Class 12-commerce NCERT Solutions Accountancy Chapter 3 - Reconstitution of a Partnership Firm - Retirement/Death of a Partner

A partner can retire from the firm:

1. With the consent of all partners: A partner must take the consent of all the other partners of the firm before his/her retirement. The partner can retire from the firm only if all the partners have approved the decision of his/her retirement.
2. According to the terms of the express agreement: If there is an express agreement among the partners, the partner may retire according to the terms of the agreement.
3. At his own will: If the partner wants to retire at his/her own will, then a partner may retire by giving a written notice to all the other partners informing them about his/her intention to retire.

Various matters which need to be adjusted at the time of retirement of partner/s:

1. Computation of new profit-sharing ratio of the remaining partners of the firm
2. Computation of new gaining ratio of all the remaining partners of the firm
3. Computation of goodwill and its treatment
4. Adjustment for the revaluation of assets and liabilities
5. Distribution of accumulated profits and losses and reserves between all the partners including retiring partner
6. Adjustment of joint life policy
7. Settlement of the dues of retiring partners
8. Adjustment of capital account of the continuing partner in their new profit-sharing ratio

At the time of retirement or death of a partner, it becomes essential to revalue the assets and liabilities of the firm for finding out their true and fair values. Revaluation is needed as the value of assets and liabilities may increase or decrease with the passage of time. Further, it may be possible that certain assets and liabilities are left unrecorded in the books of accounts. The retiring or the deceased partner may be benefited or may bear loss due to change in the values of assets and liabilities. Therefore, the revaluation of the assets and liabilities is necessary to ascertain the true profit or loss which is to be distributed among all the partners in their old profit-sharing ratio.

The retiring/deceased partner is entitled to a share of goodwill of the firm because goodwill is an intangible asset which is earned by the efforts of all the partners in the firm. In the future, the fruits of past performance and reputation will be shared only by the remaining partners after the retirement or death of a partner. Therefore, the remaining partners should compensate the retiring/deceased partner by entitling him/her a share of the firm's goodwill. 

The total amount due towards a retiring partner can be paid in any of the following manner:

(i) In lump sum: If the amount due to the retiring partner is to be paid in lump sum on the day of his/her retirement. This method is usually adopted when the amount payable is small and the following entry is passed to record such a payment.

(ii) In instalments: Sometimes, the amount payable to the retiring partner is quite a large amount which a firm is unable to pay in one payment. In such cases, the amount not paid at the time of retirement (or amount which has been decided to be paid in instalments) is transferred to his/her loan account. In this case, the retiring partner receives equal instalments along with the interest on the amount outstanding. The following necessary journal entry is to be passed:

(iii) Partly in Cash and Partly in Instalments: If the amount due to the retiring partner is to be paid partly in cash and partly in equal instalments, then a certain amount is paid in cash to the retiring partner on the date of the retirement and the rest amount due to him/her is transferred to his/her loan account. The following necessary journal entry is to be passed:

The amount payable to the deceased partner can be ascertained by preparing his/her capital account. The legal executer of the deceased partner would be entitled to the balance in deceased partner's capital account. The balancing figure of the deceased partner's capital account is derived after posting the below mentioned items:

1. Crediting deceased partner's capital account with

1. Credit balance of capital account and/or current account
2. Deceased partner's share of profit up to the date of his/her death
3. Deceased partner's share of goodwill
4. Deceased partner's share in accumulated reserves and profit account
5. Deceased partner's share in gain on revaluation of assets and liabilities
6. Deceased partner's share of Joint Life Policy
7. Interest on capital, if any, up to the date of the death
8. Salary or commission, if any, up to the date of the death 

2. Debiting deceased partner's capital account with

Debit balance of the deceased partner's capital account and/or current account.

1. Drawings up to the date of death of the partner
2. Interest on drawings, if any, up to the date of the death
3. Deceased partner's share in loss on revaluation of assets and liabilities
4. Deceased partner's share of loss up to the date of the death
5. Deceased partner's share in the accumulated losses of the firm 

The legal executor is entitled to the balancing figure which is the excess of the credit side over the debit side of the deceased partner's capital account.

Generally, in accounting terms, the retiring or deceased partner's capital account is credited with his share of goodwill and continuing partner's capital accounts are debited from the gaining ratio. This treatment is based on Para 16 of Accounting Standard 10, which states that it is mandatory to record goodwill in the books only when consideration in money or money's worth has been paid for it.

In case of retirement and death of a partner, goodwill account cannot be raised. There are namely two probable situations on which the treatment of goodwill rests.

1. If goodwill already appears in the books of the firm
2. If no goodwill appears in the books of the firm 

The treatment of goodwill in the above two scenarios is discussed below.

Scenario 1: Goodwill already appears in the books of the firm

Step 1: Write off the existing goodwill

The goodwill already appearing in the old balance sheet of the firm (if mentioned in the question), is first written off and is to be distributed among all partners of the firm including the retiring or deceased partner in their old profit-sharing ratio. The following journal entry is passed to write off the old/existing goodwill:

Step 2: Adjusting goodwill through partner's capital account

After writing off the old goodwill, the goodwill needs to be adjusted through the partner's capital account with the share of the goodwill of the retiring or the deceased partner. The following journal entry is passed:

Scenario 2: No goodwill appears in the books of the firm

In case no goodwill appears in the books of the firm, the goodwill is adjusted through the partner's capital account with the share of the goodwill of the retiring or deceased partner.

The following is the journal entry which is passed to give the required affect:

A deceased partner's share of profits can be calculated on any of the following basis depending on the agreement between partners.

1. On the basis of time:

Profit up to the date of the death of the partner is calculated on the basis of last year's profit or average profit of last few years. In this approach, it is assumed that the profit will be uniform throughout the current year. The deceased partner will be entitled to the share of the profit proportionately up to the date of his/her death.

Share of Deceased Partner in Profit =

Example:

L, M and N are equal partners. The profit of the firm for the years 2013, 2014 and 2015 are Rs 20,00,000, Rs 14,00,000 and Rs 26,00,000, respectively. N dies on 31 March 2016. The share of N in the firm's profit will be calculated on the basis of the average profit of the last three years. The firm closes its books every year on 31 December.

In this case, N's share in the profits will be calculated for four months, i.e. from 1 January 2016 to 31 March 2016.

2. On the basis of sale: Profit is calculated on the basis of last year's sale. In this situation, it is assumed that the net profit margin of the current year's sale is similar to that of the last year.

Example: P, Q and R are equal partners. Sales for the previous year and the profits were Rs 12,50,000 and Rs 1,25,000. R died on 30 June 2015. Sale of the current year till the date of R's death amounted to Rs 6,00,000. The firm closes its books on 31 December every year.

Working Note:

Working Note:

Since, sufficient balance is not available to pay the amount due to Brijesh, the balance of his Capital Account transferred to his loan account.

3.Interest Amount

The firm closes its books every year on march 31 While installments to Pammy's Executor are paid on sept.30 every year.

Amount outstanding on 30 September = 75,400 - 15,400 = 60,000