Accounting Treatment of Revaluation of Assets and Liabilities: Change in Profit Sharing Ratio

Last Updated : 05 Apr, 2023

The value of Assets and Liabilities undergoes a change with the passage of time due to many reasons, like regular wear and tear, appreciation in the value of assets, bankruptcy of any debtor, and so on. In the Partnership firm, whenever there is a change in the profit-sharing ratio among the partners, it becomes necessary to revalue the assets and reassess the liabilities of the firm to ascertain the current value of these. The Revaluation of Assets and Reassessment of Liabilities are done because of any change in the value of the assets and liabilities that belong to the period prior to the change in the profit-sharing ratio. Therefore, any increase or decrease in the value of the assets and liabilities shall be shared among the partners in their old profit-sharing ratio. The Revaluation of Assets and Liabilities are recorded in a separate account named as “Revaluation Account” or “Profit and loss Adjustment Account“.

Meaning:

With time it becomes essential to revise the value of the assets and liabilities to ascertain the current value of these assets and liabilities because the actual value may differ from the value mentioned in the firm’s balance sheet. This act of revising the value of the assets and liabilities is called the Revaluation of Assets and Liabilities.

Nature:

The nature of the Revaluation Account is that of a Nominal Account. Any increase in the value of assets or decrease in the value of liabilities is considered a profit for the firm. The differential amount is recorded on the credit side of the revaluation account. Similarly, any decrease in the value of assets or increase in the value of liabilities is a loss for the firm, and the differential value is debited to the revaluation account.

Explanation of certain words used in revaluation:

Increased To/ Raised To: This means the value of the asset or liability has been increased to the adjustment amount. The value recorded in the revaluation account is the difference between the adjustment amount and the amount shown in the balance sheet and the adjustment amount is recorded in the balance sheet.
Increased By/ Raised By: This means the differential amount is already given in the adjustment, which is to be recorded, as it is in the revaluation account and is added to the value of assets and liabilities in the balance sheet.
Decreased To/ Written down To: This means the value of the asset or liability has been reduced to the adjustment amount. The difference between the adjustment amount and the amount shown in the balance sheet is shown on the correct side of the revaluation account, and the adjustment amount is recorded in the balance sheet.
Decreased By/ Written down By: This means the differential amount is already given in the adjustment, which is to be recorded, as it is in the revaluation account and is deducted from the value of assets and liabilities in the balance sheet.
Valued At/ Taken At: This means the amount given in the adjustment is the value of the assets or liability. If such asset or liability is unrecorded, then the total amount of adjustment is recorded on the correct side of the revaluation account and in the balance sheet as well.

Accounting Treatment:

Whenever the assets are revalued or liabilities are reassessed, the Partners may decide to act in either of the two ways:

Case1: When assets and liabilities are shown at a revised value in the books of the firm:

The separate account titled the ‘Revaluation Account’ is opened to record the adjustments related to the revaluation of assets and liabilities. An increase in the value of the assets or a decrease in the liability is recorded on the credit side of the Revaluation Account, and any decrease in the asset or increase in the liability is debited. The unrecorded assets and liabilities are also taken into consideration. An unrecorded asset is recorded on the credit side, and an unrecorded liability, if any, is debited. Then the profit or loss, as the case may be, is transferred to the partner’s capital/current account in their old profit sharing ratio. Both sides of the Revaluation Account are compared to determine the profit or loss. When the total of the credit side is more than the total of the debit side, the balance in the account is a profit, and the balance is a loss if the total of the debit is bigger than the total of the credit side.

Journal Entries:

1. Increase in the value of an asset:

2. Decrease in the value of an asset:

3. Increase in the value of a liability:

4. Decrease in the value of a liability:

5. Recording Unrecorded assets:

6. Recording Unrecorded Liability:

7. Transferring the balance of the Revaluation Account:

(a) In case of Profit:

(b) In case of Loss:

Format of Revaluation Account:

*Revaluation A/c can either have a debit or credit balance.

Illustration 1:

A, B, and C are partners sharing profits and losses in the ratio of 3:3:2. Partners decided that with effect from 1st April, 2022, their new profit-sharing ratio shall be 4:3:2. The firm’s balance sheet as on 31st March, 2022 was:

Additional Information:

Stock is valued at ₹55,000.
Machinery to be depreciated by 10%.
A Provision for Doubtful Debts to be made on Debtors @ 5%.
Building to be appreciated by 20%
Sundry Creditor to be decreased by ₹1,250.

