1. Treatment of Goodwill on Change in PSR
When PSR changes, goodwill built under the old arrangement must be valued and the sacrificing partners must receive credit for it. There are three methods permitted:
Method A — Goodwill Account Raised and Written Off
Step 1 — Raise Goodwill (in old ratio):
Dr Goodwill A/c | Cr Partners' Capital/Current A/cs (in OLD ratio)
Step 2 — Write off Goodwill (in new ratio):
Dr Partners' Capital/Current A/cs (in NEW ratio) | Cr Goodwill A/c
Net effect: Sacrificing partners' Capital A/cs show a net credit; gaining partners' Capital A/cs show a net debit.
Method B — Premium (Gaining Partner Pays Sacrificing Partner Directly)
The gaining partner(s) pay the sacrificing partner(s) directly in cash or by credit to their Capital A/cs:
Dr Gaining Partner's Capital A/c | Cr Sacrificing Partner's Capital A/c
Amount = Goodwill Value × Gaining Ratio share
Fully Worked Example — Method A
A and B share profits 3:2. New ratio: 2:3. Agreed goodwill = ₹1,00,000.
| Partner | Cr (old 3:2) | Dr (new 2:3) | Net effect |
|---|---|---|---|
| A | 1,00,000 × 3/5 = 60,000 | 1,00,000 × 2/5 = 40,000 | Net Cr 20,000 (A sacrifices — receives) |
| B | 1,00,000 × 2/5 = 40,000 | 1,00,000 × 3/5 = 60,000 | Net Dr 20,000 (B gains — pays) |
Journal (net entry via Method B):
Dr B's Capital A/c ₹20,000 | Cr A's Capital A/c ₹20,000
2. Treatment of Existing Accumulated Reserves and Surpluses
At the time of change in PSR, accumulated reserves (General Reserve, P&L credit balance, Workmen Compensation Reserve, Investment Fluctuation Reserve, etc.) and deferred expenses (P&L debit balance) must be transferred to partners' Capital/Current Accounts in the old ratio.
Types of Reserves and Treatment
| Item | Balance | Treatment | Journal |
|---|---|---|---|
| General Reserve / P&L (Cr) | Credit | Distribute to partners in old ratio | Dr General Reserve A/c | Cr Partners' Capital/Current A/cs (old ratio) |
| P&L A/c (Dr balance — accumulated loss) | Debit | Charge to partners in old ratio | Dr Partners' Capital/Current A/cs (old ratio) | Cr P&L A/c |
| Workmen Compensation Reserve — no claim exists | Credit | Distribute to partners in old ratio (surplus not needed) | Dr WCR A/c | Cr Partners' Capital/Current A/cs |
| Investment Fluctuation Reserve — investments at cost | Credit | Distribute the full IFR to partners (no adjustment to investments needed) | Dr IFR A/c | Cr Partners' Capital/Current A/cs |
| Investment Fluctuation Reserve — investments fall in value | Credit | First adjust investment to market value (Dr IFR, Cr Investment); distribute surplus if any | Dr IFR A/c → Cr Investment A/c (for fall); balance of IFR → Partners |
Alternative Treatment — No Distribution (Memorandum Method)
Instead of distributing existing reserves and then building them again, partners may agree to leave reserves in the books and only adjust the new partner's Capital Account to reflect what they owe/are owed. This is recorded via a Memorandum Revaluation Account — tested in comprehensive problems.
3. Complete Sequence on Change in PSR
Step 1: Calculate Sacrificing Ratio and Gaining Ratio
Step 2: Prepare Revaluation Account (assets/liabilities at revised values) → distribute profit/loss in OLD ratio
Step 3: Distribute existing reserves/accumulated profit in OLD ratio
Step 4: Adjust Goodwill — raise in old ratio, write off in new ratio (or via direct payment between partners)
Step 5: Prepare revised Balance Sheet after all adjustments
