Chapter 4
Reconstitution of a Partnership Firm – Retirement and Death of a Partner
According to section 32(1) of the Indian Partnership Act, 1932:
A partner may retire in any of the following ways:
- With the consent of all the partners.
- In accordance with an express agreement by the partners.
- Where the partnership is at will, by giving notice in writing to all the other partners of his intention to retire.
Retirement means one or more partners may leave the firm and it is the end of an existing agreement between the partners (one of the ways of reconstitution of partnership firm) but it does not mean the end of the business.
Accounting treatment/ Adjustments to be made at the time of Retirement of a partner:
- Calculation of New Profit-Sharing Ratio and Gaining Ratio.
- Treatment of Goodwil.
- Treatment of Accumulated Profit/ Losses and Reserves.
- Revaluation of Assets and Reassessment of Liabilities.
- Preparation of Balance Sheet.
Calculation of New Profit Sharing Ratio:
The ratio of remaining partners is known as New Profit Sharing Ratio, in which they will share the future profits. When a partner retires from the firm, the remaining partners acquired share of retiring partner either in their old ratio or in specified ratio.
New Profit Sharing Ratio = Old Ratio + Gaining Ratio
Calculation of Gaining Ratio: It is the ratio in which retiring partner’s share is acquired by the remaining partner.
Gaining Ratio = New Ratio – Old Ratio
Case:-1 When New profit sharing ratio of continuing partners is not given, in such a situation, it is assumed that they will share profits in their old ratio.
Example: A, B and C are partners sharing profit in the ratio of 3 : 2 : 1. If A retires from the firm.
Calculate New and Gaining Ratio.
The New and Gaining ratio between B and C will be 2:1.
Solution:
Total share of profits = 1
Remaining share after A’s retirement = 1- 3/6 = 3/6
New Profit sharing Ratio:
B = 2/6 × 6/3(reciprocal of the remaining share) = 2/3
C = 1/6 × 6/3(reciprocal of the remaining share) = 1/3
Therefore New Profit sharing Ratio = 2 : 1
Gaining Ratio = New Ratio – Old Ratio
B’s gaining share = 2/3 – 2/6 = (4-2)/6 = 2/6
C’s gaining share = 1/3 – 1/6 = (2-1)/6 = 1/6
Therefore gaining ratio = 2 : 1
Case:- 2 When new profit sharing ratio of continuing partner is given.
Example: A, B and C are partners sharing profit in the ratio of 3 : 2 : 1. If A retires from the firm.
The New ratio between B and C will be 3 : 2.
Calculate gaining ratio.
Solution:
Gaining Ratio = (New Ratio – Old Ratio)
B’s Gaining share = 3/5 – 2/6 = (18- 10)/30 = 8/30
C’s gaining share = 2/5 – 1/6 = (12- 5)/30 = 7/30
Gaining Ratio between B and C = 8 : 7
Case:- 3 When continuing partners acquire retiring partner’s share in some specified proportion.
Example: A, B and C are partners sharing profits in the ratio of 15 : 12 : 3. A gets retirement from the firm and his share is taken by remaining partners equally. Calculate New and Gaining Ratio.
Solution: A retire and his share = 15/30
This share of A is taken by B and C equally
B’s gaining share = 15/30 × 1/2 = 15/60
C’s gaining share = 15/30 × 1/2 = 15/60
Gaining Ratio = 1:1
New Profit sharing ratio = Old share + gaining share
B’s new share = 12/30 + 15/60 = (24+ 15)/60 = 39/60
C’s new share = 3/30 + 15/60 = (6+ 15)/60 = 21/60
Therefore New Profit sharing Ratio = 39:21 = 13:7
Case:- 4 When Retiring Partner sells his share to the Continuing partners.
Example: X, Y and Z are partners sharing profits in the ratio of 5 : 3 : 2. Y retires and sells his share of goodwill to X for ₹ 12,000 and to Z for ₹ 8,000. Calculate gaining ratio and new ratio of X and Z.
Solution:
Gaining share of X and Z is ₹ 12,000 and ₹ 8,000 = 3 : 2
It means X and Z has acquired Y’s share in 3:2.
X’s gaining share = 3/10 × 3/5 = 9/50
Z’s gaining share = 3/10 × 2/5 = 6/50
New profit sharing ratio:
X’s new share = 5/10 + 9/50 = (25+ 9)/ 50 = 34/50
Z’s new share = 2/10 + 6/50 = (10+ 6)/50 = 16/50
New Ratio = 34:16 = 17 : 8
Treatment of Goodwill:
- At the time of retirement of a partner, he/she will get his/her capital, profit, reserves etc. and also goodwill.
- The goodwill of retiring partner will be calculated and will be adjusted among remaining partners in gaining ratio.
- Retiring Partner’s share of goodwill = Total Goodwill of the firm × Retiring Partner’s share
Journal Entries for Goodwill:
Gaining Partner’s Capital A/c Dr.