Partners agreed that the revised values are to be recorded in the books. Prepare Revaluation Account, pass necessary Journal Entries and prepare a revised Balance sheet.

Solution:

Illustration 2:

X, Y, and Z are partners sharing profits and losses in the ratio of 2:2:1. Partners decided that with effect from 1st April, 2021, their new profit-sharing ratio shall be 4:4:2. Their Balance Sheet as at 31st March, 2021 was:

Additional Information:

Creditors are overvalued by ₹5,000.
₹2,500 is not likely to rise, which is included in Bills Payable.
An outstanding Expense of ₹2,500 is not recorded at all.
Land to be appreciated by 10%.
A typewriter worth ₹2,500 is unrecorded.
A Provision for Doubtful Debts to be made on Debtors @ 5%
Stock is overvalued by ₹1,000.

Partners agreed that the revised values are to be recorded in the books. Prepare Revaluation Account, pass necessary Journal Entries and prepare a revised Balance sheet.

Solution:

Case 2: When assets and liabilities are not shown at a revised value in the books of the firm:

Under this situation, no separate Revaluation Account is prepared, rather the Profit/Loss arising out of revaluation of assets and reassessment of liabilities are directly adjusted through the Capital/Current Account of the Partners. In the case of the Profit on Revaluation, the Capital/Current Account of the Gaining Partner is debited, and that of Sacrificing Partner is credited. Similarly, when the Loss on Revaluation is ascertained, the Adjustment is made by debiting the Capital/Current Account of the Sacrificing Partner and crediting the Capital/Current Account of the Gaining Partner.

In order to make the above Adjustment, the following Steps are to be taken:

Step 1. Calculation of Net Effect of Revaluation:

Step 2. Calculation of share of Gain or Sacrifice by the Partners:

Share of Sacrifice = Old Ratio − New Ratio

Share of Gain = New Ratio − Old Ratio

Step 3. Calculation of Proportional share of Net Effects of Revaluation:

Share of Gaining Partner = Share of Gain × Net Effects of Revaluation

Share of Sacrificing Partner = Share of Sacrifice × Net Effects of Revaluation

Step 4. Passing Journal Entry:

(A) In Case of Profit on Revaluation:

(B) In Case of Loss on Revaluation:

Illustration 1:

Ram, Shyam, and Radha are partners sharing profits and losses in the ratio of 3:2:1. The Partners agreed that from 1st January 2020, they will share profits and losses in the ratio of 4:4:1. They also decided not to record the net effect of revaluation in the books of the firm and make the adjustments directly through Capital Account.

Solution:

Step 1. Calculation of Net Effect of Revaluation:

Step 2. Calculation of share of Gain or Sacrifice by the Partners:

Old Ratio = 3:2:1

New Ratio = 4:4:1

Sacrificing/ Gaining Ratio:

Ram = $\frac{3}{6}-\frac{4}{9}=\frac{1}{18}(Sacrifice)$

Shyam = $\frac{2}{6}-\frac{4}{9}=\frac{-2}{18}(Gain)$

Radha = $\frac{1}{6}-\frac{1}{9}=\frac{1}{18}(Sacrifice)$

Step 3. Calculation of Proportional share of Net Effects of Revaluation:

Share of Ram (Sacrifice) = $\frac{1}{18}\times(13,500)=750$

Share of Shyam (Gain) = $\frac{2}{18}\times(13,500)=1,500$

Share of Radha (Sacrifice) = $\frac{1}{18}\times(13,500)=750$

Step 4. Passing Journal Entry:

Illustration 2:

Amit, Ankit, and Sumkit are partners sharing profits and losses in the ratio of 5:3:2. Partners decided that with effect from 1st April 2021, their new profit-sharing ratio shall be 2:2:1. Their Balance Sheet as on 31st March, 2021 was:

Additional Information:

Stock to be increased by ₹40,000.
Provision for Doubtful Debts to be reduced by ₹4,000.
Furniture to be depreciated by 20%.
Computers to be reduced by ₹60,000.
Goodwill of the firm is valued at ₹2,00,000.

Partners decided to carry the same Balance of Reserve and Profit/Loss Account and not to record any changes in the value of assets and liabilities in the Books of Accounts. Pass an Adjustment entry and prepare a Balance Sheet after Adjustment.

Solution:

1. Calculation of Net Effect of Revaluation: