RECONSTITUTION OF PARTNERSHIP FIRM ----Change in Profit Sharing Ratio----

Topics covered:

v  Introduction

v  Calculation of Sacrificing Ratio and Gaining Ratio

v  Methods of valuation of Goodwill

v  Treatment Goodwill

v  Distribution of Accumulated Profit and Reserves

v  Revaluation of Assets & Reassessment of Liabilities

v  Treatment of Joint Life Policy

v  Adjustment of capital

v  Introduction

There is no restriction as per the Indian Partnership Act 1932, if the partners decided to change their profit sharing ratio. The old partners may change their profit sharing ratio through mutual understanding but this change may result in the sacrifice or gain to any partner. Hence the gaining partner must compensate the losing partner by way of goodwill.

v  Calculation of Sacrificing Ratio and Gaining Ratio;

That part of total profit share which is surrendered is called ‘Sacrificing Ratio’ while the share gained by each partner is called ‘Gaining Ratio’.

 

 SACRIFICING RATIO = OLD  RATIO  - NEW RATIO 

 v  Goodwill

Goodwill means the ‘good-name’ or the reputation earned by a firm through the hard work and honesty of its owners. If a firm renders good service to the customers, the customers who feel satisfied will come again and the firm will be able to earn more profits in future.

Thus, goodwill is the value of the reputation of a firm, which enables it to earn higher profits in comparison to the normal profits earned by other firms in the same trade.

Goodwill is an intangible real asset. It perhaps the most intangible of the intangibles. But it is not a fictitious asset. Goodwill is an asset, which has countless definitions.

According to Lord Macnaghten, “Goodwill is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connections of a business. It is the attractive force, which brings in customers. It is one thing, which distinguishes an old established business from a new business at its first start.”

Lord Eldon says, “Goodwill is nothing more than the probability that the old customers will resort to the old place.”

In the words of Spicer and Pegler, “Goodwill may be said to be that element arising from the reputation, connection or other advantage possessed by a business which enables it to earn greater profits than the return normally to be expected on the capital represented by the net tangible assets employed in the business.”

Thus, goodwill may be described as the extra saleable value attaching to a prosperous business beyond the intrinsic worth of the net marks, copyrights, concessions, etc. It is non-visible. It does not become obsolete but it is subject to fluctuations. 

Write a short note on nature of goodwill.

Goodwill is an intangible asset, as it cannot be seen. It is not fictitious in the case of profitable concerns. It can be sold, though a sale will be possible only along with the sale of business itself.

v  Methods of valuation of Goodwill

(a)      Average Profits Method;

(b)      Super Profits Method;

(c)      Capitalization Method;