Reconstitution of partnership firm

Partnership agreement defines the relationship among the partners and whenever there
is a change in relationship, it results in reconstitution of the firm.

In other words, any change in existing agreement of the partnership is reconstitution of

the firm. As a result, existing agreement comes to an end and new agreement comes into
existence. But the firm continues.

A firm is reconstituted, whenever there is a

a) Change in the profit sharing ratio among the existing partners.
b) Admission of new partner.
c) Retirement of an existing partner.
d) Death of a partner.
e) Amalgamation of two partnership firms.
 Change in profit sharing ratio among the existing partners

1. Sacrifice ratio: refer to the ratio in which the partners surrender their share of profit
in favor of other partners. The part of share which is surrendered is know as sacrifice
ratio. It is calculated as follows :

Sacrifice Ratio = Old Ratio – New Ratio

1. Gaining Ratio: as a result of change in the profit sharing ratio, any one or more than one
partner receive a share of profit from the other partner/partners. The share of profit
received is known as gaining ratio.

Gaining Ratio = New Ratio – Old Ratio

Q.1 A, B and C are partners in a firm sharing profit and loss in the Ratio of 3 : 2 : 1. they decided to
share profit and loss in the ratio of 2 : 2 : 1 from 1st Jan., 2017 onwards. Determine each partner’s
gain and sacrifice ratio.

Solution : Old Ratio = A, B and C = 3 : 2 : 1

New Ratio = A, B and C = 2 : 2 : 1

Sacrifice/(Gaining) Ratio = Old Ratio – New Ratio

A’s share = 3 – 2 15 – 12 = 3
= (sacrifice)
6 5 30 30
B’s share = 2 – 2 10 – 12 = -2
= (Gain)
6 5 30 30
C’s share = 1 – 1 = 5–6 = -1
(Gain)
6 5 30 30
Q.2 A, B and C are partners in a firm sharing profit and loss in the Ratio of 3 : 3 : 2. they decided to
share profit and loss equal ratio from 1st Jan., 2017 onwards. Determine each partner’s gain and
sacrifice ratio.

Solution : Old Ratio = A, B and C = 3 : 3 : 2

New Ratio = A, B and C = 1 : 1 : 1

Sacrifice/(Gaining) Ratio = Old Ratio – New Ratio

3 – 1 = 9–8 = 1 (sacrifice)
A’s share =
8 3 24 24
3 – 1 = 9–8 = 1 (sacrifice)
B’s share =
8 3 24 24
2 6–8 -2
C’s share = – 1 = = (Gain)
8 3 24 24
Q.3 A, B and C are equal partners in a firm. They decided to share profit and loss in the ratio of
3 : 3 : 2 from 1st Jan., 2017 onwards. Determine each partner’s gain and sacrifice ratio.

Solution : Old Ratio = A, B and C = 1 : 1 : 1

New Ratio = A, B and C = 3 : 3 : 2

Sacrifice/(Gaining) Ratio = Old Ratio – New Ratio

1 – 3 = 8–9 = -1 (Gain)
A’s share =
3 8 24 24

B’s share = 1 – 3 = 8–9 = -1 (Gain)

3 8 24 24

1 – 2 = 8–6 = 2 (Sacrifice)
C’s share =
3 8 24 24
 Accounting Treatment of Goodwill

At the time of change in profit sharing ratio gaining partner should compensate the sacrificing
partners by payment of goodwill to him in the gaining ratio.

Following entry pass to adjustment of goodwill:

Gaining partners’ capital/current A/c Dr

To Sacrificing partners’ capital/current A/c
Q.4 A, B and C are equal partners in a firm. They decided to share profit and loss in the ratio of
3 : 3 : 2 from 1st Jan., 2017 onwards. The goodwill of the firm valued at Rs. 30,000. Pass journal
entry for the accounting of goodwill.

Solution
W.N. Sacrifice/(Gaining) Ratio = Old Ratio – New Ratio
1 – 3 = 8–9 = -1
A’s share = (Gain)
3 8 24 24
1 – 3 = 8–9 -1
B’s share = = (Gain)
3 8 24 24

1 – 2 = 8–6 = 2
C’s share = (Sacrifice)
3 8 24 24

Since C has sacrificed 2/24th share so A and B compensate to ‘C’ 1/24 and 1/24

C’s sacrifice share in goodwill = 30000 x 2/24 = 2500

A’ gaining share in goodwill = 30000 x 1/24 = 1250

B’ gaining share in goodwill = 30000 x 1/24 = 1250

 Journal entry

Date Particular L.F. Amount (Dr) Amount (Cr)

2017 A’S Capital A/c Dr 1,250
Jan. 1 B’s Capital A/c Dr 1,250
To C’s Capital A/c 2,500
(being the goodwill Adjusted on change in the
profit sharing ratio
Q.5 X, Y and Z share profit and loss in the ratio of 5 : 3 : 2. They decided to share profit and loss in
the ratio of 4 : 4 : 2 from 1st Jan., 2019 onwards. The goodwill of the firm valued at two year
purchase of the average profit of the preceding five years. The profit and loss of the preceding five
year are : 2011-12 Rs. 70,000; 2012-13 Rs. 85,000; 2013-14 Rs. 45,000; 2014-15 Rs. 35,000 and 2015-
16 Rs. 10,000 (Loss). You are required to calculate goodwill and pass journal entry.

