Change in Profit Sharing Ratio Among
Existing Partners
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Reconstitution
of the Firm:
It refers to change in Existing agreement of Partnership Deed.
Reconstitution of the Firm takes Place when
·
There is Change in profit Sharing Ratio
·
On admission, retirement or Death of a Partner
·
On Amalgamation of two or more Partnership
Firms
Determination
of Sacrificing Ratio & Gaining Ratio
Sacrificing ratio
The ratio in which partners sacrifice their share of Profit in favour
of other partners of the firm.
Sacrificing Ratio /Share of Partner = Old
Ratio of Partner – New Ratio of Partner
Gaining Ratio
The ratio in which partners gain their share of Profit ratio due to
sacrifice made by other Partners.
Gaining Ratio /Share of Partner = New Ratio
of Partner – Old Ratio of Partner
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Accounting
Treatment of Goodwill/ Premium for Goodwill
Whenever, there is change in Profit Sharing Ratio we pass Journal entry
to adjust goodwill A/C by debiting Gaining partners’ capital A/C and
Crediting Sacrificing Partners’ Capital A/C by an amount which can compensate
Sacrificing Partner/s loss due to sacrifice in their Profit sharing ratio by
Gaining Partner/s for acquisition of their shares.
Journal Entry passed is
Gaining Partners’ Capital A/C/ Current A/C
………………Dr
To Sacrificing Partners’ Capital A/C/
Current A/C
Amount of Compensation payable by Gaining
Partner to Sacrificing Partner = Firm’s Goodwill Value × Share of Profit Gained.
Note: In case, Multiple Partners sacrifice,
then above amount will be credited to sacrificing Partners’ Capital A/C in
sacrificing ratio.
For Example,
Partner C Gained 2/10 share equally from
Partner A & B that is 1/10 from Partner A and 1/10 from Partner B. value
of Goodwill is Rs. 100000. In this case
Amount of Compensation payable by Gaining
Partner to Sacrificing Partner = Firm’s Goodwill Value × Share of Profit Gained =
2/10 × Rs. 100000 =
Rs. 20000
Amount credited to Partner A & B
Capital A/C will be in sacrificing ratio that is 1:1.
1/2 × Rs. 20000 = Rs. 10000 Payable to
Partner A.
1/2 × Rs. 20000 = Rs. 10000 Payable to
Partner B.
Journal Entry:
C’s Capital A/C ………………..Dr 20000
To A’s capital A/C
10000
To B’s capital A/C
10000
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Accounting
Treatment of Existing Goodwill
Existing Goodwill means Goodwill appearing in Balance Sheet. It is a
loss to the Firm and is written off by debiting Partners’ Capital / Current
A/C in their Old Profit Sharing Ratio.
Journal Entry passed for the same is
Partners’ Capital / Current A/C………………..Dr
To Existing Goodwill A/C
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Accounting
Treatment of Reserves & Accumulated Profits or Losses
These items are transferred to Partners’ Capital A/C/ Current A/C in their Old Profit Sharing Ratio, if
appearing in Balance Sheet, before Reconstitution of the Firm takes Place.
Journal Entries are as follows:
For Transfer of reserve &
Accumulated Profits:
Reserve A/C……………………………………………….Dr
Investment Fluctuation Reserve A/C………….Dr
Workmen Compensation Reserve A/C………..Dr
Accumulated Profit / P&L A/C……………………..Dr
To Partners’ Capital A/C/ Current A/C
For Transfer of Accumulated
Losses:
Partners’ Capital A/C/ Current A/C …………………..Dr
To Accumulated Losses / P&L A/C
To Advertisement Expenditure A/C
To Deferred Revenue Expenditure A/C
Note:
Employees’ Provident Fund is a Liability.
So it is not distributed among partners.
Reserves, Accumulated Profit & Losses
are accounted even if question is silent with regard to it.
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Investment
Fluctuation Reserve (IFR)
Reserve set aside out of Profit to meet fall in Market Value of
Investment. Accounting treatment of IFR can be understood with the help of
following cases.
Case 1. When Book Value &
Market Value of Investment is same
In this case, Total Balance of IFR is transferred to Partners’ capital/
Current A/C in their Old Profit Sharing ratio (OPSR).
