partner including expenses or excluding expenses
Treatment when contract to partner is inclusive of expenses
Case-2 When Partners decide to carry old values in the Balance Sheet-Memorandum Revaluation Account
Applicable when revised (changed) values of assets and liabilities are not to be recorded
Gain (Profit) or Loss on Revaluation of Assets and Reassessment of Liabilities is adjusted through Capital Accounts by passing an adjustment entry by debiting/crediting the Capital/Current Accounts of gaining partners and crediting/debiting the sacrificing partners
STEPS
a) Calculation of the Net Effect of Revaluation
b) Calculate Sacrificing/Gaining Ratio = Old Share – New Share
c) Calculate share of Gaining and Sacrificing Partner in the Net Effect (computed in step a)
Journal Entry – In case of Gain/Profit on Revaluation
Journal Entry – In case of Loss on Revaluation
Important to Note: The Assets and Liabilities remain at the book value. No adjustment in the Balance Sheet of the revalued assets/liabilities
Topic - 5 | ADJUSTMENT OF CAPITAL:
Video Lectures [2]
Study Material & Notes
Study Material & Notes for the Chapter 3
Partnership – Change in Profit Sharing Ratio
V. ADJUSTMENT OF CAPITAL
Applicable when Partners decide that the capitals shall be in their profit-sharing ratio
STEPS
Compute the new profit-sharing ratio
Compute partners’ existing capital post adjustment of Revaluation, Reserves Accumulated losses & Goodwill etc.
Determine firm total capital which is the sum-total of existing capital of all the partners
Compute the New Capital of each partner by multiplying Total Capital with his new share
Compare the new capital with existing capital and any shortfall to be brought in and excess is refunded