Solution :
W.N. 1 calculation of goodwill
Goodwill = 70,000 + 85,000 + 45,000 + 35,000 – 10,000 X2 = 90,000
5
W.N. 2 Sacrifice/(Gaining) Ratio = Old Ratio – New Ratio
5 4 5–4 1
X’s share =
10 – 10 = 10 = 10 (Sacrifice)

Y’s share = 3 4 3– 4 -1
– = = (Gain)
10 10 10 10
Z’s share = 2 2 2– 2 0
– = = 10 (No Sacrifice/gain)
10 10 10
Since X has sacrificed 1/10th share, he will we compensated with Rs. 9,000 (i.e. Rs. 90,000 x 1/10) for
goodwill By Y.
 Journal Entry

Date Particular L.F. Amount (Dr) Amount (Cr)

2017 Y’s Capital A/c Dr 9000
Jan 9000
To X’s Capital A/c
(being the goodwill adjusted on change in the profit
sharing ratio)
Q.5 P, Q and R share profit and loss in the ratio of 5 : 3 : 2. They decided to share further profit and
loss in the ratio of 4 : 4 : 2.. The goodwill of the firm valued at Rs. 40,000 . Goodwill already
appeared in the books of the firm at Rs. 60,000. Pass necessary journal entry.

Solution :
W.N. 2 Sacrifice/(Gaining) Ratio = Old Ratio – New Ratio

P’s share = 5 4 5–4 1

– = = (Sacrifice)
10 10 10 10

Q’s share = 3 4 3–4 -1

(Gain)
10 – 10 = 10 = 10

2 2 2–2 0
R’s share =
10 – 10 = 10 = 10 (No Sacrifice/gain)

Since P has sacrificed 1/10th share, he will we compensated with Rs. 4,000 (i.e. Rs. 40,000 x 1/10) for
goodwill By Q.
 Journal entry

Date Particular L.F. Amount (Dr) Amount (Cr)

1. P’s Capital A/c Dr 30,000
Q’s Capital A/c Dr 18,000
R’s Capital A/c Dr 12,000
To Goodwill A/c 60,000
(being old goodwill written off by Debiting all partners
capital account in their old ratio i.e. 5 : 3 : 2 )
2. Y’s Capital A/c Dr 4000
To X’s Capital A/c 4000
(being the goodwill adjusted on change in the profit
sharing ratio)
 Undistributed reserves and accumulated profit
At the time of change in existing profit sharing ratio; admission of a new partner; retirements and
death of a partner existing undistributed reserves and accumulated profit can be adjusted by the two
following methods:

1. (a) When undistributed reserves and accumulated profit & loss accounts are closed by
transferred to old partners capital/current account in their old ratio.
General reserve A/c Dr
profit and loss (Cr) a/c Dr
Workman compensation reserve A/c Dr
Investment fluctuation fund A/c Dr
To old partners capital/Current A/c

(b) Transfer of undistributed Losses:

Old partners capital A/c Dr
To Profit and loss A/c (Debit bal.)
2. When undistributed reserves and accumulated profit & loss accounts are not closed by
transferred to old partners capital/current account in their old ratio i.e. these account balances
are carry forward in reconstituted firm.
(a) entry for positive effect (profit)

Gaining partners’ capital/current A/c Dr

To Sacrificing partners’ capital/current A/c

(b) entry for negative effect (Loss)

Sacrificing partners’ capital/current A/c Dr

To Gaining partners’ capital/current A/c
Q.6 A,B and C are partners sharing profit and loss account in the ration of 4 : 3 : 2. on 1st April 2017
they decided to share profit and loss equally. On that date the books of account shows Rs.
1,80,000 in general reserve and Rs. 60,000 in workman companion fund and debit balance of Rs.
45,000 in profit and loss account. Pass journal entry for the above treating that the above may be
transfer to partners capital account.
Solution: Journal entry
Date Particular L.F. Amount (Dr) Amount (Cr)
1. General reserve A/c Dr 1,80,000
Workman compensation fund A/c Dr 60,000
To A’s Capital A/c 1,06,667
To B’s Capital A/c 80,000
. To C’s Capital A/c 53,333
(Being general reserve, workman compensation fund
transfer to partner capital account in their Old Ratio i.e.
4 : 3 : 2)

