Study Material & Notes-Partnership Change in PSR

Study Material & Notes for the Chapter 4

Partnership - Change in Profit Sharing Ratio

I.   DETERMINATION OF SACRIFICING & GAINING RATIO

A.  Definitions

Table 4.1.A1

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 

II.   ACCOUNTING FOR GOODWILL

  1. If Partners decide to change their profit-sharing ratio, the gaining partner must compensate the sacrificing partner 
  2. The compensation by gaining partner to the sacrificing partner is payment of Goodwill in the gaining ratio
  3. 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

Table 4.2.M1

Method-2 Goodwill is adjusted through Partners’ Capital Accounts

Table 4.2.CM2

 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
Table 4.2.CM1

 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
Table 4.2.CM2

III. ACCOUNTING OF RESERVES, ACCUMULATED PROFITS / LOSSES

  1. On reconstitution of partnership Firm, the partners scans Firm’s Financial position (Balance Sheet) i.e. Reserves, Accumulated Losses, Assets & Liabilities
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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
  1. Debit balance in Profit & Loss A/C
  2. Deferred revenue Expenses
  3. Preliminary Expenses
  4. Advertisement Suspense A/C
Method-1 Accumulated Losses are written off

Table 4.3.AM1

 Important to Note: If question is silent, Method-1 is the preferred treatment

Method-2 Accumulated Losses are carried forward
Table 4.3.AM2
B. Accounting treatment of Free Reserves

Free Reserves include 

  1. Credit balance in Profit & Loss A/C
  2. General Reserve
  3. Accumulated Profits
  4. Contingency Reserve
Method-1 Reserves are distributed amongst partners

Table 4.3.BM1

 Important to Note: If question is silent, Method-1 is the preferred treatment

Method-2 Accumulated Losses are carried forward

Table 4.3.BM2

C. Workmen Compensation Reserve
  1. All good firms take necessary safety precautions and train their workmen to avoid any accidents
  2. 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.
  3. Since the accident taken place at the Firm’s premises, there is a claim from the workmen/employee
  4. To meet such contingencies, good firms generally set aside funds and create specific reserve Workmen Compensation Reserve
  5. Any claim from workmen is paid out of the Workmen Compensation Reserve
Accounting Treatment under various scenarios 

Table 4.3.C1

D. Investments Fluctuation Reserve
  1. In case a firm has surplus funds, which are not be used in business immediately, invests these funds.
  2. The Market value of the investments is not static and keeps on varying (higher/lower) due to various economic conditions
  3. 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
  4. In case of a permanent fall in the value of Investments, Firm utilize Investment Fluctuation Reserve
  5. 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 

Table 4.3.D1

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

Table 4.4.A1

 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
  1. On the Revaluation of Assets and Reassessment of Liabilities, a new account is opened Revaluation Account
  2. 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

Table 4.4.B1

* 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

Table 4.4.C1

  1. Firm gives contract to partner including expenses or excluding expenses
  2. 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

Table 4.4.C2

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

Table 4.4.C3

Journal Entry – In case of Loss on Revaluation

Table 4.4.C4

 Important to Note: The Assets and Liabilities remain at the book value.  No adjustment in the Balance Sheet of the revalued assets/liabilities  

V. ADJUSTMENT OF CAPITAL

     Applicable when Partners decide that the capitals shall be in their profit-sharing ratio

      STEPS

  1. Compute the new profit-sharing ratio
  2. Compute partners’ existing capital post adjustment of Revaluation, Reserves Accumulated losses & Goodwill etc.
  3. Determine firm total capital which is the sum-total of existing capital of all the partners
  4. Compute the New Capital of each partner by multiplying Total Capital with his new share
  5. Compare the new capital with existing capital and any shortfall to be brought in and excess is refunded
Previous
error: Content is protected !!