Journal Entry in this case is:
IFR A/C………………………Dr
To Partners’ capital / Current A/C
Case 2. When Market Value of
Investment is less than Book Value
Three situations can exist under this case.
Situation
1. Fall in Market Value of Investment is less than IFR
In this Case, Balance of IFR to the extent of fall in Value (Book Value
– Market Value) will be transferred to Investment A/C and Remaining Balance
of IFR will be transferred to Partners’ capital/ Current A/C in their Old
Profit Sharing ratio (OPSR).
Journal Entry in this case is:
IFR A/C………………………Dr
To Investment A/C
To Partners’ capital / Current A/C
Situation
2. Fall in Market Value of Investment is equal to IFR
In this Case, Total Balance of IFR will be transferred to Investment
A/C and nothing will be transferred to Partners’ capital/ Current A/C.
Journal Entry in this case is:
IFR A/C………………………Dr
To Investment A/C
Situation
3. Fall in Market Value of Investment is more than IFR
In this Case, Total Balance of IFR will be transferred to Investment
A/C and Fall in value amount in excess of IFR will be transferred/ debited to
Revaluation A/C.
Journal Entry in this case is:
IFR A/C……………………………….Dr
Revaluation A/C…………………Dr
To Investment A/C
Case 3. When there is an
increase in Market Value of Investment
In this case, Total Balance of IFR is transferred to Partners’ capital/
Current A/C in their Old Profit Sharing ratio (OPSR) and amount of increase
in value (Market Value – Book value) will be credited to Revaluation A/C.
Journal Entry in this case is:
IFR A/C………………………Dr
To Partners’ capital / Current A/C
To Revaluation A/C
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Adjustment
of Accumulated Profits, Losses & Reserve through Capital A/C only, that
is, when they are to be retained in the Books after Reconstitution and not to
be Distributed
In this case, we calculate the net effect of Accumulated Profits,
Losses & Reserve which means Accumulated
Profits + Reserve– Accumulated Losses.
Then we calculate Gain / Sacrifice ratio of Share of Partner/s.
Gaining Partner will compensate to Sacrificing Partner in Sacrificing
Ratio in case of Positive Net effect.
Journal
entry passed will be:
Gaining Partner/s Capital / Current A/C…………..Dr
To Sacrificing Partner/s Capital/ Current A/C
In Case of Negative effect, Journal
Entry will reverse.
Sacrificing Partner/s Capital/ Current A/C………..Dr
To Gaining Partner/s Capital / Current A/C
Note:
Positive effect means Resulting value of
Accumulated Profits + Reserve– Accumulated Losses wiil be positive value and
vice versa for negative value.
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Revaluation
of Assets & Reassessment of Liabilities
In case of Reconstitution of Firm, Assets and Liabilities are revalued
and Loss or gain on revaluation is debited or credited to Partners’ Capital
A/C in their Old Profit Sharing Ratio. Two situations can exist:
I. When revised value of Assets and Liabilities are to be recorded in
Balance Sheet.
II. When revised value of Assets and Liabilities are not to be recorded
in Balance Sheet.
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I.
When revised value of Assets and Liabilities are to be recorded in Balance
Sheet.
In this case, Journal entries passed for Revaluation of Assets and
Liabilities are as follows:
1. for increase in Value of Asset:
Asset A/C……………………………….Dr
To Revaluation A/C
2. For Decrease in Value of Asset:
Revaluation A/C………………………….Dr
To Asset A/C
3. For Increase in Liability:
Revaluation A/C…………………….Dr
To Liability A/C
4. For Decrease in Liability:
To Liability A/C………………………….Dr
To Revaluation A/C
5. For Recording an Unrecorded Asset:
Unrecorded Asset A/C……………………………….Dr
To Revaluation A/C
6. For Recording an Unrecorded Liability:
Revaluation A/C…………………….Dr
To Unrecorded Liability A/C
7. For Transfer of Balance of Revaluation A/C
In Case of Gain on Revaluation:
Revaluation A/C………………….Dr
To Partners’ Capital / Current A/C (in OPSR)
In Case of Loss on Revaluation:
Partners’ Capital / Current A/C (in OPSR)………………….Dr
To Revaluation A/C
Format
of Revaluation A/C
Note
* Either of the two will come. Loss and
Gain can not come together.
