The chapter/topic allotted: Change in the Profit-Sharing Ratio among the

existing partners sacrificing ratio, gaining ratio, accounting for revaluation of

assets and reassessment of liabilities and treatment of reserves, accumulated
profits and losses. Preparation of revaluation account and balance sheet.
Prepared by : B.P Nayak, PGT(Commerce)
Class-12
Subject : Accountancy
Chapter/Topic : 3
Reconstitution of Partnership Firm
Reconstitution of partnership firm means making a new agreement in place of
old agreement and the same business unit will be continued with new terms
and conditions as decided by the partners. It is also called as dissolution of
partnership. A partnership is formed by an agreement. In the reconstitution of
the partnership firm, the existing agreement comes to an end and a new
agreement takes place. The firm is therefore, said to be reconstituted due to the
following reasons:
i) Change in profit sharing ratio as agreed by all existing partners
ii) Admission of a new partner with new terms and conditions in
admission
iii) Retirement of a partner with the consent of remaining partners
iv) Death of a partner
v) Amalgamation of two or more existing partnership firms to start a
big firm
i) Change in the Profit-Sharing Ratio:
The profit-sharing ratio among the of existing partners may be changed if all
the partners agreed to it. So, a new agreement is made by all the existing
partners with new terms and conditions to change their old profit-sharing ratio
and to share future profit according new ratio. It leads to reconstitution of the
firm. This change may be due to a change in capital contribution or increased
participation in management by one or more partners.
As the same partner continue the same business in change in the profit-sharing
ratio,
The aggregate amount of gain by one or more partners =Aggregate amount of
sacrifice by other partners.
As a result of this change in profit sharing ratio, one or more partners may get
extra share of profits which is compensated by the other partners, who is
losing on account of such change.
The accounting treatment for change in profit-sharing ratio includes the
following adjustments:
a) Calculation of gaining and sacrificing ratio
b) Accounting treatment of goodwill
c) Accounting treatment of reserves and accumulated profit/loss
d) Revaluation of assets and reassessment of liabilities
e) Adjustment of capital
f) Preparation of reconstituted Balance Sheet
a) Calculation of gaining and sacrificing ratio :
Gaining Ratio:
It is the ratio in which the remaining partners gain some share from other
partner(s) or the outgoing partner’s share of profit.
It is equal to the difference between the new share and old share of the old
partner/s.
Formula:
Gaining share of a partner = new share- old share
Sacrificing Ratio:
It refers to the ratio in which the old partner(s) sacrifices some of their share of
profit in favour of new partner(s).
It is equal to the difference between the old share and the new share of the old
partner/s.
Formula:
Sacrificing share of a partner = old share- new share
Example: A, B and C are partners in a firm sharing profits in the ratio of 3: 2:
1. Their capitals on 1st April 2022 were Rs.5,00,000; Rs.3,00,000 and
Rs.2,00,000. With effect from 1st April 2022 they decided to share the profits
in the ratio of 1: 1: 1. This change in profit sharing ratio will result into the
reconstitution of the firm. Calculate gaining and sacrificing ratio.
Soln.:
Old ratio of partners: A: B: C =3: 2: 1
New ratio of partners: A: B: C =1: 1: 1
A B C
Old share: 3/6 2/6 1/6

New share: -1/3 -1/3 -1/3

Difference in share: +1/3 NIL -1/3
Sacrifice No gain or sacrifice Gain
So, A sacrifices 1/3 share of profit & C gains 1/3 share of profit
In other words, share of partner ‘A’ decreases and share of another partner ‘C’
increases.
b) Accounting treatment of goodwill:
Goodwill is also adjusted at the time of change in profit sharing ratio of the
partners. Goodwill refers to the reputation build by a business. It is the super
profit earning capacity of a business. It is the difference between the fair or
market value of the net assets of the partnership and their book value. The
compensation paid by gaining a partner to sacrificing partner is known as
“goodwill” or “premium for goodwill”. This compensation is paid in their
sacrificing ratio by the partner(s) who gains to the partner(s) who sacrifices.
Treatment of goodwill:
The compensation for share of goodwill is paid in their sacrificing ratio by the
partner(s) who gains to the partner(s) who sacrifices.
Amount of compensation = value of a firm’s goodwill X share of profit
gained
A. When goodwill is adjusted through partners’ capital account :
(i) In the case of fluctuating capital:
Gaining a partner’s capital A/Cs----------Dr. XX
To sacrificing partner’s capital A/Cs XX

(ii) In the case of fixed capital:

