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Reconstitution- Retirement/Death of a Partner

Ascertaining the amount due to retiring/deceased partner

Objective

After going through this lesson, you shall be able to understand the following concepts.

  • Retirement/Death of a Partner
  • Ways of Retirement
  • Ascertainment of Amount Due to the Retiring/Deceased Partner
  • Adjustments Required at the time of Retirement

Retirement of a Partner

Retirement of a partner implies a situation when a partner leaves a partnership firm for any reason and the remaining partners of the firm decide to continue with the business. There may be various reasons due to which a partner may seek retirement from a partnership firm.  Some of these reasons are old age, illness, change in interests, etc. As on the event of retirement of a partner, there exists a change in the existing partnership agreement and relationship between the partners, so it can be said that retirement of partner leads to reconstitution of partnership firm. That is, to put in different words, in case of retirement of a partner, the old partnership deed gets terminated and is replaced by a new partnership deed, which defines new relationship among the remaining/continuing partners.

Ways of Retirement

A partner may retire from a partnership firm in any of the following ways.

(i) With the Consent of all the Partners-  In this way, it becomes compulsory for the retiring partner to obtain the consent of all other partners of the firm before seeking retirement. This implies that the partner can get retirement if and only if all the partners agree on the decision of his/her retirement.

Example:  A, B and C are the partners in a partnership firm sharing profits and losses in the ratio of  4 : 3 : 1. On April 01, 2011, B wants to retire from the firm. To this, both A and C agreed. Thus, as B has obtained consent of all the partners so, now he can take retirement from the firm. 

(ii) With Express Agreement by All the Partners-  In case of written agreement among the partners, a partner may retire from the firm by expressing his/her intention of leaving the firm through a notice to the other partners of the firm. In other words, if a partner wants to leave the firm, he/she can do so by giving a notice to the other co-partners

Example:  A, B and C are the partners in a partnership firm sharing profits and losses in the ratio of 4 : 3 : 1. It was provided in their partnership deed that any partner may retire from the firm by giving a notice. On April 01, 2011, B wants to retire from the firm. So, he expresses his intention of retirement to A and C. In this case, B can retire from the firm even without obtaining the consent of all the partners.

(iii) By Giving a Written Notice-  If partnership among the partners is at will then a partner may retire by giving notice in writing to all the other partners informing them about his/her intention to retire.

Example:  A, B and C are the partners in a partnership firm sharing profits and losses in the ratio of 4 : 3 : 1. The partnership between the partners is at will. B wants to retire from the firm. He can retire by giving a written notice to A and C expressing his intention to retire.

Ascertaining the Amount Due to the Retiring Partner

At the time of retirement of a partner, he/she is entitled to receive the following amounts.

  1. Credit Balance of his Capital / Current Account
  2. Share of Goodwill
  3. Share of Accumulated Profits (Reserves)
  4. Share in the Gain of Revaluation of Assets and Liabilities.
  5. Share of Profits upto the Date of Retirement.
  6. Interest on Capital (if any) upto the Date of Retirement
  7. Salary or Commission (if any) upto  the Date of Retirement.

All these amount are posted on the credit side of the Retiring Partner's Capital Account.

Deductions

The following are some deductions (if any) which are to be made from his/her amount due (mentioned above).

  1. Debit Balance of his/her Current Account
  2. Share of Accumulated Losses
  3. Share of Loss on Revaluation of Assets and Liabilities
  4. Share of Loss upto the Date of Retirement
  5. Drawings upto the Date of Retirement
  6. Interest on Drawings (if any) upto the Date of Retirement.

All these amount are posted on the debit side of the Retiring Partner's Capital Account.

Example: A, B and C were partners sharing profits and losses equally. C decided to retire from the firm. Before taking into consideration the below-mentioned items, the capital of A, B and C were Rs 1,00,000, Rs 1,30,000 and Rs 90,000, respectively.

  1. Interest on Capital at 5% p.a.
  2. Drawings by C of Rs 12,000 and interest thereon amounted to Rs 600
  3. Profit on revaluation of assets and liabilities Rs 30,000
  4. Undistributed Profit and Loss (debit balance) Rs 6,000
  5. Joint Life Policy Rs 50,000 and its surrender value Rs 36,000.

Prepare C’s Capital Account at the time of his retirement.

Solution

C’s Capital Account

Dr.

 

 

Cr.

