Reconstitution of a Partnership Firm- Retirement / Death of a Partner
PSR refers to the share in which the partners divide profit & loss of their firm. Alternation in profit sharing ratio among existing partners in a partnership business is known as change in profit sharing ratio. Profit and losses should be divided equally in the absence of partnership deed or any other agreement regarding sharing of profits and losses. A change in the profit-sharing ratio amongst existing partners means reconstitution of the firm. This type of reconstitution takes place without admission and retirement or death of a partner. Adjustments required in the event of changing profit sharing ratio of partners, are: calculation of gaining ratio and sacrificing ratio, accounting treatment of goodwill, adjustment of reserves and accumulated profits/losses, revaluation of assets and liabilities
Sacrificing ratio refers to that part of old ratio that is surrendered in favour of other partners. Gaining ratio is calculated to determine the amount of compensation to be paid. For Goodwill, sacrificing partners are compensated by gaining partners and compensation is calculated on the basis of sacrifice. Goodwill can be recorded in books only when some consideration in money or money’s worth has been paid for it. Therefore, only purchased goodwill should appear in the books. In case of change in profit sharing ratio among partners, goodwill cannot be raised in books of firm because no consideration in money or money’s worth is paid for it. Reserve fund and accumulated profits/losses should be transferred to the existing Partners’ Capital Accounts in their old ratio. New profit-sharing does not affect treatment of such reserves and surplus. Revaluation is the valuation of assets and liabilities at the time of reconstitution of the firm. Revaluation account is a nominal account. The profit/loss from the revaluation account is transferred to partner’s capital account. Reconstitution of firm may require the capitals of the partners in the new firm to be in accordance with their profit sharing ratio. Surplus in partners’ capital account will be either withdrawn from the business or credited to partners’ current account. Deficit in partners’ capital account will either be met through introduction of capital in the business or by debiting Current Account.