Gaining a partner’s Current A/Cs----------Dr. XX
To sacrificing partner’s Current A/Cs XX

B. When the goodwill account is opened:

(i) Goodwill A/c ------------Dr. XX
To partners’ capital/current A/cs XX

Note : In case any goodwill is appearing in the books then this goodwill is to
be written off because the fresh valuation of goodwill is made due to change
of profit sharing ratio. If existing goodwill is not written off, it will lead to an
accounting of goodwill twice up to the extent of existing goodwill.
The following entry is to be made:
(i) Entries to write off goodwill appearing in the books(Old Balance Sheet):
All partners’ capital/current A/Cs…Dr (in the old ratio) XX
To Goodwill A/c (with the existing value of goodwill) XX
(ii)Entries to adjust goodwill share gained:
Gaining a partner’s capital/current A/Cs----------Dr. XX
To sacrificing partner’s capital/ current A/Cs XX

c) Accounting treatment of reserves and accumulated profit/loss :

When there is change in existing ratio, any reserves and accumulated profits
or losses shall be shared by old partners in old ratio.
All free reserves and profits (like General Reserves, Profit and Loss Account,
etc.) given in the liabilities side should be credited to all partners’ capital
accounts (when capitals fluctuating) or Current Accounts (if capitals are
fixed).
All fictitious Assets/Accumulated losses (like Profit and Loss Account, etc.)
given in the asset side should be debited to all partners’ capital accounts (when
capitals fluctuating) or Current Accounts (if capitals are fixed).
A new partner is not entitled to any share in such accumulated balances of the
firm while transferring these reserves and profits/ losses to the partners’
capital accounts, as these Reserves and profits/losses are only for old partners
and should be transferred to them only, in old ratio.
Journal entries for treatment of reserves and accumulated profit/losses:
(i)For transfer of reserves and accumulated profits:
General Reserves A/c---------------Dr XX
Profit and loss A/c (Cr balance) ---Dr XX
Workmen compensation A/c-------Dr XX
Investment fluctuation reserve A/c---Dr
To all partner’s capital/current A/cs XX
(ii)For transfer of reserves and accumulated losses:
All partners’ capital/current A/cs------Dr XX
To Profit and loss A/c (Dr Balance) XX
To deferred revenue expenditure A/c XX
To Advertisement suspense A/C XX
(a)Specific treatment of workmen compensation reserves (WCR)
Workmen Compensation reserve is a special reserve besides free reserves to
be paid for any accident happen to workmen at the workplace. It may or may
not arise or if arises claim may be equal to, higher or lower than the amount of
reserve.
When a claim against WCR does not exist, the amount of Workmen
compensation reserves is transferred to the partner’s capital account in their
old profit-sharing ratio.
(i) Entry for distribution of WCR when claim does not exist:
Workmen compensation Reserve A/c --------Dr XX
To all partner’s capital/current A/c XX
(Being WCR is transferred to partner’s capital/current a/c)
(ii) Entry for distribution of WCR when claim exist:
(a)When a claim against WCR exist and claim = WCR
Workmen compensation reserve A/c --------Dr XX
 To provision for Workmen compensation claim A/c XX
(b)When a claim against WCR exist and claim > WCR
(i) Entry for excess claim after adjusting WCR:
Workmen compensation reserve A/c --------Dr XX
Revaluation A/c --------------------------------Dr XX
To provision for Workmen compensation claim A/c XX
(ii) Entry for distributing revaluation loss:
Partner’s capital/current A/c---------Dr XX
To Revaluation A/c XX
To provision for Workmen compensation claim A/c XX
(c)When a claim against WCR exist and claim < WCR
(i) Entry for settlement of claim after adjusting WCR:
Workmen compensation reserve A/c --------Dr XX
To provision for workmen compensation claim A/c XX
To partner’s capital/current A/cs XX

(b)Specific treatment of Investment Fluctuation Reserve (IFR):

