Reconstitution of Partnership Firm
Change in Profit-Sharing Ratio (Part A)
Sacrificing ratio, gaining ratio, treatment of reserves and accumulated profits, revaluation of assets and liabilities, and adjustment of capitals — everything on change in PSR among existing partners. Goodwill (nature, valuation and its treatment) is covered separately in Part B.
Same Firm, New Agreement — Purani Deal Khatam, Nayi Deal Shuru
Jab existing partners apna profit-sharing ratio change karte hain, the old agreement ends and a new one begins — this is reconstitution. The firm continues, partners are the same, but ab ek partner apna share sacrifice kar raha hai aur doosra gain. So everything the firm has earned till today — reserves, hidden profits in assets — must first be settled in the old ratio, kyunki wo purani mehnat ka result hai.
1. Reconstitution of Partnership
Reconstitution of a partnership firm means a change in the existing agreement among partners. The old partnership agreement comes to an end and a new agreement takes its place, but the firm continues — it is not dissolved. Reconstitution takes place in four situations:
Change in Profit-Sharing Ratio
Existing partners mutually decide to change their PSR — the subject of this chapter.
Admission of a Partner
A new partner joins the firm (Section 31, Indian Partnership Act, 1932).
Retirement of a Partner
An existing partner leaves the firm (Section 32).
Death of a Partner
The partnership is reconstituted among the remaining partners.
2. Change in Profit-Sharing Ratio Among Existing Partners
When existing partners agree to share future profits in a new ratio, effectively one partner purchases a share of profit from another. The partner whose share decreases is the sacrificing partner; the partner whose share increases is the gaining partner. This change gives rise to four accounting issues: (i) treatment of goodwill (covered in Part B), (ii) reserves and accumulated profits/losses, (iii) revaluation of assets and re-assessment of liabilities, and (iv) adjustment of capitals.
3. Sacrificing Ratio and Gaining Ratio
Why calculate these ratios? The gaining partner must compensate the sacrificing partner — mainly for goodwill (Part B me detail) and for adjustments of reserves or revaluation when book values are not to be changed. Trick to remember: S = O − N (“SON”) and G = N − O.
Solution (make denominators equal — LCM of 10 and 3 is 30): Old ratio = 15/30, 9/30, 6/30. New ratio = 10/30 each.
| Partner | Old Share | New Share | Old − New | Result |
|---|---|---|---|---|
| A | 15/30 | 10/30 | + 5/30 | Sacrifice 5/30 (i.e. 1/6) |
| B | 9/30 | 10/30 | − 1/30 | Gain 1/30 |
| C | 6/30 | 10/30 | − 4/30 | Gain 4/30 |
4. Treatment of Reserves and Accumulated Profits / Losses
Reserves, accumulated profits and losses appearing in the books on the date of change belong to the partners in the OLD ratio, because they were earned before the change. Two treatments are possible:
Case 1 — When they are distributed (default treatment)
| Item in Balance Sheet | Journal Entry (in OLD ratio) |
|---|---|
| General Reserve, Reserve Fund, P&L A/c (Cr.), Workmen Compensation Reserve (excess over claim) | Reserve / P&L A/c Dr. → To Partners’ Capital A/cs |
| P&L A/c (Dr. balance), Deferred Revenue Expenditure, Advertisement Suspense A/c | Partners’ Capital A/cs Dr. → To P&L A/c / Advertisement Suspense A/c |
Special reserves — exam favourites
| Reserve | Situation | Treatment |
|---|---|---|
| Workmen Compensation Reserve (WCR) | No claim | Entire WCR distributed in old ratio |
| Claim < WCR | Claim portion → Workmen Compensation Claim A/c (liability); balance distributed in old ratio | |
| Claim > WCR | Entire WCR → Claim A/c; the deficit is debited to Revaluation A/c | |
| Investment Fluctuation Reserve (IFR) | Fall in value of investments < IFR | IFR up to the fall → credited to Investments A/c; balance distributed in old ratio |
| Fall in value > IFR | Entire IFR set off against the fall; excess fall debited to Revaluation A/c |
Case 2 — When reserves are to CONTINUE in the books
If partners decide not to disturb the book figures, a single adjustment entry is passed for the NET effect: Gaining Partner’s Capital A/c Dr. → To Sacrificing Partner’s Capital A/c, with the amount = Net reserves/profits × share sacrificed.
