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2. Distribution of Reserves and Accumulated Profits
Distribution of reserves
and accumulated profits is the first step in any reorganisation
process. They include general reserves, credit balance in P & L
accounts or any other fund that are retained in the business.
These are profits earned in the past, but not taken out by the
partners, or profits kept aside. Therefore, when the partners
decide to change their future profit sharing ratio, the past
profits retained in the above accounts should be distributed to
partners in the old ratio as a first step.
3. Calculating new ratio,
sacrificing ratio and gaining ratio
When a new partner comes
into the business, old partners have to give him his profit
share from their portion. Thus change in profit sharing ratio is
an important aspect to be considered on reconstitution by
admission. In academic accounting, change in profit sharing
ratio can be presented in various ways. The existing partners
may decide to change their profit sharing ratio for various
reasons. When the profit sharing ratio is revised among existing
partners, there ought to be a partial sacrifice of profit share
by some partners in favour of others. The sacrifice of one or a
group of partners becomes the gain of the remaining partners.
Following is the formula for calculating sacrificing ratio:
Sacrificing ratio = Old
ratio – new ratio
When the profit sharing
ratio is revised it is important to calculate the sacrificing
ratio and gaining ratio. These ratios are required to adjust the
value of goodwill of a firm without raising goodwill account in
the books.
Gaining ratio is the
opposite of sacrificing ratio. This is the ratio gain to the
existing partners of a firm when they revise the profit sharing
ratio, or when the profit share of the deceased or retired
partner is shared by the other partners. This ratio is
calculated by deducting the old ratio from the new ratio. The
new share will be higher than the old when there is a gain.
Gaining ratio = New
ratio – old ratio
Examples of ratio
calculations on reconstitution by admission
a.
The new partner’s share is mentioned without specifying the old
partner’s profit sharing arrangement.
In this case it is to be
assumed that the profit available after paying the new partner’s
share is to be divided by the old partners in their old profit
sharing ratio. In other words the even though the overall profit
sharing ratio changes, the old ratio is still maintained between
the old partners, within the new ratio.
Illustration 2.1
Calculate new profit
sharing ratio in the following cases:
i)
A & B
sharing profits and losses equally admit C for 1/5th
share in future profits
C’s Share of profit = 1/5th
of the profit of the firm.
Balance of profit
available for A & B = 4/5th of the profit, which is
shared by them equally.
A’s New share = 4/5 x 1/2
= 4/10
B’s New share = 4/5 x ½ =
4/10
Ratio between ABC =
4/10:4/10:1/5
= 2:2:1
ii)
A & B
sharing profits and losses in the ratio 3:1 admit C for 1/5th
share in future profits.
C’s share of profit = 1/5
Balance available for A &
B = 1-1/5 = 4/5 of the profit which is shared by them in the
ratio 3:1
A’s New share = 4/5 x 3/4
= 3/5
B’s New share = 4/5 x ¼ =
1/5
New Ratio = 3/5 : 1/5 :
1/5
= 3:1:1
iii)
A &B
sharing profits and losses in the ratio 3:2 admit C for 1/5th
share in future profits.
C’s Share = 1/5
Balance available for A &
B = 4/5 which is shared by them in the ratio 3:2
A’s new share = 4/5 x 3/5
= 12/25
B’s new share = 4/5 x 2/5
= 8/25
C’s share = 1/5
New profit sharing ratio =
12/25 : 8/25 : 1/5
12:8:5
iv)
A & B
sharing profits and losses in the ratio 2/3 and 1/3 admit C into
partnership giving him 1/4th share in future profits
C’s share of profit = 1/4
Balance available for A &
B = 3/4
A’s new share = 3/4 x 2/3
= 2/4
B’s new share = 3/4 x 1/3
= 1/4
New profit sharing ratio =
2/4:1/4:1/4 ie. 2:1:1
v)
A & B who
are equal partners admit C for 1/6th share in future
profits
C’s share of profits = 1/6
Balance available to A & B
= 5/6
A’s new share = 5/6 x 1/2
= 5/12
B’s new share = 5/6 x 1/2
= 5/12
New profit sharing ratio =
5/12: 5/12: 1/6
= 5:5:2
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