Investment Fluctuation Reserve is a special reserve created out of the profits to
meet the fall in the market value of investments. Excess of Investment
Fluctuation Reserve over the difference between book value and market value
is credited to old partners in their old profit-sharing ratio.
When book value and market value are the same, the amount of IFR is
transferred to Old partner’s capital (if capital is fluctuating) or Current
Accounts (if capital is fixed) in their old profit-sharing ratio when the market
value of the investment is less than the book value.
If there is any fall in value is less than the reserve, IFR, to the extent of fall
in the value, is transferred to Investment Account and the balance is
distributed among the old partners in their old profit-sharing ratio
If the fall in value is equal to reserve, the amount of IFR is transferred to
Investment Account and no amount is distributed among the old partners
If the fall in value is more than the reserve, the amount in excess of the
amount of Investment Fluctuation Reserve is debited to Revaluation Account.
(a) Entry for distribution of IFR after adjusting difference between book
value and market value of investment when IFR is excess:
Investment fluctuating reserve A/c --------Dr XX
To all partner’s capital/current A/cs XX
(b) Entry for transferring to IFR for difference between book value and
market value of investment when IFR is less:
(i)For transferring amount to IFR for shortage:
Revaluation A/c --------Dr XX
To Investment fluctuating reserve A/c XX
(ii) For distributing revaluation loss:
All partner’s capital/current A/cs A/c --------Dr XX
To Revaluation A/c XX
Note: Do not distribute the following:
1.E.P.F or employee provident fund 2. Taxation reserve
3. Machinery replacement fund

d) Revaluation of assets and Re-assessment of liabilities :

When partners decide to change their existing ratio, a separate account is
opened, which is known as Profit and Loss Adjustment Account or
Revaluation Account to make the revaluation of assets and re-assessment of
liabilities. Revaluation Account (Nominal account) is a temporary account
opened when assets are revalued and liabilities are reassessed and cancelled
after distribution of profit or loss among partners.
Entries are recorded on Revaluation of assets and Re-assessment of liabilities:
1. For increase in the value of assets :
Asset A/c -------Dr. XX
To Revaluation A/c XX
2. For Decrease in the value of assets :
Revaluation A/c ------Dr. XX
To Asset A/c XX
3. For increase in the value of liabilities :
Revaluation A/c -----Dr. XX
To Liability A/c XX
4. For Decrease in the value of liabilities :
Liability A/c -----Dr XX
To Revaluation A/c XX
5. When unrecorded assets are recorded :
Asset A/c -------Dr XX
To Revaluation A/c XX
6. When unrecorded liabilities are recorded :
Revaluation A/c ----Dr XX
To Liability A/c XX
7. When profit on revaluation transferred to all partners in old ratio :
Revaluation A/c ----Dr XX
To All partners Capital A/c’s XX
8. When loss on revaluation transferred to all partners on old ratio :
All partner’s Capital A/c’s ------Dr XX
To Revaluation A/c XX
Proforma of Revaluation Account:
Dr. Cr.
Particulars Amount Particulars Amount
(Rs.) (Rs.)
To Increase in value of By Decrease in value of
liabilities XX liabilities XX
To Decrease in value of By Increase in value of
assets XX assets XX
To unrecorded liabilities XX By unrecorded assets XX
To All partners’capitalA/c
A- XX
B- XX
C- XX XX
(profit distributed)
 XX XX
Note: if there will be loss, then the loss distributed among all partners and
posted in opposite side (credit side).
e) Adjustment of capital :
When all partners agreed to adjust their old capital after all the above
adjustment and make their new capital according to their new profit sharing
ratio, then new capital will be calculated as per new agreement by preparing
partners’ capital Account(if capital is fluctuating) or partners’ current
Account(if capital is fixed) and any shortage or excess of capital either
brought in or paid in cash or transferred to current account as decided in the
agreement.
The following entry is to be made:
(i) Entries for shortage of capital of partners:
Bank /All partners’ current A/Cs XX
To All partners’ capital A/Cs XX
(i) Entries for excess capital of partners:
All partners’ capital A/C XX
To Bank /All partners’ current A/Cs XX
f) Preparation of reconstituted Balance Sheet:
Finally, reconstituted Balance Sheet will be prepared in the case of change in
existing ratio where all new value of assets, new value of liabilities and new
capital of all partners will be shown. All the necessary adjustments is made
first and then prepare the necessary accounts which are affected by the change
in ratio, after that New Balance Sheet will be prepared in the firm after
reconstitution.
NEW BALANCE SHEET
Particulars Amount Particulars Amount
(Rs.) (Rs.)
All Liabilities at new XX All assets at new value XX
value
All Partners’ new capital XX
XX XX
Note : When all partners agreed to adjust their capital for change in profit
sharing ration but decided to show all the items in their old value without
showing at new value, then the gaining share of profit or loss is compensated
by the partner(s) who gain to the partner who sacrifice.

