Why the ratio changes
A change in the profit-sharing ratio among the same partners is a reconstitution of the firm: the old agreement ends and a new one begins. It happens when a partner does more work, brings more money, or becomes less active.
Three things must be settled: goodwill, revaluation of assets and liabilities, and reserves and accumulated profits or losses.
Sacrificing ratio and gaining ratio
Sacrifice = Old share − New share (positive). Gain = New share − Old share (positive).
The ratio of the sacrifices is the sacrificing ratio; the ratio of the gains is the gaining ratio. On a change in ratio among existing partners, total sacrifice = total gain.
Goodwill entry: Gaining Partner's Capital A/c Dr, To Sacrificing Partner's Capital A/c (share of goodwill in gain/sacrifice).
Revaluation of assets and reassessment of liabilities
Book values may not match real values. A Revaluation Account (a nominal account) records the changes:
- Increase in an asset or decrease in a liability → credit (gain).
- Decrease in an asset, increase in a liability, or an unrecorded liability → debit (loss).
Its balance is shared among partners in the old ratio. Alternatively, if partners do not want to change book values, one adjustment entry (gainer Dr, sacrificer Cr) for the net effect is passed.
Reserves and accumulated profits or losses
General Reserve, Reserve Fund, credit balance of P&L, and similar funds belong to the old partners in the old ratio: Reserve A/c Dr, To Partners' Capital A/cs. A debit balance of P&L or deferred revenue expenditure is debited to partners in the old ratio.
Special reserves
- Workmen Compensation Reserve: if the claim is less than the reserve, the excess goes to partners; if more, the extra is a loss in Revaluation.
- Investment Fluctuation Reserve: covers a fall in the value of investments; any excess goes to partners.
If partners want to keep reserves in the books, pass one adjustment entry instead (gainer Dr, sacrificer Cr).
Key formulas and definitions
- Sacrifice = Old share − New share
- Gain = New share − Old share
- Goodwill paid by gainer = Firm's goodwill × Gain
- Revaluation profit/loss → partners in OLD ratio
- Reserves and accumulated profits → partners in OLD ratio
- Adjustment instead of revaluing: (Net effect × Gain) paid by gainer to sacrificer
Worked examples
1. A and B share 3:2. New ratio 1:1. Find sacrifice and gain.
A: 3/5 − 1/2 = 1/10 sacrifice. B: 1/2 − 2/5 = 1/10 gain.
2. Same case, goodwill ₹60,000. Pass the entry.
B's Capital A/c Dr ₹6,000, To A's Capital A/c ₹6,000.
3. X, Y, Z share 5:3:2. New ratio 2:3:5. Find each one's change.
X: 5/10 − 2/10 = 3/10 sacrifice. Y: no change. Z: 5/10 − 2/10 = 3/10 gain.
4. Revaluation: building up ₹20,000, stock down ₹5,000, provision for bad debts ₹3,000 created. Old ratio 3:2. Share the result.
Gain 20,000 − 5,000 − 3,000 = ₹12,000. A 7,200, B 4,800 (credited to capitals).
5. General Reserve ₹50,000 and P&L debit balance ₹10,000. Old ratio 3:2. Entries?
Reserve: A Cr 30,000, B Cr 20,000. P&L loss: A Dr 6,000, B Dr 4,000.
6. Workmen Compensation Reserve ₹20,000; claim ₹26,000. Treatment?
Reserve used fully; extra ₹6,000 debited to Revaluation A/c (a loss shared in old ratio).
7. A, B share 3:2 → 1:1. Partners do not want to change book values. Net effect of revaluation and reserves = +₹40,000. Adjustment?
Gain of B = 1/10. 40,000 × 1/10 = 4,000. B's Capital Dr ₹4,000, To A's Capital ₹4,000.
Common mistakes
- Sharing revaluation profit in the new ratio. Use the old ratio.
- Crediting goodwill to all partners. Only sacrificers are credited.
- Crediting the whole Workmen Compensation Reserve when a claim exists. Only the excess goes to partners.
- Forgetting that a partner with no change neither pays nor receives.