CBSE Class 12 Accountancy Partnership Ratio Analysis Notes

                                                BALANCE SHEET

                                            As at 31st March, 2012

                                                    Particulars

 I. EQUITY AND LIABILITIES
 Equity Share Capital                                                3,00,000

 Preference Share Capital                                         1,00,000

 Reserves                                                                  50,000

 Profit & Loss Balance                                               65,000

 12% Mortgage Loan                                                 1,80,000

 Current Liabilities                                                      1,20,000

                                                          TOTAL              8,15,000

II. ASSETS:

 Fixed Assets                                                             4,50,000

 Share Issue Expenses                                              15,000

  Current Assets                                                         3,50,000

                                                          TOTAL              8,15,000

What conclusions do you draw from the above ratios?

SOLUTION 5.

(i) Debt Equity Ratio = Debt/Equity or Long term Loans/Shareholder's Funds

Shareholder’s Funds = Equity Share Capital + Pref. Share Capital + Reserves + P & L Balance – Share Issue Exp.

= 3,00,000 + 1,00,000 + 50,000 + 65,000 – 15,000

= 5,00,000

Mortgage Loan is Long Term Loan,

Hence, Debt Equity Ratio = 1,80,000/5,00,000 =.36 : 1

Comments: This ratio indicates what proportion of funds is provided by Longterm loans in comparison to Shareholder’s funds. Generally, the ratio should not be more than 2 : 1. Debt-Equity ratio of the above company is .36:1,

which indicates that long-term loans are only .36 in comparison to shareholder’s funds. Hence, it may be considered that the long-term financial position of the company is very sound.

(ii) Total Assets to Debt Ratio = Total Assets/Debt

                                                   = Fixed Assets+ Current Assets/Long-term Loans

                                                   = 4,50,000 + 3,50,000/1,80,000 =4.44 : 1

Comments: Total assets of this company are 4.44 times in comparison to long-term debts of the company. The higher ratio indicates the use of lower debts in financing the assets which means higher security to lenders.

(iii) Proprietary Ratio = Equity/Total Assets

                                    = Shareholder's Funds/Fixed Assets + Current Assets

                                    = 5, 00,000

                                        4, 50,000 + 3, 50,000

                                     = 0.625 or 62.5%

Comments: Shareholder’s Funds of this Company are 62.5% in comparison to total assets of the company. In other words, 62.5% of the total assets of the company are funded by equity which indicates that the long-term financial position of the company is very sound.

QUESTION 6.
From the following balance sheet and other information calculate (i) Working Capital Turnover Ratio, (ii) Debt Equity Ratio and (iii) Trade Receivables Turnover Ratio.

                                                       BALANCE SHHET

                                                   As at 31st March, 2012

                                                            Particulars

I. EQUITY AND LIABILITIES

Share Capital                                                                       2,00,000

General Reserve                                                                  80,000

Profit and Loss                                                                     1,20,000

Loan @ 15%                                                                         2,40,000

Trade Payables                                                                     1,00,000

                                                                  TOTAL                 7,40,000

II. ASSETS:

Fixed Assets                                                                          3,60,000

Inventory                                                                                80,000

Trade Receivables                                                                 1,80,000

Cash                                                                                      1,00,000

Preliminary Expenses                                                             20,000

                                                                        TOTAL            7,40,000

Topic 1: Introduction and New Profit Sharing Ratio and Sacrificing Ratio

1. Meaning

Admission of a partner is one of the ways of reconstituting the firm under which the old partnership ends and a new one between all partners (including the incoming partner) begins. According to Section 31(1) of Indian Partnership Act, 1932, 'A new partner can be admitted only with the permission of all the existing partners'.

A new partner is admitted for the following reasons:

• For getting additional capital.
• For gaining additional managerial skills.

A newly admitted partner gets the following two main rights in the firm:

• Share in the future profits of the firm.
• Share in the assets of the firm.

2. Adjustments Required at the Time of Admission of a New Partner

• Calculation of new profit sharing ratio and sacrificing ratio.
• Accounting treatment of goodwill.
• Accounting treatment of revaluation of assets and re-assessment of liabilities.
• Accounting treatment of reserves, accumulated profit and losses.
• Adjustment of capital.

3. New Profit Sharing Ratio

The ratio in which all the partners (including the incoming partner) share the future profits and losses is known as the new profit sharing ratio.

New Profit Sharing Ratio = Old Ratio - Sacrificing Ratio

4. Sacrificing Ratio

It is the ratio in which the old partners have decided to give up their share of profits in favour of a new or incoming partner.

