PARTNERSHIP CHANGE IN PROFIT SHARING RATIO

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Albert Malone
5 years ago
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1 PARTNERSHIP CHANGE IN PROFIT SHARING RATIO A firm earned Net Profit during last five years as follows: Rs. 7, Rs. 6, Rs. 8, Rs. 7, Rs. 6, The Capital investment of the firm is Rs. 4,. A fair return on capital in the market is 2%. Find out the value of Goodwill of the business if it is based on three year's purchase of average super profits of the past five years. 7, 6, 8, 7, 6, Solution: Average Profits = = 3, Rs. 7, 2 Normal Profits = 4, = Rs. 4,8 Super Profits Good will = Average Profit Normal Profit = 7, 4,8 = Rs. 2,2 = Super Profits No. of years of purchase = Rs. 2,2 3 = Rs. 6,6 2. A firm earned profits of Rs. 8,, Rs., Rs. 2, and Rs. 6, during 22, 23, 24 & 2 respectively. The firm has capital investments of Rs.,. A fair rate of return on, investment is % p.a. Calculate goodwill of the firm based on three years' purchase of average super profits of last four years. Solution: A. Average Profit = 8,, 2, 6, = Rs., 4 B. Normal profit = Rs., / = Rs. 7, C. Super Profit = Rs., Rs. 7, = Rs. 4, D. Good will = Rs. 4, 3 = Rs. 2, 3. The average net profits expected of a firm in future are Rs. 68, per year and capital invested in the business by the firm is Rs. 3,,. The rate of interest expected from capital invested in this class of business is 2%. The remuneration of the partners of estimated to be Rs. 8, for the year. You are required to find out the value of good will on the basis of two years' purchases of Super-Profits. Solution: Normal Profit = 3,, 2/ + 8, = Rs. 42, + 8, = Rs., Expected Profit = Rs. 68, Super Profits = Rs. 68, Rs., = Rs. 8, Good will = Rs. 8, 2 = Rs. 36, 4. On April st, an existing firm had assets of Rs. 7, including cash of Rs,,. The partner's capital accounts showed a balance of Rs. 6, and reserves constituted the rest. If the normal rate of return is % and the

2 goodwill of the firm is valued at Rs. 24, at 4 years' purchase of super profits, find the average profits of the firm. Normal Rate of Return Solution: Normal Profits = Capital Invested = 7, / = Rs. 7, Good will = Rs. 24, No. of years of purchases = 4 Good will = Super Profits No. of years of purchase Rs. 24, = Super Profits 4 24, Super Profits = 4 = Rs. 6, Super Profits = Average Profits Normal Profits 6, = Average Profits 7, Average Profits = 6, + 7, = Rs. 3,. Divya and Ajinkya were sharing profits in the ratio of 3 : 2. They decided to admit Kamal into the partnership for /6 th share of the future profits. Goodwill, valued at 4 times the average super profits to the firm, was Rs. 8,. The firm had assets worth Rs. lakhs and liabilities Rs. 2 lakhs. The normal earning capacity of such firms is expected to be % p.a. Find the Average Profits/Actual Profits earned by the firm during the last 4 years. Solution: Goodwill = Super Profit No. of years of purchase 8, = Super Profits 4 Super Profit 8, = = Rs. 4, 4 Capital employed = Assets = Rs.,, Rs. 2,, = Rs. 3,, Normal Profit = 3,, / = Rs. 3, Super Profit = Average Profit Normal Profit 4, = Average Profit 3, Average Profit = 4, + 3, = Rs. 34, 6. A firm earn Rs. 6, as its average profits. The rate of normal profit being %. The assets of the firm amount to Rs. 72, and liabilities are Rs. 24,. Calculate the value of goodwill. 6, Solution Capitalized value of firm = = Rs. 6, Net Assets = Assets = 72, 24, = 48, Good will = Capital value Net Assets = Rs. 6, Rs. 48, = Rs. 2, 7. Kevin, Jamie and Brandon were partners in a firm sharing profits and losses equally. The firm was engaged in the storage and distribution of canned juice and its godowns were located at three different places in the city. Each godown was being managed individually by Kevin, Jamie and Brandon. Because of increase in business activities at the godown managed by Jamie, he had to devote more time. Jamie demanded that his share in the profits of the firm be

3 increased, to which Kevin and Brandon agreed. The new profit sharing ratio was agreed to be : 2 :. For this purpose the goodwill of the firm was valued at two years purchase of the average profits of last five years. The profits of the last five years were as follows: Year Profit I 4,, II 4,8, III 7,33, IV (Loss) 33, V 2,2, You are required to: (i) (ii) Calculate the goodwill of the firm. Pass necessary Journal Entry for the treatment of goodwill on change in profit sharing ratio of Kevin, Jamie and Brandon. Solution: (i) Calculation of the goodwill for the firm: ` 4''+ ` 4,8, + ` 7,3, - ` 33, + ` 2,2, Average Profits = ` 8,, = = ` 3,6, Goodwill = ` 3,6, 2 = ` 7,2, JOURNAL S.No. Particulars L.F. Dr. Cr. (i) Jamie's Capital A/c To Kevin's Capital A/c To Brandon's Capital A/c (adjustment of goodwill in existing partners) Dr.,2, Working Notes: Calculation of Gain or Sacrifice: Kevin : Jamie : Brandon Old Ratio : : New Ratio : 2 : Kevin's Change = (Sacrifice) Jamie's Change = 2 (Gain) 3 4 Brandon's Change = (Sacrifice) Kevin's Sacrificing Goodwill = Rs. 7,2, 2 = Rs. 6, 6, 6, Jamie's Sacrificing Goodwill = Rs. 7,2, 2 2 = Rs.,2, Brandon's Sacrificing Goodwill = Rs. 7,2, 2 = Rs. 6, 2 Marks Questions 9. The following is the balance sheet of James and Dias as at 3st December, 27. Assets

