Sacrificing Ratio:
A partnership firm is established when two or more individuals come together with the common goal of making a profit. It's important to note that in such firms, the partners have unlimited liability, meaning they are collectively responsible for all the debts and losses incurred.
However, partners typically distribute their profits and losses based on a predetermined ratio. It's worth mentioning that partners have the flexibility to adjust this ratio through mutual agreement, and they can also choose to admit or exclude new partners into the firm.
In situations like these, financial tools like the sacrificing ratio play a crucial role in helping partners maintain the smooth financial management of the firm.
Sacrificing Ratio Meaning
The sacrificing ratio refers to the proportion in which existing partners forego their share of profits and losses in the firm to accommodate a new partner who is being admitted. When a new partner joins, there is a shift in the distribution of profits and losses among the partners.
This change occurs because the future profits and losses allocated to the new partner are subtracted from the existing partners' shares in the firm's profits and losses. The share allocated to the new partner can be contributed by all existing partners equally, based on an agreed ratio, or entirely by a single partner.
Sacrificing Ratio Formula
The sacrificing ratio is computed to establish the compensation that a new partner needs to pay to the existing partner(s) who are giving up a portion of their share in the form of a premium for goodwill.
Sacrificing Ratio = Old Ratio – New Ratio
Calculation of Sacrificing Ratio
The sacrificing ratio is calculated differently in three specific scenarios:
When the new partner's share is offered without disclosing the sacrifices made by existing partners:
In this case, the sacrifice ratio is identical to the profit-sharing ratio before the new partner's entry. This assumes that former partners have forgone their right to participate in the previous profit-sharing ratio, ensuring that the existing partners' profit-sharing ratios remain unchanged.
When both the previous partner ratio and the new partner ratio are provided:
Subtracting the new partner's share from the old partner's share determines the sacrifice made by each partner. This calculation method allows for a clear understanding of the sacrifices made by individual partners based on the given ratios.
When a new partner acquires a share by surrendering a portion of existing partners' shares:
To calculate the involvement of each old partner in the reconstituted firm, subtract the portion surrendered by the old partner from their original share. The shares relinquished by existing partners in favour of the new partner are combined to determine the new partner's share in the firm.
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What is the Gaining Ratio?
The gaining ratio is the proportion in which the partners who continue to be part of a company divide the profits and losses after one partner retires, resigns, or exits the partnership. This ratio decides how the departed partner's share is reallocated among the partners who remain in the business.
Sacrificing Ratio Vs Gaining Ratio
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Feature
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Sacrificing Ratio
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Gaining Ratio
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Definition
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Determines the ratio in which existing partners relinquish their share for the new partner.
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Determines the ratio in which existing partners receive the share from the outgoing partner.
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Occurrence
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When a new partner joins the partnership.
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When a partner exits the partnership.
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Calculation
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Calculated by comparing the sacrificing partner’s share before and after the new partner’s entry.
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Calculated by comparing the gaining partner’s share before and after an existing partner leaves.
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Impact on Profits
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Affects the division of profits between existing and new partners.
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Affects the division of profits between existing partners and the outgoing partner.
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Allocation of Losses
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Determines how losses are shared between existing partners and the new partner.
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Determines how losses are shared between existing partners and the departing partner.
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Change in Ownership
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Does not impact existing partners’ ownership in the partnership.
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Reflects the change in ownership interest of existing partners after a partner leaves.
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Future Profit Sharing
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Does not influence future profit-sharing among existing partners.
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May lead to a change in the future profit-sharing ratio among the remaining partners.
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Sacrificing Ratio Example
As an illustration, let's consider two existing partners, A and B, who are currently sharing profits in a ratio of 5:2. Now, they have decided to admit a new partner, C, with a profit-sharing ratio of 4:2:1 (A:B:C).
In this situation, the calculation of the sacrificing ratio for A and B is as follows:
For A: Old ratio minus New ratio = 5/7 minus 4/7 = 1/7
For B: Old ratio minus New ratio = 2/7 minus 2/7 = 0
So, the sacrificing ratio for A and B is 1:0. This implies that partner A is sacrificing 1/7th of his share of profits in favor of the new partner C, while partner B is not sacrificing any portion of his share.
