To understand the concept of sacrificing ratio effectively, we must be somewhat familiar with how a partnership firm functions.
Typically, such a firm is formed when two or more individuals decide to run a business with the common aim to earn profits. The liability of partners of such a firm tends to be unlimited, and all partners are jointly held accountable for all debts and losses.
However, partners tend to share all their accrued profits and losses in a pre-determined ratio. Notably, partners may decide to change their profit and loss sharing ratio on mutual agreement and may also opt to include or exclude a new partner into their firm.
It is under situations like these that financial tools like sacrifice ratio come into play and help partners to keep the accounting aspect of a firm smooth.
That being said, let’s now take a detailed look at the sacrificing ratio and the exact situations under which it is most effective.
What is Sacrificing Ratio?
The meaning of sacrifice ratio in accounting can be explained as the proportion in which existing partners surrender their share of profit in favour of newly admitted partners. The share thus sacrificed is usually given to new partners by either some existing partners or all of them. It must also be noted that existing partners may opt to forego shares for the new admission in an agreed proportion.
So, in simple words, it can be said that sacrifice ratio is simply the difference between their old ratio and their new ratio.
The Sacrifice Ratio Formula can also be Expressed as –
Sacrificing ratio = Old profit sharing ratio – New profit sharing ratio
A partnership firm needs to compute this ratio. It helps to determine the sum of money that would be paid by gaining partners as compensation to sacrificing partners. Usually, such compensation is paid as per the defined amount of goodwill.
Now, it must be noted that sacrificing partners are those individuals whose share of profit decreases with the change in partner’s profit-sharing ratio. On the other hand, a gaining partner is that individual whose share of profit increments with a change in the partner’s profit-sharing ratio.
Test Your Knowledge:
Problem 1: Jake and Gina are partners in a firm and share profits in the ratio of 3:1. Terry is admitted into a partnership for 1/8th share of profits. Find out the new profit sharing ratio in this case.
Problem 2: Ross and Phoebe are partners in a firm and share profit and loss in the ratio 5:3. A new partner, Joey, enters the firm for 1/5th share and acquires his portion of share from Ross. Find the new profit-sharing of Ross and Phoebe.
Learn how to solve these problems and much more by referring to our study solutions.
When Can One Apply the Sacrificing Ratio?
Sacrificing ratio in partnership can be used under two situations. Read along to find out more about those situations.
Situation 1 – When partners decide to change their profit and loss sharing ratio
Sometimes partners decide to revise their existing profit and loss sharing ratio to enhance the existing partners’ profit-earning prospect. However, to ensure it, some partners may have to sacrifice their share of profit in an agreed proportion.
In such a situation, the sacrificing ratio is used to find out the share of profit some of the partners have to forego to benefit the other existing partner. It must be noted that the sacrificing ratio formula is applied in case of each partner and both their old and new ratios are factored in. Through the course of calculation, if the outcome is positive in value, it would indicate that the specific partners are sacrificing their share for other existing partners. Contrarily, if the outcome is negative in value, it would indicate that the partners are gaining shares in prospective profits and assuming additional liability for future losses.
Situation 2 – In case of admission of a new partner in the firm
When an individual enters the firm as a firm partner, it becomes mandatory to adopt a new profit sharing ratio. Nevertheless, it must be noted that there are different situations when the new profit sharing ratio of partners has to be computed.
A few of such situations are as follow –
When just the profit-sharing ratio of the new partner is mentioned.
When existing partners are surrendering a fixed portion of their share in favour of newly admitted partners.
In a situation when partners decide to forego a specific proportion of their share.
Now that we have gained a substantial idea about the sacrificing ratio; let’s now take a look at the point of differences between two concepts that are often confusing.
This table below would offer you a fair idea about the differences between the two financial measures and help to eliminate fundamental doubts and queries.
Difference Between Sacrificing Ratio and Gaining Ratio
In case, you want to learn in details about the sacrifice ratio and other associated concepts of partnership, in general, you can access Vedantu’s compact study solutions online.
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