Meaning of Gaining Ratio
The gaining ratio is a term that is more frequently used in partnership accounts. This ratio denotes a gain in the share of profit of partners with some reconstitution of the firm. The gaining ratio occurs due to reconstitution that generally takes place due to the exit or death of any current partner. It can be simply defined as a tool that helps in the determination of the ratio in which the remaining partners of the firm will distribute the profits of a partner in case of his/her death or retirement. The gaining ratio represents the proportion of profit gained by the continuing partners. It is also termed as new partnerships ratio in economic and financial terms.
With the formulation of gaining ratio, a new partnership gets formed and the existing ratios of the partnership come to an end. The continuing partners of the firm will follow this new ratio for the distribution of profits among them if any.
The retirement of the partner of a partnership firm can take be:
- Out of mutual consent and approval of all the partners of the firm.
- As per the rules of the partnership agreement.
- Following his/her own will.
Whatever the reason or mode of retirement may be, the partner’s retirement from the partnership firm brings changes to the structure of the firm. This needs to be accounted for in association of a partnership firm.
Formula for Computing Gaining Ratio
It is not at all a complex process to calculate the gaining ratio when the new ratio of continuing partners and the old ratio of partnerships is known. The gaining ratio is the difference between new and old ratios. Therefore, for knowing the gaining ratio, the old ratio of the partnership must be deducted from the newer ratio. The gaining ratio will denote how much change has taken place while changing the ratio of partnership from old to new.
Gaining Ratio = New Ratio – Old Ratio
Importance of Gaining Ratio
It plays a key role in the determination of profit’s share post the retirement of a partner from the firm. The importance of gaining ratio can be listed below:
- At the retirement of one partner from the firm, the new partners need to divide the share of the retired partner in a new ratio. The gaining ratio assists the current and continuing partners in realizing their shares in a new partnership firm.
- Gaining ratio is also essential as it without any discord among the continuing partners enables the realization of new profit share. In the absence of a gaining ratio being set, the continuing partners may ask for a profit share that might be higher than the accurate amount. So, this way, it can be said that the gaining ratio helps in the settlement of disputes associated with profit sharing in general too.
- It enables an understating of what will be the new profit-sharing ratio when the existing profit-sharing ratio is in the hands of new partners.
- The gaining ratio can be considered as the difference between the older and newer profit-sharing ratio. Therefore, the gaining ratio serves as a bridge between the existing and newer profit-sharing ratios.
Issues in Gaining Ratio
The gaining ratio also leads to multiple accounting issues:
- The profit-sharing model of the firm gets changes with new gaining and new profit-sharing options. New options bring in new changes and therefore new accounting entries need to be made.
- Accounting entries must also be made in the case of the disbursement of a retiring partner.
- Accounting changes may be needed while determining of the new capital of the existing partners. When one member goes out of the picture, new capital is left behind that is different in form and shape from former situations. In all such cases, accounting entries are needed.
- Goodwill too needs to be accounted for in case of an increase or decrease in the good reputation of the firm.
- The accounting entries may be needed for sealing with accumulated profits and reserves too.
- Generally, changes occur when a partnership ratio is made among the new members. The gaining ratio influences the accounting book in case of settling new changes and evaluating the cost of assets and liabilities.
The gaining ratio plays a key role in the management of partnership firms. As a member’s retirement creates a void in the structure of the firm, both in terms of operations and finance, the gaining ratio assists the remaining partners in realizing their proportion easily. Due to the existence of the gaining ratio, no dispute takes place among partners and the firm can carry on its operations without any halt.