2. A’s Capital A/c Dr 20,000

B’s Capital A/c Dr 15,000
C’s Capital A/c Dr 10,000
To Profit and Loss A/c 45,000
(Being debit balance of profit and loss transfer to
partner capital account in their Old Ratio i.e. 4 : 3
: 2)
Q.7. A B AND C are partners sharing profit and loss account in the ration of 4 :3 : .2. on 1st april
2017 they decided to share profit and loss equally. On that date the books of account shows Rs.
1,80,000 in general reserve and Rs. 60,000 in workman companion fund and debit balance of Rs.
45,000 in profit and loss account. Pass journal entry for the above treating that the above may not
be transfer to partners capital account.
Solution : (A) Calculation of Net effect of accumulated profit, Losses and Reserves :
Book Value (Rs.)
General Reserve 1,80,000
Workman Compensation Fund 60,000
2,40,000
Less: profit and loss (Dr) 45,000
1,95,000
(B) Sacrifice/gain ratio = old ratio – new ratio

4 1 4–3 1
A’s Share = – = = (Sacrifice)
9 3 9 9
3 1 3–3 0 (No Sacrifice/ gain)
B’s Share = – = =
9 3 9 9
2 1 2–3 -1 (Gain)
C’s Share = – =
9 3 9 9
A sacrifice and C gain so C compensate to A

A’s share = 1,95,000 x 1/9 = 21,667

C’s share = 1,95,000 x 1/9 = 21,667

Journal entry

Date Particular L.F. Amount (Dr) Amount (Cr)

1. C’s Capital A/c Dr 21,667
To A’s Capital a/c 21,667
(Being adjustment of undistributed profit and
losses due to change in profit sharing ratio)
Q.8. A B and C were partners sharing profit and loss account in the ration of 1 :3 : .2. They decided
that with from 1st January, 2017, they will share profits in the ratio of 4 : 6 : 5. for this purpose the
goodwill of the firm is valued at the total of preceding three year’s profits. The profits were: 2012-
Rs. 40,000; 2013- Rs. 10,000 (loss); 2014- Rs. 80,000 (loss); 2015- Rs. 1,20,000; 2016- Rs. 1,40,000.
Reserve and profit appeared in the balance sheet at Rs. 40,000 and Rs. 30,000 respectively. Partners
neither want to show goodwill in the books nor want to distribute the reserves and profits
appearing in the balance sheet. Pass a single journal entry to record the change.

Solution : (A) Goodwill of the firm = 1,40,000 + 1,20,000 – 80,000 = 1,80,000

(B) Calculation of amount to be distributed among the partners :

Book Value (Rs.)
Reserve 40,000
Profit and Loss 30,000
Goodwill 1,80,000
2,50,000
(C) Sacrifice/gain ratio = old ratio – new ratio
1 4 15 – 24 -9 -1
A’s share = – = = OR (Gain)
6 15 90 90 10
3 6 45 – 36 9 1
B’s share = – = = OR (Sacrifice)
6 15 90 90 10
2 5 30 – 30 0
C’s Share = – = = (no Sacrifice/gain)
6 15 90 90

B sacrifice and A gain so A compensate to B

Journal entry
Date Particular L.F. Amount (Dr) Amount (Cr)
1. A’s Capital A/c (2,50,000 x 1/10) Dr 25,000
To B’s Capital a/c 25,000
(Being adjustment of undistributed profit and
losses due to change in profit sharing ratio)
Q.9. A B and C were partners sharing profit and loss account in the ration of 1 :3 : .2. They decided
that with from 1st January, 2017, they will share profits in the ratio of 4 : 6 : 5. for this purpose the
goodwill of the firm is valued at the total of preceding three year’s profits. The profits were: 2012-
Rs. 40,000; 2013- Rs. 10,000 (loss); 2014- Rs. 80,000 (loss); 2015- Rs. 1,20,000; 2016- Rs. 1,40,000.
Reserve and profit appeared in the balance sheet at Rs. 40,000 and Rs. 30,000 respectively. Partners
neither want to show goodwill; reserves and profits in the books. Pass journal entry.

Solution : (A) Goodwill of the firm = 1,40,000 + 1,20,000 – 80,000 = 1,80,000

(B) Sacrifice/gain ratio = old ratio – new ratio

1 4 15 – 24 -9 -1
A’s share = – = = OR (Gain)
6 15 90 90 10
3 6 45 – 36 9 1
B’s share = – = = OR (Sacrifice)
6 15 90 90 10
2 5 30 – 30 0
C’s Share = – = = (no Sacrifice/gain)
6 15 90 90

B sacrifice and A gain so A compensate to B

180000 x 1/10 = 18000
Date Particular L.F. Amount (Dr) Amount (Cr)
1. A’s Capital A/c Dr 18,000
To B’s Capital a/c 18,000
(Being adjustment of goodwill due to change
in profit sharing ratio)

2. Reserve A/c Dr 40,000

Profit and Loss A/c Dr 30,000
To A’s Capital a/c 11,667
To B’s Capital A/c 35,000
To C’s Capital A/c 23,333
(Being reserve and profit transfer to partner
capital account in their Old Ratio i.e. 1 : 3 : 2)