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The new profit sharing ratio refers to the ratio at which partners decide to share profits or losses in the future. When there is a requirement for extra managerial help or for any other reasons, a new partner may be admitted. In such a case, a new partner acquires his profit share from the old partners. Whenever a new partner is permitted entry, he is provided with a right to share the firm’s profits in the future. Due to this, a change must occur in the firm’s old profit sharing ratio.
What is the New Profit Sharing Ratio?
When studying the new profit sharing ratio, we need to focus on two important aspects. These include the new profit sharing ratio and the sacrificing ratio. The new profit sharing ratio is the agreed proportion in which the distribution of the future profit to the firm’s partners (both old and new) is to take place.
This ratio is determined at the time of a new partner’s admission. This is because the new partner has the right to the firm’s future profits. In case the new profit sharing ratio agreement does not occur, there is an equal sharing of profits and losses among the partners.
What is the Sacrificing Ratio?
A sacrifice may come from the old partners regarding a portion of the profit share favouring the new partner. Either all the firm partners may make this sacrifice or only some of them. Sacrificing ratio is the profit proportion that old partners sacrifice to benefit the new partner.
The purpose of sacrificing ratio is the sharing of the goodwill that the new partner brings in. The calculation of the sacrificed share takes place by the deduction of the shares that are new from the old share.
Adjustments that are Required
At the time of admission of a new partner, various types of adjustments are required. These adjustments are as follows:
- Calculation of the sacrificing ratio
- Calculation of the new profit sharing ratio
- Accounting treatment of goodwill
- Accounting treatment of accumulated profit
- Accounting treatment of reserves
- Accounting treatment of accumulated loss
- Accounting treatment of revaluation of assets
- Accounting treatment of reassessment of liabilities
- Adjustment of new profit sharing ratio’s capital
Calculation of New Profit Sharing Ratio
Let us see the calculation of the new profit sharing ratio under different conditions:
When this ratio is given:
In such a case, the calculation of sacrificing ratio must take place as follows:
- Sacrificing ratio = ratio of old partners’ share sacrificed
- Sacrificed share = share that is old – new share
When this ratio is not given:
(a) When we have the sacrificed share:
When this ratio is not given but sacrificed share is given, the calculation can take place as:
- Share that is new of old partner = share that is old – sacrificed share
- New partner share = sum of old partners’ sacrificed shares
(b) When we have the sacrificed share proportion:
(i) When we have the sacrificed share proportion on the old partners’ share:
- Old partner sacrificed share = share that is old x sacrificed share proportion
- Old partner Share that is new = share that is old – sacrificed share
- Share of new partner = sum of old partners sacrificed shares
(ii) When we have the sacrificed share proportion on the new partner’s share:
- Old partner share that is new = share that is old – sacrificed share
- Sacrificed share = new partner’s share × sacrificed share proportion
(c) When we don’t have sacrificed share proportion:
- Sacrificed share = new partner’s share x share that is old
- Old partner share that is new = share that is old – sacrificed share
Conclusion
The new profit sharing ratio is when partners decide to share profits or losses. A new partner gets the right to share the firm’s profits in the future. In this context, one must understand the basics of the new profit sharing ratio and the sacrificing ratio, the various adjustments required when a new partner joins the firm and how the new profit sharing ratio is calculated under different conditions.
