Change in Profit-Sharing Ratio among Existing Partners — Notes

Existing partners may agree a new profit-sharing ratio without anyone joining or leaving, for example when a partner takes on more work, gives less time, or contributes more capital or skill. The change is a reconstitution of the firm.

It sets off four adjustments:

1. Some partners sacrifice and others gain.
2. Gainers compensate sacrificers for goodwill.
3. Assets and liabilities are revalued, and the gain or loss is shared in the old ratio.
4. Reserves and accumulated profits or losses are distributed in the old ratio (or one adjustment entry is passed).

• Sacrifice of a partner = old share − new share (when positive).
• Gain of a partner = new share − old share (when positive).
• Sacrificing ratio: ratio of the sacrifices; gaining ratio: ratio of the gains.
• A partner with old share = new share is unaffected.
• Check: total sacrifice = total gain.

Special cases

• A fraction of the firm's profit is given: subtract it from the giver, add it to the taker.
• A fraction of a partner's own share is given: multiply it by that share first.
• Equal sharing: each new share = 1 ÷ number of partners.

Accounting Standard 26 (Intangible Assets): goodwill is recorded only when purchased for a consideration. Goodwill generated by the firm itself is never recorded, so no goodwill account is raised on a change in ratio.

Adjustment entry:

• Goodwill may first be valued by the average profit, super profit or capitalisation method (Chapter 1).
• A partner whose share is unchanged does not appear in the entry.

• Goodwill already in the balance sheet is written off among all partners in the old ratio: Partners' Capital A/cs Dr. To Goodwill A/c.
• Then the current value of goodwill is adjusted between gaining and sacrificing partners.
• If capitals are fixed, every adjustment (goodwill, reserves, revaluation) passes through the partners' current accounts.

Book values may differ from current values, and some assets or liabilities may be unrecorded. These changes arose under the old ratio, so they are settled before the new ratio begins.

• Revaluation account (a nominal account): gains credited, losses debited.
• Increase in an asset, decrease in a liability, unrecorded asset: credit.
• Decrease in an asset, increase in a liability or provision, unrecorded liability: debit.
• For a provision for doubtful debts, debit only the increase over the existing provision.
• Balance (profit or loss) to partners' capital accounts in the old ratio.

• General reserve, contingency reserve, profit and loss credit balance: credited to partners in the old ratio.
• Profit and loss debit balance: debited to partners in the old ratio.
• Workmen compensation reserve (WCR): the expected claim is transferred to a provision for workmen compensation claim; any excess goes to partners; if the claim exceeds the reserve, the excess is debited to revaluation.
• Investment fluctuation reserve (IFR): a fall in investments is met from it first; any balance goes to partners; a fall larger than the reserve is a revaluation loss; a rise in value is a revaluation gain and the whole IFR goes to partners.

If partners want reserves and book values to stay unchanged:

1. Add reserves and accumulated profits, subtract accumulated losses, and add the net revaluation result (gain +, loss −).
2. Multiply the total by each partner's sacrifice or gain.
3. Pass one entry: Gaining Partners' Capital A/cs Dr. To Sacrificing Partners' Capital A/cs.

Goodwill can be included in the same total. Both methods leave each partner equally well off.