Key Points - Retirement/Death of a Partner

Introduction ­ Like admission and change in profit sharing ratio, in case of retirement or death also the existing partnership deed comes to an end and the new one comes into existence among the remaining partners. There is not much difference in the accounting treatment at the time of retirement or in the event of death.
Amount due to retiring deceased Partner (To be credited to his capital account)

1. Credit Balance of his capital.

2. Credit Balance of his current account (if any)

3. Share of Goodwill.

4. Share of Reserves or Undistributed profits.

5. His share in the profit revaluation of assets and liabilities.

6. Share in profits upto the date of Retirement/Death.

7. Interest on capital if involved.

8. Salary if any

Deduction from the above sum (to be debited to the capital account)

1. Debit balance of his current account (if any)

2. Share of Goodwill to be written off.

3. Share of Accumulated loss.

4. Drawings and interest on drawings (if any)

5. Share of loss on account of Revaluation of assets and liabilities.

6. His share of business loss.

Accounting Treatement

1. Calculation of new profit sharing ration and gaining ratio

2. Treatment of goodwill.

3. Revaluation a/c preparation with the adjustment in the respect of unrecorded assets/ liabilities.

4. Distribution of reserves and accumulated profits/loss.

5. Ascertainment of share of profits/loss till the date of retirement/death.

6. Adjustment of capital if required

7. Settlement of the Accounts due to Retired/Deceased partner.
New Profit Sharing Ratio & Gaining Ratio
New Profit Sharing Ratio ­ It is the ratio in which the remaining partners will share further profits after retirement/death.
Gaining ratio ­ It is the ratio in which the continuing partners have acquired the share from the outgoing partner
Calulation of the two ratios

Following situations may arise.

1. When no information about new ratio or gaining ratio is given in the question
In this case it is considered that the share of the retiring partner is acquired by the remaining partners in the old ratio. Then no need to calculate the new ratio/gaining ratio as it will be the same as before.
Example 1 :­ A Band C are partners sharing profit and loss in the ratio of 3:2:1 then on retirement of the gaining ratio/new ratio will be
A­ 2:1
B­ 3:1
C­ 3:2

2. Gaining ratio is given which is different than the old ratio
In this case
New share of continuing partner = his old share + gained from the outgoing partner.
Example 2 : A, B & C share profits in the ratio 3:2:1. On C's death his share is taken by A & B in the ratio of 2:1 Calculate new ratio
Solution ­ In this case gaining ratio = 2:1 (given)
A's old share = 3/6, B's old share = 2/6 & C's share = 1/6
A's gain = 2/3 of C's share = 2/3*1/6 = 2/18
B's gain = 1/3 of C's share = 1/3 * 1/6= 1/18
A's new share = A's old share + A's gain
= 3/6+2/18 = 11/18
B's new share = B's old share+B's gain
= 2/6+1/18= 7/18
New ratio = 11:7

3. If the new ratio is given then
Gaining ratio = New Ratio ­ Old Ratio
Example 3 :­ A, B & C are partners in the ratio of 3:2:1 C retires & A & B decide to share future profit in the ratio of 5:3
A's Gain = 5/8­3/6 = 3/24
B's Gain = 3/8­2/6=1/24
Gaining ratio = 3:1
Distinction between the Sacrificing and Gaining Ratio
Basis

1. Meaning

2. When calculated

3. Formula

4. Purpose
Sacrificing Ratio
It is the ratio in which the old partners surrender a part of their share of profits in favour of a new partner.
At the time of admission of a new partner
Sacrificing Ratio=
Old Ratio­ New Ratio
New partners share of goodwill is divided between old partners in this ratio.

5. Gaining Ratio
It is the ratio in which the remaining partner's acquire the outgoing partner's share of profit
At the time of retirement or death of a partner.
Gaining Ratio= New Ratio­
Old Ratio
Retiring or deceased partner's share of goodwill is paid by the continuing partners in this ratio

Treatment of Goodwill
According to accounting standard ­ 10, Goodwill account can't be raised. Therefore only adjustment entry is done for goodwill.
Steps to be followed :­

1. When old goodwill appears in the books then first of all this is written off in the old ratio.
Remember Old Goodwill Old Ratio
All Partners' capital A/c Dr
To Good will A/c

2. After writing off old goodwill adjustment of retiring partner's share of goodwill will be made through the following journal entry.
Remaining Partner's Cap A/c
Dr (in gaining ratio)
To Retiring/Deceased Partner's Cap A/c
Example 4 : M, N & P are partners in a firm. P retires & the goodwill of the firm is valued at Rs.30000.
M & N decide to share future profits in the ratio of 3:2. Pass necessary adjustment entries.

