Difference between Sacrificing ratio and Gaining ratio

Difference between sacrificing ratio and gaining ratio

When the profit-sharing ratio of the current partners in a partnership firm changes, the requirement for goodwill valuation arises. A change in the profit-sharing ratio results in a gain for one partner and a loss for the other. As a result, the partner who benefits from the new ratio must compensate the partner who suffers. In terms of profit share, the gaining partner may purchase his profit share from either one or both of the other partners, as the case may be. The partners who sell the shares may sacrifice in equal or different proportions. The amount of goodwill awarded to the partner(s) from whom the gaining partner purchases his share is always proportional to the sacrifice made.

Such a kind of situation may arise when the profit-sharing ratio amongst the partners is changed, on the joining of a new partner, when a partner retires or dies, on sale of a business, amalgamation, etc. In all of these scenarios, it is necessary to determine the sacrificing and gaining ratio.

Sacrificing ratio

When a new partner joins in a partnership, the existing partners must give up a portion of their profits in order for the new partner to be admitted. The difference between the old profit-sharing ratio and the new profit-sharing ratio of the existing partners is referred to as the sacrificing ratio. In this situation, the current partners may make a sacrifice in the ratio in which they were sharing profits prior to admittance, or in another ratio.

Sacrificing ratio = Old Share of Profit – New Share of Profit

For example, if A and B split earnings in a 5:3 ratio, and when C is admitted for a 1/7^th share in profits, the new ratio between A, B, and C is agreed upon as 4:2:1. Now, the sacrifice ratio of A and B will be determined as follows:

The sacrificing ratio is 3:5. This is the ratio in which A and B will surrender a portion of their profits to make up for 1/7^th share for C.

In exchange for the right to a share in the partnership firm’s assets and income, a new partner contributes an agreed-upon amount of capital, either in cash or in kind. Furthermore, in the case of an existing corporation that earns higher profits than the standard rate of return on capital, the new partner is obligated to contribute some additional sum known as premium or goodwill. This is done mostly to compensate the existing partners for the loss of their percentage in the firm’s super-profits. This amount of goodwill is divided by the current partners in the ratio in which they relinquish their shares in favour of the new partner, which is known as the sacrificing ratio. In other words, goodwill brought by the new partner is distributed among the existing partners in their sacrificing ratio, i.e., it is credited to their individual capital accounts and is debited to the new partner’s capital account.

Journal entry for recording the amount of goodwill is as follows:

Bank Dr.

To New Partner’s Capital A/c

(Being amount of goodwill and capital brought by the new partner)

New Partner’s Capital A/c Dr.

To Old Partners’ Capital Accounts (individually)

(Being the value of goodwill brought in by the new partner, shared by the old partners in the sacrificing ratio)

Note that if the new partner is unable to bring anything for goodwill, it shouldn’t be raised in the books. It is advisable that such value of goodwill should be adjusted through the partners’ capital accounts by making the above journal entry.

If the amount of goodwill is withdrawn:

Old Partners’ Capital Accounts Dr.

To Bank

(Being the amount of goodwill brought in by the new partner withdrawn by the old partners in the sacrificing ratio)

Gaining ratio

The gaining ratio denotes the share of profit gained by a partner as a result of the firm’s reconstitution. This gaining ratio is generated by reconstitution, which typically occurs as a result of the exit or death of any existing partner.

When one of the partners retires or dies, the profit shares of the remaining partners increase. Old shares should be subtracted from new shares of remaining partners in order to find the ratio in which the remaining partners have profited.

Gaining ratio = New Share of Profit – Old Share of Profit

For example, if A, B, and C share profits and losses in the proportion of 7:5:3, and following B’s retirement, A and C decide to share earnings in the proportion of 3:2, then the gaining ratio will be determined as follows:

The gaining ratio is 2:3. This is the ratio in which A and C will gain from B’s retirement and his foregoing 5/15^th share in the firm.

In the event of a partner’s retirement, goodwill is valued in the same way that it is valued in the event of a partner’s admission. In this situation, the continuing partners benefit from a higher profit-sharing ratio. As a result, the continuing partners must share the retiring partner’s goodwill in the gaining ratio. In this scenario, the retiring partner’s capital account is credited with his share of goodwill, while the capital accounts of the continuing partners are debited with the amount in the gaining ratio.

Journal entry for recording the amount of goodwill is as follows:

Remaining Partners’ Capital A/c Dr. (individually)

To Retiring Partner’s Capital Account

(Being the amount of goodwill credited to the retiring partner and adjusted from the remaining partners’ accounts in their gaining ratio)

Differences between sacrificing ratio and gaining ratio

Basis	Sacrificing ratio	Gaining ratio
Meaning	Existing partners agree to give up their profit share in favour of the new partner	Remaining partners gain from the profit share of the retiring partner exiting the firm
Formula	Old Share of Profit – New Share of Profit	New Share of Profit – Old Share of Profit
Debit/Credit	Individual capital accounts of old partners are credited and the new partner’s capital account is debited.	The retiring partner’s capital account is credited while the capital accounts of the continuing partners are debited.
Need	The new partner who benefits from the new ratio must compensate the partners who have sacrificed their share of profit.	The continuing partners who have benefitted from the new ratio must compensate the retiring or outgoing partner who has given up his share.
Circumstances (some partners gain while others lose)	When profit-sharing ratio amongst the partners is changed, on the admission of a new partner, on sale of a business, amalgamation, etc.	When profit-sharing ratio amongst the partners is changed, when a partner retires or dies, on sale of a business, amalgamation, etc.
Impact	Old partners’ share of profit decreases.	Continuing partners’ share of profit increases.

Takeaway

The sacrificing ratio is the ratio in which the existing partners agree to give up their profit share in favour of the new partner. On the other hand, the gaining ratio is the ratio in which the remaining partners gain from the profit share of the retiring partner exiting the firm.

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