When a partner retires or dies, the firm is reconstituted. The retiring/deceased partner must be paid all amounts due to them (capital, share of goodwill, revaluation gains, accumulated reserves, share of profit till date of retirement/death).
Retirement of a Partner
- 1.A partner retires voluntarily or due to old age, ill health, or other reasons. On retirement:
- 2.New ratio of continuing partners is calculated
- 3.Gaining Ratio = New Ratio - Old Ratio (for each continuing partner)
- 4.Goodwill is adjusted: Continuing (gaining) partners compensate the retiring partner
- 5.Revaluation of assets and liabilities is done
- 6.Accumulated profits/losses/reserves are distributed among ALL partners (including retiring partner) in old ratio
- 7.Amount due to retiring partner is computed and settled
Gaining Ratio
The ratio in which continuing partners GAIN the share of the retiring partner is called the Gaining Ratio.
Gaining Ratio = New Ratio - Old Ratio (for each remaining partner)
Gaining ratio is used for goodwill treatment on retirement.
Treatment of Goodwill on Retirement
Retiring partner is entitled to their share of firm's goodwill.
Entry:
Gaining Partners' Capital A/cs Dr (in gaining ratio)
To Retiring Partner's Capital A/c
Calculation of Amount Due to Retiring Partner
Amount Due = Capital (after adjustments) + Share of Goodwill + Revaluation Profit - Revaluation Loss + Share of Accumulated Reserves - Share of Accumulated Losses + Share of Profit to date of retirement
Settlement of Amount Due
- 1.Options for payment:
- 2.Paid immediately in full — Cash/Bank A/c Dr; Retiring Partner's Capital A/c Cr
- 3.Retained as loan — Retiring Partner's Capital A/c → Retiring Partner's Loan A/c; interest @ agreed rate (or 6% if no deed)
- 4.Paid in instalments
Death of a Partner
- On death, similar adjustments are made. Additionally:
- Profit to date of death is calculated (time basis or turnover basis)
- Life insurance policy (if held) proceeds credited
- Executor of deceased's estate is entitled to all dues
JLP (Joint Life Policy): A policy taken on the lives of all partners. On death of one partner, the amount received is credited to all partners in old ratio; then the deceased's share is transferred to their executor.
New Ratio After Retirement
If not stated, continuing partners may share in their old ratios:
New Ratio of continuing partners = their old ratio (if they take retired partner's share in old ratio)
Or as specifically agreed.
---
A, B and C share profits 4:3:2. B retires. A and C share profits equally after B retires. Find gaining ratio.
· Steps: · Old ratio: A=4/9, B=3/9, C=2/9
New ratio (A and C equally): A=1/2, C=1/2
Gaining Ratio: A = 1/2 - 4/9 = 9/18 - 8/18 = 1/18; C = 1/2 - 2/9 = 9/18 - 4/18 = 5/18
Gaining Ratio A:C = 1:5
P, Q and R share profits 5:4:1. R retires. P and Q share future profits 3:2. Find gaining ratio.
· Steps: · P's gain = 3/5 - 5/10 = 6/10 - 5/10 = 1/10
Q's gain = 2/5 - 4/10 = 4/10 - 4/10 = 0
Gaining Ratio: P gains, Q has no change. Goodwill is compensated only by P.
X, Y and Z share profits 3:2:1. Z retires. Goodwill of firm = Rs 60,000. X and Y continue in 2:1. Pass entry for goodwill.
· Steps: · Z's share of goodwill = 1/6 x 60,000 = Rs 10,000
Gaining ratio: X = 2/3 - 3/6 = 4/6 - 3/6 = 1/6; Y = 1/3 - 2/6 = 2/6 - 2/6 = 0. Only X gains.
X's Capital A/c Dr 10,000
To Z's Capital A/c 10,000
A retires. His capital after all adjustments = Rs 1,50,000. The firm agrees to pay Rs 50,000 immediately and the rest as a loan at 9% p.a. interest. What entry is passed?
· Steps: · A's Capital A/c Dr 1,50,000
To Bank A/c 50,000
To A's Loan A/c 1,00,000
Interest on loan: 1,00,000 x 9% = Rs 9,000 per year until repaid.
Revaluation on retirement of B (A, B, C in ratio 2:2:1): Machinery Up Rs 30,000; Bad Debts Rs 5,000; Unrecorded liability Rs 8,000. Calculate gain/loss per partner.
· Steps: · Net Revaluation = 30,000 - 5,000 - 8,000 = Rs 17,000 (Profit)
A = 2/5 x 17,000 = Rs 6,800; B = 2/5 x 17,000 = Rs 6,800; C = 1/5 x 17,000 = Rs 3,400
D dies on 1st September. Profit for last year = Rs 1,20,000. Profit share of D (ratio 1/4) to date of death — time basis (financial year April to March).
· Steps: · Period from 1 April to 1 September = 5 months
D's share to date of death = 1/4 x 1,20,000 x 5/12 = Rs 12,500
Profit and Loss Suspense A/c Dr 12,500
To D's Capital A/c 12,500
JLP of Rs 1,20,000 (surrender value Rs 40,000 in books) received on death of C (partners A, B, C in ratio 2:2:1).
· Steps: · Bank A/c Dr 1,20,000
To JLP A/c 1,20,000
JLP A/c Dr 1,20,000
To A's Capital A/c 48,000 (2/5 x 1,20,000)
To B's Capital A/c 48,000
To C's Capital A/c 24,000
(Existing JLP surrendered value of Rs 40,000 is first reversed, then the profit of 80,000 distributed)
Common mistakes
- Using old ratio instead of gaining ratio for goodwill credit/debit on retirement.
- Treating the retired partner's loan account as capital; they are separate.
- Forgetting to include the share of profit to date of retirement in the final amount due.
- Distributing reserves in new ratio instead of old ratio.
Summary
On retirement/death of a partner, the firm recalculates the profit-sharing ratio for continuing partners, computes the gaining ratio, adjusts goodwill (gaining partners compensate the retiring partner), revalues assets/liabilities, distributes reserves, and settles the amount due. For death, profit to date of death and JLP proceeds must also be considered.