Particulars

Amount

Rs

Particulars

Amount

Rs

Drawings

12,000

Balance b/d

90,000

Interest on Drawings

600

Interest on Capital

4,500

Profit and Loss (Loss)

2,000

Revaluation (Profit)

10,000

C’s Loan

1,01,900

Joint Life Policy

12,000

 

1,16,500

 

1,16,500

 

 

Adjustments Required at the time of Retirement

Following are some of the accounting matters that are to be adjusted at the time of retirement of a partner.

i. Calculation of New-Profit Sharing Ratio
ii. Calculation of Gaining Ratio
iii. Treatment of Goodwill
iv. Revaluation of Assets and Liabilities
v. Distribution of Accumulated Profits and Losses
vi. Settlement of Amount due to the Retiring Partner
vii. Treatment of Joint Life Policy (JLP)
viii. Adjustment of Capital Accounts (if required)

Objective

After going through this lesson, you shall be able to understand the following concepts.

  • Calculation of New Profit Sharing Ratio in case of Retirement/Death of a Partner
  • Calculation of Gaining Ratio
  • Difference between Gaining Ratio and Sacrificing Ratio

Introduction to New Profit Sharing Ratio

As learnt in the previous chapter that at the time of the retirement/death of any partner one of the existing partners discontinues his/her services to the partnership firm. The share of profit of the retiring/deceased partner is taken-over by the remaining/continuing partners. Consequently, there exists a change in the profit sharing ratio among the remaining/continuing partners of the reconstituted firm. Thus, there arises a need to calculate the new profit sharing ratio among the continuing partners.

New profit sharing ratio (in case of retirement/death) is defined as a ratio in which the continuing partners agree to share their future profits and losses. In case of retirement/death of a partner, the new profit sharing ratio of the continuing/remaining partners can be described as a sum of their old profit share and portion of profit share acquired from the outgoing partner. Algebraically,

New Profit Share of the Continuing Partners = Old Profit Share + Part of Profit Share acquired from the Outgoing Partner.

Calculation of New Profit Sharing Ratio in case of Retirement and Death of a Partner

Generally, in case of retirement and death of a partner, there arise two cases in which the remaining partners acquire the share of the outgoing or retiring partners. These are:

(i) No information regarding acquisition of profit share by the remaining partners is mentioned. 

(ii) When the share of the retiring or deceased partner is purchased in a particular ratio by the remaining partners.

(i) No information regarding Acquisition of Profit Share by the Remaining Partners is mentioned.

In this case, no information regarding how the profit share of the outgoing partner is acquired by the remaining partners is mentioned in the question. In this case, the new profit sharing ratio of the remaining partners is computed just by crossing out the share of the outgoing partner.

Example:

P, Q and R are the three partners in the partnership firm sharing profits and losses in the ratio 4 : 3 : 1. On April 01, 2011, Q decided to take retirement from the firm.

Solution:

As we can see that in this case, no information is given as to how P and R are acquiring Q's profit share, so the new profit sharing ratio between P and R is calculated just by crossing out the Q’s share. That is, the new ratio becomes 4 : 3 : 1 i.e. 4 : 1.

Example: X, Y and Z are partners in a firm sharing profits and losses in the ratio of 5 : 3 : 2. On January 01, 2012, Y died.

Solution

Similar to the above example, no information is given as to how X and Z are acquiring Y's profit share, so the new profit sharing ratio between X and Z is calculated just by crossing out the Y’s share. That is, the new ratio becomes 5 : 3 : 2 i.e. 5 : 2.

(ii) When the share of the retiring or deceased partner is purchased in a particular ratio by the remaining partners.

It may happen that in case of retirement/death of a partner, the profit share of the outgoing partner is acquired by the remaining partners in an agreed/specified ratio. In this case, the new profit sharing ratio of the remaining partners is computed by adding the share of profit acquired from the outgoing partner to their old profit share.

Example: P, Q and R are the three partners in a firm sharing profits and losses in the ratio of 4 : 3 : 2. On April 01, 2011, Q retires from the firm. On his retirement, P and R decided to acquire Q's profit share in the ratio of  3 : 2. Calculate new profit sharing ratio.

Solution

Q's share in profit  =  

P and R decided to acquire his share in the ratio of 3 : 2

Share of Q acquired by P  =  

Share of Q acquired by R  =  

New Profit Share  =  Old Profit Share  +  Share Acquired from Q

P's new share  =  

R's new share  =  

∴ New Profit Sharing Ratio  =  29 : 16

Important Note

Sometimes, the new profit sharing ratio of the continuing partners is specifically mentioned in the question. So, in such cases, there is no need to calculate the new profit sharing ratio.

Gaining Ratio

On the eve of retirement/death of a partner, the continuing partners acquire the profit share of the retiring partner. The ratio in which the outgoing partner's profit share is gained or acquired by the remaining partners is known as Gaining ratio. This ratio is calculated by taking the difference between the new ratio and the old ratio of the partners.