Sacrificing Ratio = Old Ratio - New Ratio

Topic 2: Treatment of Goodwill

1. Accounting Treatment of Goodwill

When a new partner joins, his share in future profits of the firm is equal to the profit given up by an existing partner or partners of the firm. The amount he pays to make up for this sacrifice is called goodwill.

2. Various Cases Related to the Treatment of Goodwill

(i) When a premium for goodwill is paid privately by a new partner.

In case a new partner pays premium to the old partners privately or directly or outside the business, it will not be recorded because it is a transaction outside the business. However, an entry will be made for capital brought in by a new partner.

(ii) When premium for goodwill is brought into the business by new partner in cash and held in the business

(a) Write-off the existing goodwill (if any) appearing in the books of the firms

Old Partner's Capital A/c Dr [In old ratio]
To Goodwill A/c

(b) For bringing premium for goodwill and capital in cash:

Cash/Bank A/c Dr
To Premium for Goodwill A/c To New Partner's Capital A/c

(c) For distributing premium to sacrificing (old) partners in their sacrificing ratio:

Premium for Goodwill A/c Dr
To Sacrificing Partner's Capital A/c

(iii) When premium for goodwill is brought in kind

(a) For bringing premium for goodwill and capital in assets:

Assets A/c Dr
To Premium for Goodwill A/c To New Partner's Capital A/c

(b) For distributing premium to sacrificing (old) partners in their sacrificing ratio:

Premium for Goodwill A/c Dr
To Sacrificing Partner's Capital A/c

(iv) When premium for goodwill is brought in by new partner and is taken out by old (sacrificing) partners fully or partly.

(a) For bringing premium for goodwill in cash by new partner

Cash/Bank A/c Dr [Amount of premium]
To Premium for Goodwill A/c

(b) For sharing of premium for goodwill by sacrificing partners

Premium for Goodwill A/c Dr [Amount of premium]
To Sacrificing Partner's Capital A/c (in sacrificing ratio)

(c) For withdrawal of premium money by sacrificing partners fully/partly

Sacrificing Partner's Capital A/c (Amount withdrawn) Dr To Cash/Bank A/c

(v) When a new partner brings only a part of premium for goodwill in cash

(a) For amount brought in by incoming Partner

Cash/Bank A/c Dr
To Premium for Goodwill A/c To New Partner's Capital A/c

(b) For distributing the total goodwill due from incoming partner to sacrificing (old) partners in their sacrificing ratio

Premium for Goodwill A/c Dr
New Partner's Capital/ Current A/c Dr
To Sacrificing (old) Partner's Capital/ Current A/c

(vi) When the new partner is unable to bring his share of premium for goodwill in cash or kind

New Partner's Capital/Current A/c Dr
To Sacrificing (old) Partner's Capital/Current A/c

3. Hidden Goodwill

Hidden or inferred goodwill is the amount by which the desired total capital of the firm exceeds the actual combined capital of all the partners. In case, the value of goodwill is not given at the time of admission of a new partner, it is required to be calculated based on an inferred method of profit sharing ratio or capitalisation.

Format of Revaluation Account

3. Accounting Treatment of Reserves, Undistributed Profits or Losses

The new partner is not entitled to any share in undistributed profits or losses shown in the balance sheet at the time of admission, as these are earned by the old partners. So, these should be moved to old partners' capital/current account.

Journal entries passed will be

(i) For Undistributed Profits,

General Reserve A/c Profit and Loss A/c Workmen Compensation Fund A/c Investment Fluctuation Fund A/c [between book value and market value]
To Old Partner's Capital/Current A/c [Old ratio]

(ii) For Undistributed Losses

Old Partner's Capital/Current A/c Dr [Old ratio]
To Profit and Loss A/c To Deferred Revenue Expenditure A/c

Topic 4: Adjustment of Capital

At the time of admission of a new partner, the partners may decide that their capitals should also be adjusted so as to match their profit sharing ratio.

The capitals of partners may be adjusted in any of the following ways:

(i) Adjusting the capitals of old partners on the basis of the capital of incoming partner
(When the total capital of the new firm is not given)

Steps involved in adjusting the capitals of old partners:

Step 1 Calculate total capital of the firm based on capital of new partner.
Step 2 Calculate the new capitals of each partner.
Step 3 Find the present capital of old partners (adjusted).
Step 4 Calculate the surplus/deficit capital by comparing Step 2 and Step 3.

(ii) Determining the new partner's capital on the basis of combined capital of old partners

Steps involved in the determination of capital of new partner:

Step 1 Calculate the adjusted old capitals of old partners (after all adjustments have been made).
Step 2 Calculate the total capital of the new firm.
Step 3 Calculate the total capitals of new partners as follows:
Total Capital (Step 2) x Share of New Partner


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