What is gain ratio formula?
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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:
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,
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