PROBLEM-1: X, Y and Z are partners in a firm sharing profits in the ratio of

3: 2: 1. Their capitals on 1st April 2022 were Rs.5,00,000; Rs.3,00,000 and
Rs.2,00,000. With effect from 1st April 2022 they decided to share the profits
in the ratio of 1: 1: 1. This change in profit sharing ratio will result into the
reconstitution of the firm. The goodwill of the firm valued at Rs. 60,000. The
partners maintain fluctuating capital. Calculate gaining and sacrificing ratio
and pass adjustment entry for goodwill.
Soln.:
Old ratio of partners: X: Y: Z =3: 2: 1
New ratio of partners: X: Y: Z =1: 1: 1
X Y Z
Old share: 3/6 2/6 1/6

New share: -1/3 -1/3 -1/3

Difference in share: +1/3 NIL -1/3
Sacrifice No gain or sacrifice Gain
So, X sacrifices 1/3 share of profit & Z gains 1/3 share of profit
Total goodwill of the firm = 60,000
Share of goodwill of X to be given by Z= 60,000 X 1/3 = 20,000
Entries to adjust Goodwill:
Z’s Capital A/C -------Dr. 20,000
To X’s Capital A/C 20,000
(Being goodwill share compensated by Z to X)
PROBLEM-2: X, Y and Z are partners in a firm sharing profits in the ratio of
3: 2: 1. Their capitals on 1st April 2022 were Rs.5,00,000; Rs.3,00,000 and
Rs.2,00,000. With effect from 1st April 2022 they decided to share the profits
in the ratio of 1: 1: 1. This change in profit sharing ratio will result into the
reconstitution of the firm. In Balance Sheet the General Reserve in liability
side is Rs. 30,000 and Profit and Loss Account in asset side is Rs. 24,000. The
partners maintain fluctuating capital. Pass journal entries for distribution of
accumulated profit or loss.
Soln.
Journal entries for treatment of reserves and accumulated profit/losses:
(i)General Reserves A/c---------------Dr 30,000
To X’s capital A/cs 15,000
To Y’s capital A/cs 15,000
To Z’s capital A/cs 15,000
(Being accumulated profit distributed among all partners)
(ii)X’s capital A/cs 12,000
Y’s capital A/cs 8,000
Z’s capital A/cs 4,000
To Profit and loss A/c (Dr balance) 24,000
(Being accumulated loss distributed among all partners)
PROBLEM-3: X, Y and Z are partners in a firm sharing profits in the ratio of
3: 2: 1. Their capitals on 1st April 2022 were Rs.5,00,000; Rs.3,00,000 and
Rs.2,00,000. With effect from 1st April 2022 they decided to share the profits
in the ratio of 1: 1: 1. This change in profit sharing ratio will result into the
reconstitution of the firm with following terms:
The building value increased from Rs. 50,000 to new value Rs 80,000
The furniture value decreased from Rs. 40,000 to new value Rs.30,000
The creditors increased from Rs. 20,000 to new value Rs.36,000
The Bills payable value decreased from Rs. 30,000 to new value Rs.10,000
An unrecorded claim for damages to be taken as Rs. 12,000
The partners maintain fluctuating capital. Pass journal entries for revaluation
of assets and reassessment of liabilities Prepare Revaluation A/C.
Soln.
Entries are recorded on Revaluation of assets and Re-assessment of liabilities:
1.Building A/c -------Dr. 30,000
To Revaluation A/c 30,000
(Being increase in the value of building recorded)
2. Revaluation A/c ------Dr. 10,000
To Furniture A/c 10,000
(Being decrease in the value of furniture recorded)
3. Revaluation A/c -----Dr. 16,000
To Creditors A/c 16,000
(Being increase in the value of creditors recorded)
4. Bills payable A/c -----Dr 20,000
To Revaluation A/c 20,000
(Being decrease in the value of bills payable recorded)
5. Revaluation A/c ----Dr 12,000
To Claim for damages A/c 12,000
(Being unrecorded liabilities recorded)

7. When profit on revaluation transferred to all partners in old ratio :

Revaluation A/c ----Dr 12,000
To X’s Capital A/c’s 6,000
To Y’s Capital A/c’s 6,000
To Z’s Capital A/c’s 6,000
(Being the profit on revaluation transferred to all partners in old ratio)
Ledger:
Revaluation Account:
Dr. Cr.
Particulars Amount Particulars Amount
(Rs.) (Rs.)
 To Furniture A/c 10,000 By Building A/c 30,000
To Creditors A/c 16,000 By Bills Payable a/c 20,000
To claim for damages A/c 12,000
To Partners’capital A/c
X- 6,000 12,000
Y- 4,000
Z- 2,000
(profit distributed)
50,000 50,000

