Gaining Ratio

What is Gaining Ratio?

Gaining ratio is a term related to partnership firms. When a partner of a partnership firm retires, the remaining partners need to form a new partnership with a new partnership ratio. This new ratio is applied in distributing the profits and losses to the remaining partners. In financial and economic terms, the new partnerships ratio is called the gaining ratio.

With the formation of the gaining ratio, the existing ratio of the partnership comes to an end, and a new partnership is formed. The continuing partners of the firm follow this new ratio to get the profits distributed among them if any. In legal terms, the gaining ratio is formed according to the existing partners' shares and then deducting the share of the retiring partner from the calculation.

A partner of a partnership firm can retire −

• With the mutual approval and consent of all the partners of the firm.

• According to the rules of the partnership agreement.

• Following his/her own will.

Whatever the reason or mode of retirement, the retirement of one partner from a partnership firm changes the structure of the firm. This has to be accounted for in the association of the partnership firm. The gaining ratio helps in determining the new shares of profit or loss in the case of the new partnership agreement.

Importance of Gaining Ratio

The gaining ratio plays a key role in determining the share of profit after the retirement of a partner from the firm. Importance of this ratio can be listed as below.

• When one partner of the firm retires, the new partners must divide the retired partner's share in a new ratio too. The gaining ratio helps the current and continuing partners realize their shares in a new partnership form.

• The gaining ratio is also important because it helps in the realization of the new profit share without any discord among the continuing partners. Without the gaining ratio being set, the continuing partners may ask for shares of profit that may be higher than the accurate amount, so the gaining ratio settles the disputes related to sharing of profit in general too.

• The gaining ratio can be considered as the difference between the old profit-sharing ratio and the new profit-sharing ratio. Therefore, the gaining ratio is the bridge between the existing and new profit-sharing ratios.

• It helps in understanding what the new profit sharing ratio will be when the existing profit sharing ratio is in hands of the new partners.

Issues in Gaining Ratio

The gaining ratio is also in a host of accounting issues.

These issues include −

• New gaining and new profit-sharing options change the profit-sharing model of the firm. New options bring new changes hence new accounting entries need to be mentioned.

• In the case of disbursement of a retiring partner accounting entries must be made.

• Usually, changes take place when the partnership ratio among the new members is made. The gaining ratio impacts the accounting books in the case of settling new changes and evaluating the cost of assets and liabilities

• Accounting changes may also be required while determining the new capital of the existing partners. As one member goes out of the picture, the new capital left behind is different in form and shape than the former situations. In such cases, accounting entries may be required.

• Accounting entries may be required for sealing with accumulated profits and reserves too.

• Goodwill must also be accounted for in the case of an increase and decrease in the good reputation of a firm.

Formula for Gaining a Ratio

It is not complex to calculate the gaining formula when the new ratio of continuing partners and the old ratio of partnerships are known. The gaining ratio is the difference between the new and old ratios.

Therefore, to determine the gaining ratio, the old ratio of the partnership must be deducted from the new ratio. The gaining ratio thus shows how much change has taken place while changing the partnership ratio from the old to the new one.

$$\mathrm{Gaining\:ratio\:=\:New\:Ratio\:-\:Old Ratio}$$

Calculation of Gaining Ratio

In order to calculate the gaining ratio, the continuing partners’ shares must be calculated first. After the calculation of the partners’ shares, they must be used to form the new ratio. This new ratio is known as the gaining ratio.

Example

Let’s say that X, Y, and Z are three partners of a firm with shares 6:4:2. Y retires and X and Z decide to share the profits in the ratio of 4:2. Then, we will calculate the gaining ratio as follows −

X’s gaining share:

$$\mathrm{\frac{4}{6}-\frac{6}{12}=\frac{2}{12}=\frac{1}{6}}$$

Z’s gaining share:

$$\mathrm{\frac{2}{6}-\frac{2}{12}=\frac{2}{12}=\frac{1}{6}}$$

Thus, gaining ratio of X and Z is 1:1

X will get $\mathrm{\frac{1}{2}}$ of Y’s share of profit and z will also get $\mathrm{\frac{1}{2}}$ of Y’s share of profit.

When is the Calculation of the Gaining Ratio Needed?

The gaining ratio has no use when the partnership firm is running successfully without the retirement of a partner. However, during the death, admission, or retirement of a partner, the calculation of sacrificing and gaining ratio is needed.

However, the gaining ratio is specifically calculated under the specific situations −

• When there is nothing mentioned about the new profit-sharing proportion. As the partners need to know their share in profit in order to stay aware of the situation of the company. The partners cannot wait till the profit is made, but has to be under specific guidelines before the profit is gained.

• The gaining ratio also plays a pivotal role in situations where a firm’s partnership agreement defines a gain. This gain may be distributed equally or unequally among partners.

• The gaining ratio also gains importance when a new profit share is mentioned in the partnership agreement. This new profit share should be distributed among the partners according to new terms after the retirement of a member. In such cases, the gaining ratio is useful.

Conclusion

The gaining ratio plays a pivotal role in the management of partnership firms. As the retirement of a member creates a void in the structure of the firm, both in terms of operations and finance, the gaining ratio helps the remaining patterns to realize their proportion easily.

Therefore, due to the existence of the gaining ratio, no dispute takes place among the members of the partnership firms and they can carry on with the firms’ operations without any halt. In the financial sense, therefore, the gaining ratio is very important for partnership firms.

FAQs

Q1. What are the three specific situations when the gaining ratio is calculated especially?

Ans. The gaining ratio is calculated specifically in the situations, such as −

• When there is nothing mentioned about the new profit-sharing proportion.

• Where a firm’s partnership agreement defines a gain that is distributed equally or unequally among partners.

• When a new profit share is mentioned in the partnership agreement.

Q2. Describe the three modes in which a partner of a partnership firm can retire.

Ans. A partner of a partnership firm can retire −

• With the mutual approval and consent of all the partners of the firm.

• According to the rules of the partnership agreement.

• Following his/her own will.