1. If goodwill A/c already appears in teh books at Rs.18000

2. When no goodwill A/c appears in the books.
Solution :­ Old ratio of M, N & P = 1:1:1 (since profit sharing ratio is not given it is treated as equal)
New ratio= 3:2
M's gain = 3/5­1/3= 4/15
N's gain = 2/5­1/3= 1/15
Gaining ratio = 4:1
P's shareof goodwill = 30,000*1/3 = 10,000
Case 1.

1. Old goodwill will be written off in the old ratio i.e. 1:1:1
M's Capital A/c Dr 6000
N's Capital A/c Dr. 6000
P's Capital A/c Dr 6000
To Goodwill A/c

1.000

2. Adjustment entry will be done in gaining ratio
M's Capital A/c Dr.8000
N's Capital A/c Dr.2000
To P's Capital A/c

1.,000
Case 2. When No goodwill already appears in the books then only second entry will be done.

Hidden goodwill
Sometimes goodwill is not given in the question directly. But if a firm agrees to pay a sum which is more than his balance in capital a/c after making all adjustment with respect to reserves, revaluation of assets and liabilities etc. then excess amount is treated as his share of goodwill (known as hidden goodwill)
EXAMPLE 5 : Let R, S & T are partners in a firm sharing profit & loss in the ratio of 2:2:1. T Retires and his balance in capital a/c after adjustment for reserve & revaluation of assets & liabilities comes out to be Rs.50000. R & S agree to pay him Rs.60000. Give journal entry for the adjustmnet of goodwill.
Solution
New ratio between R & S = gaining ratio = 2:2 or 1:1
T's share of goodwill (hidden) = Rs.60000­50000=10000
Hence adjustment entry is
R's capital a/c
Dr 5000
S's capital a/c
Dr 5000
To T's capital a/c 10000 (T's share of goodwill adjusted in gaining ratio i.e. 1:1)

3. Revaluation of Assets and Reassessment Liabilities
Revaluation A/c is prepared in the same way as in the case of admission of a new partner.
Profit and loss on revaluation is transferred among all the partners in old ratio.

4. Adjustment of Reserves and Surplus (Profits) (Appearing in the Balance Sheet­ Liability Side) (a) General Reseve A/c

5. Adjustmetn of Joint Life Policy (JLP)
Introduction
JLP means the policy taken by the firm on the lives of the partners. When any of teh partners dies the insurance company pays the whole amount which makes the payment easy to deceased partner's legal representatives in case of death.
Accounting treatment in case of retirement
Case1. . When premium paid is considered as Revenue Expenditure – In this case the premium paid is debited to P&L A/c and JLP A/c doesn’t appear in the balance sheet. In this case the Retiring partner's share in the surrender value of JLP will be debited to the remaining partners Cap A/c in gaining ratio.
I.e. Remaining Partner’s Cap A/c Dr
To Retiring Partner’s Cap A/c

Case2. . When premium paid is considered as Capital Expenditure­ In this case the JLP A/c will be already appearing in the Balance Sheet at surrender value. Then no further treatment is required because it means that the retiring partners share is already included in his Cap A/c.
Disposal of the Amount Due to the Retiring Partner
The outgoing partners A/c is settled as per the terms of partnership deed. Three cases maybe there as given below­

1. When the retiring partner is paid full amount either in cash or by cheque.
Retiring Partner’s Cap A/c
Dr
To Cash or Bank A/c

2. When the retiring partner is paid nothing in cash then the whole amount due is trfd to his loan
A/c.
Retiring Partner’s Cap A/c
Dr
To retiring partner’s Loan A/c

3. When Retiring Partner is partly paid in cash and the remaining amount is treated as
Loan.
Retiring Partner’s Cap A/c Dr (Total Amount due)
To Cash/Bank A/c (Amount Paid)
To Retiring Partner’s Loan A/c(Amount of Loan)
Settlement of Loan of the Retiring Partner
Loan of the retiring partner is disposed off according to the pre decided terms and conditions among the partners. Normally the Principal amount is paid in few equal installments. In such cases interest is credited to the Loan A/c on the basis of the amount outstanding at the beginning of each year and the amount paid is debited to loan A/c.The following Journal entries are done a) For interest on Loan.
Interest A/c
Dr
To Retiring partner’s Loan A/c b) For the payment of installment.
Retiring Partner’s Loan A/c
Dr
To Cash/ Bank A/c
Example 10: ­A, B, and C are partners in a firm. B retires from the firm on 1st Jan 2008.
On the date of his retirement Rs.66, 000 were due to him. It was decided that the payment will be done in 3 equal yearly installments together with interest @ 10%p.a. on the unpaid balance. Prepare B’s Loan A/c.
B's Loan A/c
Date

