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Simerpreet
SimerpreetHelpful
In: 1. Financial Accounting > Partnerships

What is gain ratio formula?

What is gain ratio formula?
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    1. Ayushi Curious Pursuing CA
      2022-08-06T18:33:37+00:00Added an answer on August 6, 2022 at 6:33 pm
      This answer was edited.

      Introduction

      The term ‘gain ratio’ is related to partnership accounting. Gain ratio refers to the ratio in which existing partners of a partnership firm, divide among themselves, the share of profit and loss of the outgoing partners.

      There is a method of calculating this gain ratio. The method along with the concept behind gain ration is discussed below.

      Concept behind gain ratio

      A partnership firm is a form of business organisation which is conducted and carried on by members known as partners. It requires at least two partners to start a firm and the maximum limit is 50.

      The partners share the profit and loss of a business in a ratio known as Profit and loss sharing ratio.

      For example, Amanda, Bill and Chang are partners, having a P/L sharing ratio of 3:2:1 i.e. Amanda is getting 3/6, Bill is getting  2/6 of the same and Chang is getting ⅓ of the profit and loss

      If the profit is $6,000 , then Amanda will get $3,000 (3/6 of $6,000) and Bill will get $2,000 (2/6 of $6,000) and Chang will get $1,000 (1/6 of $6,000).

       

      Now if Amanda retires from the firm, then naturally, Bill and Chang’s share of profit will increase.

      The profit and loss sharing ratio will now be 2:1 (earlier it was 3:2:1) and the share of profit of Bill will be $4,000 and of Chang will be $2,000.

       

       

      Calculation of gain ratio

      The formula for calculating gain ratio = New ratio – Old Ratio

      As per the  above case:

      • Gain ratio of Bill = 2/3 – 2/6 = 2/6
      • Gain ratio of Chang = 1/3 – 1/6 = 1/6

       

      Therefore the gain ratio in which Bill and Chang gained the share of profit of Amanda is 2/6 : 1/6 or simply 2:1

      This is how we can calculate the gain ratio. But one thing to notice is that the gain ratio is equal to the P/L sharing ratio of the partnership between Bill and Chang.

      Hence, whenever a partner retires and the existing partner keep the P/L sharing ratio unchanged among themselves then, the gain ratio will be equal to their P/L sharing ratio. In that case, there is no need to calculate the gain ratio from the formula given above.

      But, when the remaining partners change the P/L sharing ratio among themselves after a partner retires, then the gain ratio is to be calculated using the formula given above.

      Suppose, upon retirement of Amanda, Bill and Chang change the P/L sharing between them to from 2:1 to 3:2

       In that case,

      • The gain ratio of Bill = 3/5 – 2/6 = 8/30
      • The gain ratio of Chang = 2/5 – 1/6 = 7/30

       

       Therefore the gain ratio in which Bill and Chang will gain the share of profit of Amanda is 8/30 : 7/30 or simply 8:7

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