To Retiring Partner’s Capital A/c/ Sacrificing Partner’s Capital A/c
(Being retiring partners share of goodwill is adjusted in the gaining ratio through the Capital accounts of the partners)
Note: Goodwill given in the Balance Sheet of the firm should be debited all old partners in their old ratio. (Same treatment as in case of change in profit sharing ratio and admission of a partner)
Hidden Goodwill:
When goodwill is not given (in adjustment), in such a case following steps to be used to calculate the Hidden Goodwill.
Step 1. Calculation of actual amount due to the retiring partner.
Step 2. Calculation of total amount to be paid to retiring partner.
Step 3. Hidden Goodwill = Step 2 – Step 1
Note: Amount of hidden goodwill is equal to the goodwill of retiring partner. The treatment of hidden goodwill is same like the treatment of goodwill discussed above.
Treatment of Accumulated Profits/Losses and Reserves:
At the time of retirement of a partner, all the accumulated profits/Losses and Reserves are to be distributed to the old partners in their old profit-sharing Ratio.
Note: Treatment of Accumulated profits/losses and Reserves at the time of retirement is similar to that at the time of Admission of a Partner.
Treatment: All free reserves and profits given in the liabilities side should be credited to Partner’s Capital Accounts or Current Account (If Capitals are fixed) and all fictitious assets/ accumulated losses should be debited to the Partner’s Capital Account or Current Account (If Capitals are fixed) in their old ratios.
Treatment of Revaluation of Assets and Reassessment of Liabilities:
Note: Treatment of Revaluation of Assets and Re-assessment of liabilities and Preparation of Revaluation Account is same as we have done in case of Admission of a partner.
In case of Retirement also we will distribute Revaluation Profits/Losses to all the partners in their old ratios.
Amount Payable to Retiring Partner:
Amount to be credited to the Retiring Partner’s Capital Account/Amount to be paid
- Balance of his/her capital account
- Balance of his/her current account
- Share of goodwill
- Share in Revaluation profits
- Share in Accumulated profits and Reserves
- Interest on Capital
- Salary/Commission etc.
- Share in the profit of current year.
Amount to be debited to the Retiring Partner’s Capital Account/Amount to be recovered
- Drawings
- Interest on drawings
- Share in Revaluation Loss
- Written off portion of goodwill appearing in the books
- Written off of fictitious assets
Death of a Partner:
In case of death of the partner, partnership will come to an end immediately. In such a case remaining partners may continue the business. All amounts due to the deceased partner will be paid to his legal representative/Executor.
Executor is the person named in a Will or appointed by a court to wind up the deceased partner’s financial affairs after death. He is entitled to all the amounts due to the deceased partner.
Calculation of deceased Partner’s share of Profit till the date of death:
If a partner dies on any date after the date of the Balance Sheet, then his share of profits is calculated from the beginning of the year to the date of death on the following basis:
- On the Basis of Time: When share of profit is calculated on the basis of time, it may be on the basis of previous years’ profit or average profit of the last year.
Profit from the date of last balance sheet to the date of death = (Number of days or month from the date of last balance sheet to the date of death/ 365 or 12) × Previous years’ profit or Average profits of given number of past years.
Example: 1 A, B and C are partners sharing profits in the ratio of 3:2:1. They closed their books on 31st March, 2021. C died on 1st August 2021. Profit of the last year was ₹ 54,000. C’s share of profit to be calculated on the basis of last year’s profit.
Solution: C’s share of profit = 54,000 × 4/12(period) × 1/6(His share) = 3,000
Example: 2 X, Y and Z are partners sharing profits in the ratio of 5:3:2. They closed their books on 31st March, 2021. Y died on 30th September, 2021. Y’s share of profit of the interim period is to be calculated on Average profits of last 3 years The Profits of the last 3 years were ₹ 18,000; ₹ 20,000; ₹ 22,000.
Solution: Y’s share of profit = (18,000 + 20,000 + 22,000)/3 = 20,000; 20,000 × 6/12(period) × 3/10 (His share) = 3,000
2. On the basis of Sales/Turnover: Profit from the date of last balance sheet to the date of death = (Sales from the date of the last Balance Sheet to date of death)/ (Previous year’s sales or Average sales of given number of past years) × Previous years’ Profits or Average Profits of given number of Past years.
Example: A, B and C are partners sharing profits equally. They closed their books on 31st March, 2021. A died on 30th June 2021. Sales for the last year was ₹ 5,00,000 and profit was ₹ 1,00,000. Sales for the period 1st April, 2021 to 3oth June 2021 was ₹ 3,00,000.
Solution: Last year’s Profit on sales = (1,00,000/ 5,00,000) × 100 = 20%
Current year’s profit up to the date of death = 3,00,000 × 20/100 = 60,000
A’s share of Profit = 60,000 × 1/3 = 20,000
OR
Profit from the date of last balance sheet to the date of death = (3,00,000/5,00,000) / 1,00,000 = 60,000
A’s share of Profit = 60,000 × 1/3 = 20,000
Journal Entries –
- In case of profit,
Profit and Loss Suspense Account ……… Dr.
To Deceased Partner’s / Current Account
- In case of Loss,
Deceased Partner’s / Current Account ……… Dr.
To Profit and Loss Suspense Account
