Test: Change In Profit Sharing Ratio - 1

Reconstitution of the firm can take place on the following occasions:
1.Change in the profit sharing ratio of the existing partners
2.Admission of a new partner 
3.Retirement of an existing partner
4.Death of a partner

Sometimes, the partners of a firm may agree to change their existing profit sharing ratio. As a result of this, some partners will gain in future profits while others will lose. In such a situation, the partner who gains by change in profit sharing ratio must compensate the partner who has made the sacrifice. In simple words, it is also known as purchase of shares of profit by one partner form another partner.

Change in profit sharing ratio is essential in the following circumstances:
1. When existing partners have decided to change their existing profit sharing ratio to new ratio.
2. When a new partner is admitted 
3. When a partner gets retirement from the firm
4. At the time of death of a partner

Any change in the relationship of partners amounts to reconstitution of the partnership firm. A change in the partnership agreement brings to an end the existing agreement and a new Agreement comes into being. This new agreement changes the relationship among the members of the partnership firm. Hence, whenever there is a change in the partnership agreement, the firm continues but it amounts to the reconstitution of the partnership firm.

The partner who is getting more because of change in profit sharing ratio is called a gainer partner. That is why gainer partner is debited and sacrificing partner is credited while adjustment is made for goodwill or reserves and profits etc.

Gaining Ratio is calculated at the time of retirement or death of partner. It is the excess of new ratio over old ratio of old partners except retired or deceased partner. Formula : Gaining Ratio = New Ratio - Old

1. Mainly sacrificing ratio is calculated at the time of Change in existing profit sharing ratio and admission of new partner.
2. Total of each old partner's Sacrifice will be equal to new ratio of new admitted partner or a gainer partner in case of change in existing profit sharing ratio. 
3. Goodwill will be adjusted at the time of admission of a partner in sacrifice ratio. 
4. Formula : Old share – New share

A sacrificing partner is one who has given or surrendered his share in favour of a new partner. That’s why a sacrificing partner is compensated by a new partner in the form of premium for goodwill.

Change in profit sharing ratio may also necessitate adjustments in the partner’s capital accounts with respect to undistributed profits and reserves, revaluation of assets and reassessment of liabilities, etc. The valuation of goodwill of a firm, its treatment, adjustment regarding undistributed profits and reserves and revaluation of assets and liabilities due to change in the profit sharing ratio of the partners.

The amount of compensation will be equal to the proportionate amount of goodwill. The valuation of goodwill of a firm, its treatment and adjustment is required at the time of change in existing profit sharing ratio among the partners.