Change in Profit Sharing Ratio: Accounting Treatment of Investment Fluctuation Fund

All business units create reserves out of their profits from each year to allot such money for specific purposes. They are usually created to buy fixed assets, pay bonuses, pay an expected legal settlement, pay for repairs & maintenance and pay off debt. Thus, reserves help a company stay financially stable. Investment fluctuation reserve is an important example of reserves created by business firms. It is created as a provision for any change in the market value of investments. It is a reserve appearing in the balance sheet on the date of admission, and it needs to be distributed among the old partners in their profit-sharing ratio.

Accounting Treatment of Investment Fluctuation Fund:

Case 1: When the book value and market value of the investment are the same:

 

Illustration:

A, B and C are partners in a firm, sharing profits in the ratio of 3:2:1. They decided to share the future profit and loss equally. The market value of the investment is the same as the book value. The Investment Fluctuation Fund is valued at ₹60,000. Pass the Journal Entry for the above adjustment.

Solution:

 

Case 2: When the market value of the investment is less than the book value:

A) Fall in the value of the investment is less than the amount of Investment Fluctuation Fund: 

 

Illustration:

X and Y are partners in a firm, sharing profits in the ratio of 2:1. They decided to share the future profit and loss equally, the Investments (market value ₹3,20,000) appear in the books at ₹3,60,000. The Investment Fluctuation Fund is valued at ₹1,00,000. Pass the Journal Entry for the above adjustment.

Solution:

 

B) Fall in the value of the investment is equal to the amount of the Investment Fluctuation Fund:

 

Illustration:

L ,M, and N are partners in a firm, sharing profits in the ratio of 5:4:1. They decided to share the future profit and loss equally. The Investment (market value ₹80,000) appear in the books at ₹1,60,000. The Investment Fluctuation Fund is valued at ₹80,000. Pass the Journal Entry for the above adjustment.

Solution:

 

C) Fall in the value of the investment is more than the amount of Investment Fluctuation Fund:

 

Illustration:

X and Y are partners in a firm, sharing profits in the ratio of 3:2. They decided to share the future profit and loss equally. The Investments (market value ₹15,000) appear in the books at ₹50,000. The Investment Fluctuation Fund is valued at ₹30,000. Pass the Journal Entry for the above adjustment.

Solution:

 

Case 3: When the market value of the investment is more than the book value

 

Illustration:

P and Q are partners in a firm, sharing profits in the ratio of 1:1. They decided to share the future profit and loss equally. The Investments (market value ₹60,000) appear in the books at ₹40,000. The Investment Fluctuation Fund is valued at ₹60,000. Pass the Journal Entry for the above adjustment.

Solution: