Sacrificing Ratio

What is Sacrificing Ratio?

The term "sacrificing ratio" is used in partnership firms. Sacrificing ratio is the ratio in which the partners decide to share the losses when one of the partners of the firm dies or retires from the business. Sacrificing ratio is used to distribute the losses among the remaining partners when a partner goes out of the partnership firm.

Usually, the assets and liabilities of the partnership firms need to be reassessed when one partner leaves the business. This results in either gain or loss. This is where the sacrificing ratio comes into play.

• The sacrificing ratio is the ratio that shows how the remaining partners decide to bear the losses after reassessment. It indicates the share of the loss that each of the partners is willing to "sacrifice" to keep the financial stability alright in the partnership.

• The sacrificing ratio is usually indicated as a fraction or percentage. It is calculated depending on various factors, such as the initial capital contributions, the profit-sharing ratios, and any other agreement that is outlined in the partnership deed.

• The sacrificing ratio indicates how the losses will be distributed among the partners, and it affects the individual balances and future profits.

• The sacrificing ratio is applicable only to losses incurred during the retirement process of a partner. To determine the shares of profit and losses usually the profit-sharing ratio is used, which may or may not be equal to the sacrificing ratio.

It is important that the partners carefully check and agree with the sacrificing ratio at the beginning so that a fair and transparent process of distribution of the losses if a partner exits the partnership, can be carried out. Consulting legal or financial professionals can be a good way of determining the sacrificing ratio too.

Therefore, in simpler words, sacrificing refers to the proportion in which the existing members allow to change their share in the profit of the firms in favor of any newly appointed partners. The instructions about sacrificing ratio can be found in the partnership deed which chalks out most rules of a partnership business.

Calculating Sacrificing Ratio

In general, although there is no fixed method to calculate the sacrificing ratio, the general method to calculate it is −

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

The phrase " $\mathrm{Old\:ratio\:-\:New\:Ratio} $" in a partnership business refers to a calculation in accounting when a change takes place in the existing partnership agreement. It may be an admission or a retirement of a partner. It is generally used to calculate the adjustment needed in the partners' capital accounts to indicate the changes that must take place in their profit-sharing ratios.

If someone joins or leaves a partnership, it leads to a redistribution of losses and profits among the remaining partners. The old ratio refers to the profit-sharing ratio before the change, while the new ratio shows the new or revised profit-sharing ratio after the change.

The calculation of sacrificing ratio involves the following steps −

• Determining the old ratio − The old ratio is the normal profit-sharing ratio that is based on the partnership agreement before any changes occur.

• Determining the new ratio − The new ratio is the revised profit-sharing ratio that is formed after considering the changes due to the admission or retirement of a partner.

• Calculating the difference − Now the new ratio should be subtracted from the old ratio. That will give the difference between the two ratios.

• Allocating the difference − The difference between the old and new ratio represents the adjustment that ust be made in the partners' capital accounts. It is allocated to the partners depending on their capital or as agreed upon in the partnership deed.

By calculating the sacrificing ratio, partners can find the extent of adjustment needed in their capital accounts to adjust with the revised profit-sharing arrangement. This adjustment makes sure that the partners' capital balances accurately indicate their entitlement to profits and losses depending on the new partnership agreement.

Application of Sacrificing Ratio

The sacrificing ratio is typically applied in the following scenarios −

• Retirement of a Partner − The sacrificing ratio comes into play when a partner decides to retire from the partnership. The retiring partner's share in the assets and liabilities must be determined. This shows the resulting gain or loss from the revaluation, which is then allocated among the remaining partners based on the sacrificing ratio. This is done to ensure the correct distribution of the retiring partner's interest. It also helps in sharing losses among the remaining partners.

• Admission of a New Partner − When a new partner is allowed to join an existing partnership, the sacrificing ratio may be used to find out the adjustment needed in the capital accounts of the existing or old partners. The old partners may decide to sacrifice a part of their share in future profits to allow the new partner to gain a fair share of interest. The sacrificing ratio also helps to calculate the new profit-sharing arrangement. Therefore, the distribution of profits among the partners is affected by the application of sacrificing ratio.

• Dissolution of the Partnership − The sacrificing ratio is applied to determine the sharing of losses among the partners during the dissolution of the firm. The assets and liabilities of the partnership are reassessed, and the loss is allocated among the partners based on their sacrificing ratio. This helps to find out each partner's share of the losses in the dissolution process.

It is notable that the sacrificing ratio is related to partnerships and is primarily used when there is a change in the structure, such as retirement, admission, or dissolution.

Conclusion

The sacrificing ratio is one of the most critical aspects of a partnership business. As it paves the path for the renewed profit-sharing ratio, partners must know about it to avoid discontent when the profit-sharing ratio needs to be changed. That is why sacrificing ratio is so important.

FAQs

Qns 1. What is meant by sacrificing ratio?

Ans. When a partner retires or a partnership is dissolved, the assets and liabilities of the partnership are revalued, and any resulting gain or loss is calculated. The sacrificing ratio is the ratio in which the remaining partners agree to bear the losses from the revaluation. It represents the proportionate share of the loss that each partner is willing to absorb or "sacrifice" to maintain the financial stability of the partnership.

Qns 2. Mention two situations when sacrificing ratio is applied in a partnership.

Ans. Admission of a new partner and dissolution of the partnership are two situations when sacrificing ratio is applied in a partnership business.

Qns 3. What is the formula for sacrificing ratio?

Ans. The formula is

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