4 James 6, Dias 4,,, 8, Land Building Furniture Stock Investment Bank Cash 6, 4, 4, 2, 6,, 2,,8,,8, The partners shared profits and losses in the ratio of 3 : 2. From st January, 28, they agreed to share profits and losses equally. For this purpose, the following particulars are provided: (i) Building is to be appreciated by 2%. (ii) Current value of furniture is to be taken at Rs. 3,. (iii) Land is valued at Rs.,. (iv) Stock is valued at Rs. 3,. Prepare a revaluation account, partners' capital accounts and the revised balance sheets as at st January, 28. Ans. Revaluation Account Dr Cr Particulars Particulars To Furniture A/c, By Building A/c, To Profit Transferred to By Land A/c 9, By Stock A/c, James 3,8 23, Dias 9,2 24, 24, Dr Particulars To Balance c/d Davi d 73,8 73,8 Capital Account Bimal Particulars Davi d 49,2 By Balance b/d 6, By Revaluation A/c 3,8 49,2 73,8 Cr Bima l 4, 9,2 49,2 James 73,8 Dias 49,2 as at st Jan, 28 Assets 8, Building (4, +,) Land (6, + 9,),23, Furniture (4,-,) Stock (2,+,),, 3, 3, 6,,

5 Investment 2. Bank Cash,4,,4,. Alec and Ben are in partnership as bakers, sharing profits and losses in the ratio of 3 : 2 respectively. Their balance sheet on 3st December, 999 was as follows: Alec 4, Ben 4, General Reserve Current 8, Assets Goodwill Other Net Assets 2, 7.,,,, Ans. On st January, 2 the partners agreed that as Alec wished to take a smaller part in the partnership business, the profit sharing ratio should change to 2 : 3 respectively with a salary of Rs., a year to Alec. For the purpose of the change only, they did not however want to alter the book values of goodwill and reserve but recorded the change by passing one single journal entry. You are required to show that single journal entry as at st January, 2. JOURNAL Date Particulars LF. (Dr.) Alec's Capital A/c Dr. To Ben's Capital A/c (Being an adjustment entry made in respect of change in profit sharing ratio) 2,6. (Cr.) 2,6 Working Note Goodwill (Dr) 2, General Reserve (Cr) 2, Difference 3, Calculation of Sacrifice or Gain Old ratio of Alec and Ben 3 : 2 New ratio of Alec and Ben 2 : 3 Sacrifice/(Gain) = Old Share New Share Alec = Sacrifice ; Ben = Gain Alec = 3, x = 2,6 Dr ; Ben = 3, x = 2,6 Cr 4 Marks Question. Sim, Tim, and Jim are partners sharing profits and losses equally. Their balance sheet as I at 3st March, 22 stood as follows:

6 Sim 2,, Tim 2,, Jim,, General Reserve 6,,,4, 6, Assets Building Plant and Machinery Patent and Copyrights Stock Debtors Bank 2,,,,,,,2,,, 7, 8,, 8,, From st April, 22 the partners decide to share profits and losses in the ratio 3:2: and for that purpose, the following revised value of assets were agreed upon: Building Rs. 2,7,, plant and machinery Rs. 9,, patents and copyrights Rs.,32,, stock Rs. 2,,, prepaid insurance Rs., and debtors Rs.,42,. Goodwill of the firm I was valued at Rs. 6,. Partners decide not to disturb the reserves. Also, they decide not to record the revised values of assets in the books of accounts. You are required to prepare (i) Partners' capital accounts. (ii) Balance sheet of the re-constituted firm. (Show your workings clearly). Ans. Partners Capital Account Dr Cr Particulars Sim Tim Jim Particulars Sim Tim Jim To Jim s capital A/c To Balance c/d 4, 2,, 2,,,9, By Balance b/d By Sim s capital A/c 2,, 2,,,, 4, 2., 2,,,9, 2., 2,,,9, Sim 2,, Tim 2,, Jim,9, General Reserve as at st April, 22 Assets Building 2,, Plant and Machinery,, Patents and,, 6,, Copyrights Stock,2,,4, Debtors,, 6, Bank 7, 8,, 8,, Working Note Calculation of Net Adjustment to be Made Increase in building 7, Decrease in plant and machinery (,) Decrease in patent's and copyrights (7,) Increase in stock 7, Prepaid insurance, Decrease in debtors (7,) Profit on revaluation,2, Adjustment for general reserve 6,

7 Adjustment for value of goodwill 6, 2,4, Calculation of Sacrifice/(Gain) Sacrifice/(Gain) Ratio = Old Ratio New Ratio Sim = Gain; Tim = = Jim = = Sacrifice Since, Sim has gained, he will be debited from of 2,4, = 4, 6 Since, Jim has sacrificed, he will be credited from of 2,4, = 4, 6 JOURNAL Date Particulars LF. (Dr.) Sim's Capital A/c 4, Dr. To Jim's Capital A/c (Being adjustment for goodwill). (Cr.) 4,

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