PROBLEM-4: K, P and S are partners sharing profit and losses in the ratio 5:
2 : 1, decided to share future profit in the ratio 1:2:5 from 1st. Apr. 2022. They
decided to record the effect of the following items without affecting their book
value, by passing single adjustment entry.
i) General Reserve Rs. 40,000
ii) Profit and Loss A/C (Dr balance) Rs. 16,000
iii) Defered Revenue Expenses A/c Rs. 8,000
Soln.
Journal entries:
S’s Capital A/C -------Dr. 12,000
To P’s Capital A/C 12,000
(Being net accumulated profit compensated by S to P)

Old ratio of partners: X: Y: Z =3: 2: 1

New ratio of partners: X: Y: Z =1: 1: 1
K P S
Old share: 5/8 2/8 1/8
New share: -1/8 -2/8 -5/8
Difference in share: +4/8 NIL -4/8
Sacrifice No gain or sacrifice Gain
So, K sacrifices 4/8 share of profit & S gains 4/8 share of profit
Net accumulated profit of the firm:
 General Reserve Rs. 40,000
Less : Profit and Loss A/C (Dr balance) (Rs. 16,000)
Less : Defered Revenue Expenses A/c (Rs. 8,000)
Net accumulated profit= 16,000
Share of profit of P to be given by S= 24,000 X 4/8 = 12,000

PROBLEM-5:
X & Y are partners sharing profits in 4 : 3 ratio. Their Balance Sheet as on
31st.Mar.2022 was as follows :

Liabilities Amount Assets Amount

(Rs.) (Rs.)
Sundry Creditors 23,000 Cash 1,800
General Reserve 7,000 Bank 13,000
Capitals : Debtors 30,500
X 70,000 Less : Provision for
Y 70,000 1,40,000 bad debt 300 30,200
Stock 25,000
Plant 40,000
Building 60,000
1,70,000 1,70,000

They agreed to share profit in 1: 1 ratio from 1st. April 2022 with the
following terms:
i) Building is to be appreciated by Rs.7,000 and Plant depreciated by
Rs.3,000.
ii) The provision for debtors to be raised from Rs. 300 to Rs.800.
iii) The total goodwill of the firm is valued at Rs.28,000. The goodwill will
not to be shown in new balance sheet. They decided to keep their capital Rs.
80,000 each as per new ratio. Any shortage or surplus they brought in or paid
cash accordingly.
Prepare: (a) Revaluation A/C
(b) Partners’ Capital A/C
(c) Balance Sheet after reconstitution.
Soln.
1.Revaluation Account:
 Dr. Cr.
Particulars Amount Particulars Amount
(Rs.) (Rs.)
To Plant A/c 3,000 By Building A/c 7,000
To Provision for bad debt A/c
To Partners’capital A/c 500
X- 2,000
Y- 1,500 3,500
(profit distributed)
7,000 7,000

Soln.
2.Partners’ Capital Account:
Dr. Cr.
Particulars X Y Particulars X Y
(Rs.) (Rs.) (Rs.) (Rs.)
To X’s capital A/c 2,000 By Balance b/d 70,000 70,000
By General Reserve
A/c 4,000 3,000
By Revaluation A/C 2,000 1,500
By Y’s Capital A/c 2,000
To Balance c/d 76,000 74,500
78,000 74,500 78,000 74,500
By Balance b/d 76,000 74.500
To Balance c/d 80,000 80,000 By Cash A/C 4,000 5,500

80,000 80,000 80,000 80,000

3.Balance Sheet
as at 1st.Apr.2022
Liabilities Amount Assets Amount
(Rs.) (Rs.)
 Sundry Creditors 23,000 Cash 11,300
Capitals : Bank 13,000
X 80,000 Debtors 30,500
Y 80,000 1,60,000 Less : Provision for
bad debt 800 29,700
Stock 25,000
Plant 37,000
Building 67,000
1,83,000 1,83,000

Working Note : for goodwill treatment :

Old ratio of partners: X: Y =4: 3
New ratio of partners: X: Y=1: 1
X Y
Old share: 4/7 3/7

Less :New share: -1/2 -1/2

Difference in share: +1/14 -1/14
Sacrifice Gain
So, X sacrifices 1/14 share of profit & Y gains 1/14 share of profit
Total goodwill of the firm = 28,000
Share of goodwill of X to be given by Y= 28,000 X 1/14 = 2,000
Entries to adjust Goodwill:
Y’s Capital A/C -------Dr. 2,000
To X’s Capital A/C 2,000
(Being goodwill share compensated by Y to X)