Adjustment of Capitals
At the time of retirement /death, the remaining partners may decide to adjust their capitals in their new profit sharing Ratio. Then
­ The sum of their capitals will be treated as the total capital of the new firm which will be divided in their New Profit Sharing Ratio.
­ Excess or Deficiency of capital in the individual capital A/c is calculated.
­ Such excess or shortage is adjusted by withdrawal or contribution in cash or transferring to their current A/cs.

E.g. On Vivek’s retirement it was agreedthat: i.
Premises will be appreciated by 5% and furniture will be appreciated by ` 2, 000.
Stockwill be depreciated by 10%. ii.
Provision for bad debts was to be made at 5% on debtors and provision for legal damages to be made for ` 14, 400. iii. Goodwill of the firm is valued at ` 48,000. iv. ` 50,000 from Vivek’s Capital A/C will be transferred to his loan A/c and the balance will be paid by cheque.
Prepare revaluation a/c, partners Capital A/cs And Balance Sheet of Vijay and Vinay after Vivek’s retirement.

Death of a Partner
Accounting treatment in the case of death is same as in the case of retirement except the following:­

1. The deceased partners claim is transferred to his executer's account.

2. Normally the retirement takes place at the end of the Accounting Period but the death may occur at any time. Hence the claim of deceased partner shall also include his share of profit or loss, interest on capital and drawings if any from the date of the last balance sheet to the date of his death.

3. On death of a partner, the insurance company pays the entire amount of the sum assured on JLP.
The treatment of profits and JLP will be taken up one by one as follows­
I. Calculation of Profits/Loss for the Intervening Period
It is calculated by any one of the two methods given below:­ a) On Time Basis: ­ in this method proportionally profit for the time period is calculated either on the basis of last year's profit or on the basis of average profits of last few years and then deceased partner’s share is calculated based on his share of profits.

To A’s Capital A/c 9, 000 c) Life Policy­ Life policies on the lives of the partners is taken by a firm to arrange money to settle the account of deceased partner. It may be of two types:­

1. Joint Life Policy­ It is taken jointly by the firm on the lives of all the partners. If any of the partners dies, the insurance company pays whole of the amount.

2. Individual life policies­ Sometimes the firm takes individual life policies on the lives of partners instead of one single Joint life policy. In this case the insurance company pays the full sum assured on the life policy of the deceased partner only.

Accounting Treatment
Case 1 – When surrender values are not appearing in the books. a) For the amount to be received on maturity (death) of a partner. i. Insurance Co. A/c Dr
To Life Policy A/C (For the amount due on the death of a partner) ii. Life Policy A/c Dr
To All Partner’s Capital A/cs (For the amount due transferred to all partners’ capital A/cs in old ratio)

6. b) For deceased partners share in the surrender values of the life policies of surviving partners.
Remaining Partners Capital A/c Dr
To Deceased Partner’s Capital A/c (For deceased partner’s share in the surrender values of surviving partner’s life policies adjusted in gaining ratio)
 

1. For the amount to be received from the Insurance Co. on Joint Life policy or the
Policy in the name of deceased partner. (a) Insurance Co. A/c Dr
To life policy A/c (For the amount due on the death of a Partner) (b) Life policy A/c Dr(By the Amount received less surrender value)
To All Partner’s Capital A/c

2. No entry for the surviving partners policies.
Example 5­ In the 3rd example if the surrender value of Rs.12, 000 is shown in the Balance Sheet then following entries will be passed.
 

1. Calculation of Goodwill
Average profit for 3years=( Rs.80, 000+90,000+1,00,000)/3
=90,000
Goodwill of the firm=Average Profit*No. Of Year of Purchase=90,000*2=Rs.1, 80,000
Total N’s Share in Goodwill=1, 80,000*1/3=60,000

2. Time from the date of last balance Sheet(31st December,2009) to the date of death(14th March, 2010)
=31 days of January+28 days of Feb (2010 is not a leap year)+14 days of March
=73 days