Always Remember, if Revaluation A/C is
prepared, Value of Assets and Liabilities will be recorded at revised values.
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II.
When revised value of Assets and Liabilities are not to be recorded in
Balance Sheet
In this case, gain or Loss on revaluation of Assets and Liabilities is
adjusted through Capital A/C by passing an Adjustment Entry by Debiting
Capital /Current A/C of Gaining Partner & Crediting Sacrificing Partners’
Capital A/C in Sacrificing Ratio.
Following steps will help to understand the concept better:
Step I. calculate Net effect of
Revaluation
*We can even add Goodwill to adjust it
among Sacrificing Partners’ in Sacrificing Ratio. Otherwise, we can do
separate calculation For Goodwill.
Step
2. After that we Calculate Gaining/Sacrificing Ratio of all Partners.
Step
3. Calculate Proportional Amount of Net effect of Revaluation
Amount of Compensation payable by Gaining
Partner to Sacrificing Partner = Share gained × Net effect of revaluation
Step
4. Pass Necessary Journal entry
Whenever, there is change in Profit Sharing Ratio, we pass Journal
entry to adjust Net effect of Revaluation, by debiting Gaining partners’
capital A/C and Crediting Sacrificing Partners’ Capital A/C by the amount
equal to gain on Revaluation amount to compensate Sacrificing Partner/s loss
due to not recording of revised value of Asset & Liabilities.
In Case there is Loss on Net effect of Revaluation, Sacrificing Partner/s
will compensate to Gaining Partner/sin Gaining Ratio /Sacrificing ratio.
Journal Entry passed is
For gain on Revaluation
Gaining Partners’ Capital A/C/ Current A/C ………………Dr
To Sacrificing Partners’ Capital A/C/ Current A/C
For Loss on Revaluation
Sacrificing Partners’ Capital A/C/ Current A/C………..Dr
To Gaining Partners’ Capital A/C/ Current A/C
Above Calculation Gets Reversed in case of
Loss on revaluation.
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Expenses
on reconstitution of the Firm
There are different cases for Expenses on Reconstitution of the Firm as
explained below:
Case
1. When expenses are borne and paid by Firm
Journal Entry Passed in this case:
Revaluation A/C………………………..Dr
To Cash/Bank A/C
Case
2. When Reconstitution expenses are borne by the Firm but paid by a Partner
Journal Entry Passed in this case:
Revaluation A/C………………………..Dr
To Concerned Partner’s Capital A/C
Case
3. When the Firm pays fixed amount to a Partner as his remuneration for
Reconstitution expenses and partner is to bear Reconstitution expenses
As Partner is paid fixed amount for Remuneration (including expenses),
No entry is passed regarding payment of expenses. Only remuneration due to
Partner journal entry is passed.
Journal Entry passed here for remuneration
due to Partner is
Revaluation A/C………………………..Dr
To Concerned Partner’s Capital A/C
Case
4. If Expenses are paid by the Firm on Behalf of the Partner
In case, amount paid by Firm on behalf of Concerned Partner is considered
as his drawings.
Journal Entry Passed in this case:
Concerned Partner’s Capital A/C…………………Dr
To Cash/Bank A/C
Case
5. When Firm pays amount to a Partner as his remuneration for reconstitution
expenses but Reconstitution expenses are borne by the Firm:
In this case, Firm pays remuneration to Concerned Partner for carrying
reconstitution work But expenses of Reconstitution are borne by the Firm.
Journal Entry passed in this case:
For remuneration due to Partner
Revaluation A/C………………………..Dr
To Concerned Partner’s Capital A/C
For expenses borne and paid by Firm
Revaluation A/C………………………..Dr
To Cash/Bank A/C
Case
6: When Reconstitution expenses are to be borne by one Partner Say A and paid
by another Partner say B.
In this case, Journal Entry passed will be
A’s Capital A/C………………….Dr
To B’s Capital A/C
Case
7. In case question is silent about treatment of Reconstitution expenses, it
is assumed that it has met by Firm
In this case, Journal Entry passed will be
Revaluation A/C………………………..Dr
To Cash/Bank A/C
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