Reconstitution of a Partnership Firm — Retirement and Death of a Partner

Retirement of a Partner: • When an existing partner leaves the firm, it is called retirement • The retiring partner ceases to be a part of the partnership • The firm continues with the remaining partners • The agreement of the continuing partners with each other constitutes a new partnership Reasons for retirement: • Old age or ill health • Disagreement with other partners • To start own independent business • As per terms of partnership deed Rights of a Retiring Partner: 1. Right to receive credit for goodwill: • The retiring partner is entitled to his share of goodwill • Goodwill is adjusted through the capital accounts of continuing partners (in gaining ratio) 2. Right to share in profit on revaluation: • Assets revalued at time of retirement; profit/loss credited/debited in old ratio 3. Right to share in accumulated profits and reserves: • Proportionate share of general reserve, P&L credit, workmen compensation fund, etc. 4. Right to receive full payment of the amount due: • Including capital balance, share of goodwill, revaluation profit, share of reserves 5. Right to share profit/interest until payment: • If final payment is deferred, the retiring partner is entitled to: (a) Interest @ 6% p.a. on the balance due, OR (b) Share of profit proportionate to his capital (as per Indian Partnership Act 1932, Section 37) 6. Protection from liability: • The retiring partner should give public notice to avoid being held liable for future debts

Gaining Ratio: • The ratio in which the continuing partners gain the share of profit surrendered by the retiring/deceased partner • The partners who remain take over the outgoing partner's share of profit Formula: Gaining Ratio = New Ratio − Old Ratio (calculated for each remaining/continuing partner) Example: A, B, C share profits 5:3:2. C retires. New ratio of A and B = 2:1 A's gain = New share − Old share = 2/3 − 5/10 = 20/30 − 15/30 = 5/30 B's gain = 1/3 − 3/10 = 10/30 − 9/30 = 1/30 Gaining ratio A:B = 5:1 Special case — if the remaining partners take over in old ratio: If A:B continue in their old ratio (5:3), they share 2/10 in ratio 5:3 A gains: 5/8 × 2/10 = 10/80 = 1/8 B gains: 3/8 × 2/10 = 6/80 = 3/40 Gaining ratio = 1/8 : 3/40 = 5:3 (same as old ratio) Significance of Gaining Ratio: 1. Goodwill adjustment: Gaining partners compensate the retiring partner → Continuing partners debit their Capital Accounts in gaining ratio → Retiring partner's Capital Account credited with his share of goodwill 2. It protects the retiring partner by ensuring he receives fair value for his profit share 3. Prevents unjust enrichment of continuing partners at the expense of retiring partner

Given: Old ratio P:Q:R = 3:2:1 R retires Goodwill = ₹60,000 R's share of goodwill = 1/6 × ₹60,000 = ₹10,000 New ratio P:Q = 1:1 Calculate Gaining Ratio: P's gain = New share − Old share = 1/2 − 3/6 = 3/6 − 3/6 = 0 Q's gain = 1/2 − 2/6 = 3/6 − 2/6 = 1/6 Gaining ratio P:Q = 0:1 (only Q gains) Journal Entry for Goodwill: Q's Capital A/c Dr. 10,000 To R's Capital A/c 10,000 (Being R's share of goodwill of ₹10,000 adjusted by debiting Q's capital account in gaining ratio 0:1) Note: If goodwill already exists in books at ₹60,000, it must first be written off: P's Capital A/c Dr. 30,000 Q's Capital A/c Dr. 20,000 R's Capital A/c Dr. 10,000 To Goodwill A/c 60,000 (Being existing goodwill written off in old ratio 3:2:1) Then raise new goodwill (if required to appear in books): Goodwill A/c Dr. 60,000 To P's Capital A/c 30,000 To Q's Capital A/c 20,000 To R's Capital A/c 10,000 (Being goodwill raised in old ratio 3:2:1) Most common treatment (goodwill not appearing in books): Q's Capital A/c Dr. 10,000 To R's Capital A/c 10,000

Given: Old ratio Anita:Bina:Charu = 4:3:2 Bina retires. General Reserve = ₹18,000 P&L Credit = ₹9,000 Total accumulated profits/reserves = ₹27,000 All existing reserves and accumulated profits must be distributed to ALL partners (including Bina) in old profit sharing ratio before retirement. Distribution of General Reserve (₹18,000) in ratio 4:3:2: Anita: 18,000 × 4/9 = ₹8,000 Bina: 18,000 × 3/9 = ₹6,000 Charu: 18,000 × 2/9 = ₹4,000 Distribution of P&L Credit (₹9,000) in ratio 4:3:2: Anita: 9,000 × 4/9 = ₹4,000 Bina: 9,000 × 3/9 = ₹3,000 Charu: 9,000 × 2/9 = ₹2,000 Journal Entries: 1. Transfer of General Reserve: General Reserve A/c Dr. 18,000 To Anita's Capital A/c 8,000 To Bina's Capital A/c 6,000 To Charu's Capital A/c 4,000 (Being general reserve distributed in old ratio 4:3:2) 2. Transfer of P&L Credit Balance: Profit and Loss A/c Dr. 9,000 To Anita's Capital A/c 4,000 To Bina's Capital A/c 3,000 To Charu's Capital A/c 2,000 (Being P&L credit balance distributed in old ratio 4:3:2) Note: If there were any P&L Debit balance (accumulated loss), it would be debited to partners' capital accounts in old ratio.

Death of a Partner: • When a partner dies, his legal heirs (executors) are entitled to the amount due to the deceased partner • The settlement procedure is similar to retirement Amount due to deceased partner's executor includes: 1. Capital Account balance at the time of death 2. Share of goodwill 3. Share of revaluation profit (or less for loss) 4. Share of General Reserve and accumulated profits 5. Share of profit from the beginning of the year to the date of death 6. Interest on capital (up to date of death) Calculation of share of profit up to date of death: Option 1 — Time basis: Profit share = (Net Profit for the year × Deceased's share) × Months/12 Option 2 — Sales basis: Profit share = (Net Profit for the year × Deceased's share) × Sales up to death / Total annual sales Journal Entries: 1. Share of profit up to death: Profit and Loss Suspense A/c Dr. [Amount] To Deceased Partner's Capital A/c [Amount] 2. Share of goodwill: Continuing Partner's Capital A/c Dr. [Amount (each in gaining ratio)] To Deceased Partner's Capital A/c [Total] 3. Share in reserves: General Reserve A/c Dr. [Total Reserve] To All Partners' Capital A/c (in old ratio) 4. Transfer to Executor's Account: Deceased Partner's Capital A/c Dr. [Total Amount Due] To Deceased Partner's Executor's A/c [Total Amount Due] (Being total amount due transferred to Executor's Loan Account) 5. Payment to executor: Executor's A/c Dr. [Amount Paid] To Bank A/c [Amount] If paid in instalments, the balance in Executor's Account carries interest @ 6% p.a.