| Date | Particulars | L.F. | Dr. (₹) | Cr. (₹) |
|---|---|---|---|---|
| 2026 Apr 1 | General Reserve A/c Dr. | 60,000 | ||
| Profit & Loss A/c Dr. | 30,000 | |||
| To R’s Capital A/c (3/5) | 54,000 | |||
| To S’s Capital A/c (2/5) | 36,000 | |||
| (Being reserve and accumulated profit of ₹90,000 distributed in the old ratio 3 : 2) | ||||
| Apr 1 | R’s Capital A/c Dr. | 9,000 | ||
| S’s Capital A/c Dr. | 6,000 | |||
| To Advertisement Suspense A/c | 15,000 | |||
| (Being accumulated loss written off in the old ratio 3 : 2) | ||||
Working: X sacrifices 3/5 − 2/5 = 1/5; Y gains 1/5. Adjustment amount = 50,000 × 1/5 = ₹10,000.
| Date | Particulars | L.F. | Dr. (₹) | Cr. (₹) |
|---|---|---|---|---|
| Y’s Capital A/c Dr. | 10,000 | |||
| To X’s Capital A/c | 10,000 | |||
| (Being adjustment for general reserve on change in profit-sharing ratio, reserve continuing in the books) | ||||
5. Revaluation of Assets and Re-assessment of Liabilities
On the date of change, assets and liabilities may be revalued so that the gain or loss till that date goes to the partners in the old ratio. A Revaluation Account (also called Profit & Loss Adjustment Account) is prepared — it is a nominal account.
| Debit Side of Revaluation A/c | Credit Side of Revaluation A/c |
|---|---|
| Decrease in value of assets | Increase in value of assets |
| Increase in liabilities | Decrease in liabilities |
| Unrecorded liabilities recorded now | Unrecorded assets recorded now |
| Profit on revaluation → transferred to Capital A/cs (old ratio) | Loss on revaluation → transferred to Capital A/cs (old ratio) |
| Dr. — Particulars / ₹ | Cr. — Particulars / ₹ | ||
|---|---|---|---|
| To Stock A/c | 8,000 | By Building A/c | 30,000 |
| To Provision for Doubtful Debts A/c | 2,000 | ||
| To Outstanding Repairs A/c | 5,000 | ||
| To Profit transferred to Capital A/cs: P (3/5) 9,000 Q (2/5) 6,000 | 15,000 | ||
| Total | 30,000 | Total | 30,000 |
6. Adjustment of Capitals
Partners may decide that after the change, their capitals should be in proportion to the new profit-sharing ratio. Steps: (1) compute the total capital of the firm (given, or sum of adjusted old capitals), (2) divide it in the new ratio to get each partner’s required capital, (3) compare with actual adjusted capital — surplus is withdrawn (or credited to Current A/c), deficit is brought in (or debited to Current A/c).
Working: Required capital (1 : 1) = ₹3,00,000 each. M has surplus 3,50,000 − 3,00,000 = ₹50,000 (withdraw). N has deficit 3,00,000 − 2,20,000 = ₹80,000 (bring in).
| Date | Particulars | L.F. | Dr. (₹) | Cr. (₹) |
|---|---|---|---|---|
| M’s Capital A/c Dr. | 50,000 | |||
| To Bank A/c | 50,000 | |||
| (Being surplus capital withdrawn by M) | ||||
| Bank A/c Dr. | 80,000 | |||
| To N’s Capital A/c | 80,000 | |||
| (Being deficit capital brought in by N) | ||||
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20 MCQs — Change in Profit-Sharing Ratio (Part A)
Mixed difficulty — theory, application, and CUET-level numericals in Q17–Q20. Goodwill-based MCQs are in Part B.
Chapter 2 (Part A) — Live Quiz
20 questions · Change in Profit-Sharing Ratio · One at a time · Instant feedback