Algebraically,

Gaining Ratio = New Profit Sharing Ratio – Old Profit Sharing Ratio

Example: P, Q and R are three partners in a firm sharing profits and losses in the ratio of 4 : 3 : 2. On April 01, 2011, Q retires from the firm. Calculate the gaining ratio.

Solution

This is the first case, in which no information regarding the acquisition of outgoing partners’ profit share by the continuing partners is mentioned, so the new ratio of P and R is 4 : 2 or 2 : 1. 

So, the Gaining Ratio is 2 : 1.

Example: K, M and N are the three partners in a firm sharing profits and losses in the ratio of  4 : 3 : 2. On March 31, 2012, M retires from the firm. After his retirement, K and N decided to acquire his share in the ratio of 3 : 2. Find out the gaining ratio.

Solution

M's share in profit  =  

K and N decided to acquire his share in the ratio of 3 : 2

Share of M acquired by K  =  

Share of M acquired by N  =  

New Profit Share  =  Old Profit Share  +  Share Acquired from Q

K's new share  =  

N's new share  =  

∴ New Profit Sharing Ratio  =  29 : 16

Example: X, Y and Z are the three partners in a firm sharing profits and losses in the ratio of  7 : 8 : 9. On December 31, 2012,  Z retires from the firm. After his retirement, X and Y decided to share future profits and losses in the ratio of 3 : 2. Calculate the gaining ratio.

Solution

New Profit-Sharing (X and Y) = 3 : 2

Gaining Ratio  =  New Ratio  –  Old Ratio

X's gain  =  

Y's gain  =  

∴  Gaining Ratio  =  37 : 8

Difference between Gaining Ratio and Sacrificing Ratio

The following are the major points of difference between the sacrificing ratio and gaining ratio.

Basis of Difference

Sacrificing Ratio

Gaining Ratio

Meaning

It is the ratio in which the old partners agree to sacrifice their share of profit in favour of new partner.

It is the ratio in which the continuing partners acquire the share of profit from outgoing partner.

Calculation

Sacrificing Ratio = Old Ratio – New Ratio

Gaining Ratio = New Ratio – Old Ratio

Time

It is calculated at the time of admission of new partner.

It is calculated at the time of retirement/death of old partner.

Objective

It is calculated to ascertain the share of profit and loss given up by the existing partners in favour of new partner.

It is calculated to ascertain the share of profit and loss acquired by the remaining partners from the retiring or deceased partner.

Effect

It reduces the profit share of the existing partners.

It increases the profit share of the remaining partners.

Objective

After going through this lesson, you shall be able to understand the following concepts 

  • Treatment of Goodwill in case of Retirement/Death of a Partner
  • Different Cases of Treatment of Goodwill

Treatment of Goodwill

As learnt in the chapter of admission that goodwill is the value of a firm's reputation and its good brand name in the market. It is an intangible asset of a firm that is earned by the hardwork and the efforts of all the partners of the firm. As we know that in case of admission of a new partner, the new partner has to bring in an additional amount (besides capital) in the form of premium for goodwill to compensate the old partners. On the contrast, in case of retirement/death of a partner, the remaining/continuing partners need to compensate the outgoing (retiring/deceased) partner. This is because after the retirement/death of a partner, the fruits of the collective past performances and reputation will be shared only by the continuing partners. Hence, the remaining partners compensate the retiring or the deceased partner by entitling him/her a share of the firm's goodwill.  

Accounting Standard 26- Treatment of Goodwill

As per the Accounting Standard 26 of ICAI, goodwill is recorded in the books only when some consideration in money or money’s worth has been paid for it. This practice is mandatory to follow. In the case of admission, retirement, death or change in profit sharing ratio among existing partners, Goodwill Account cannot be raised as no consideration is paid for it. This implies that the goodwill of a partnership firm is a self-generated goodwill, that is, the firm itself evaluates the value of the goodwill. The AS-26 standard specifies that goodwill should be immediately written off after it has been raised. That is, as per this accounting standard, goodwill has to be adjusted through Partners' Capital Account. 

Important Note: It should be noted that the treatment of goodwill in the cases of retirement and death of a partner remains the same. There is no difference in the treatment of goodwill and its posting in the Partners' Capital Account in both the cases. 

Different Cases of Treatment of Goodwill

The following are the two probable cases on which the treatment of goodwill rests.

Case-1 If goodwill already appears in the books of the firm.

Case-2 If no goodwill appears in the books of the firm.

Case 1: If Goodwill Already appears in the Book...

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