Retirement or Death of a partner class 12 Notes Accountancy
Retirement or Death of a Partner
Meaning of retirement of a partner:
Sometimes due to some reasons, like fights among the partners, a partner may leave a firm. When a partner leaves a firm, he is said to retire.
A new partnership deed comes into existence after retirement.
The following accounting steps need to be taken when a partner retires:
Computation of the new profit sharing ratio.
1. Adjustment for Goodwill.
2. Revaluation of Assets and Liabilities and distribution of reserves, accumulated profits or losses.
3. Computation of the amount to be paid to the retiring partner, and paying him off.
4. Adjustments of Capital (if so agreed by the partners).
Calculation of New Profit Sharing Ratio (PSR)
Case 1: If the new PSR is not given, then it is assumed that the remaining partners will share the future profits in the old ratio.
For example, P, Q, and R were partners in a firm sharing profits in the ratio of 5:3:1.
Now the new profit sharing ratios when:
- P retires= 3:1
- Q retires= 5:1
- R retires= 5:3
Case 2: If the remaining partners purchase the share of the retiring partner in some specified fractions.
For example, P, Q, and R were partners in a firm sharing profits in the ratio of 3:2:1. If Q retires and P and R decide to take up his share in the ratio of 3:2. Find out the new ratio.
P will gain: 2/6 X 3/5 = 1/5
Hence, P’s new share = 3/6+1/5= 21/30
R will gain: 2/6 X 2/5 = 2/15
Hence, R’s new share = 1/6+2/15= 9/30
Therefore, new ratio= A:B = 21:9
Adjustment of Goodwill
Continuing Partner’s Capital A/c Dr.
To Retiring/ Deceased Partner’s Capital A/c
(Being adjustment of Goodwill made in the gaining ratio)
Adjustment of goodwill already appearing in the books:
All Partner’s capital A/c Dr.
To Goodwill A/c
(in the old ratio)
Adjustments of revaluation of assets and liabilities & distribution of accumulated profits and losses is needed to be done among all the partners. It will be done in the old ratio in the way as discussed earlier.
- Sometimes, the firm borrow money for the Bank to repay the retiring partner. The bank demands some asset of the firm as a security for the loan. No separate entry is passed of keeping an asset as a security with the bank.
Retirement and settlement of Loan
Partner’s Loan may be paid in installments as agreed by the partners. Hence, interest on the outstanding amount will be credited in the Loan A/c and the amount paid will be debited in the Loan A/c.
In the event of the firm agreeing to give a lump sum amount to the retiring partner, the amount may be in excess of the total amount due to him. This excess is the ‘Hidden Goodwill. This goodwill will be treated in the gaining ratio and the gaining partners will compensate the sacrificing partners like done previously. Hence,
Hidden Goodwill= Lump sum Payment- retiring partner’s capital after all adjustments
DEATH OF A PARTNER
On the event of death of a partner, the amount due to him is paid to his legal representative. The accounts of the deceased partner is closed in the same way the accounts of a retiring partner were closed. But in addition, he is also entitled to the profit/loss upto the date of his death.
His capital account is adjusted and the net amount is transferred to the deceased executor’s A/c.
*An executor is a legal term referring to a person named by the maker of a will or nominated by a person to carry out the instructions of the will*
Calculation of Profit
A partner may retire at the year end, but death can occur at any point of time in the year. Hence, the executor of the deceased partner is entitled to the profit (loss) earned by the firm till the date of his death. Now, since the books of accounts are closed in the year end, it is quite difficult to ascertain the profit (loss) in the middle of the year. Hence there are 2 ways to estimate the profit (loss):
1.On time basis
2.On Turnover (Sales) Basis
1. On Time Basis - In this method, the profit of previous year(s) are used to determine current year’s trend and hence, the profit so arrived is multiplied by the days/months the deceased partner was active and then divided by 12.
2. On Turnover Basis - In this method, a percentage of last year’s profits with respect to last year’s sales is found out. This percentage is then applied to the sale done upto the date of death of the deceased partner in the current year to find out the profit due to him.