A partner may retire from the partnership firm because of old age, illness, etc. Generally, the business of the partnership firm may not come to an end when one of the partners retires. Other partners may continue to run the business of the firm. Readjustment takes place in case of retirement of a partner likewise the case of admission of a partner. Whenever a partner retires, the continuing partners make gain in terms of profit sharing ratio. Therefore, the remaining partners arrange for the amount to be paid to discharge the claims of the retiring partners. Assets and liabilities are revalued, value of goodwill is raised and surrender value of joint life policy, if any, is taken into account. Revaluation profit and reserves are transferred to capital or current accounts of partners. Lastly, final amount due to the retiring partner is determined and discharged.
4.2 Calculation of Gaining Ratio
On retirement of a partner, the continuing partners will gain in terms of profit sharing ratio. For example, if A, B and C were sharing profits and losses in the ratio of 5:3: 2 and B retires, then A and C have to decide at which ratio they will share profits and losses in future. If it is decided that the continuing partners will share profits and losses in future at the ratio of 3:2, then A gains 1/10th [(3/5)-(5/10)j and C gains 2/10 [(2/5)-(2/10)j. So the gaining ratio between A and C is 1:2. If A and C decide to continue at the ratio 5:2, this indicates that they are dividing the gained share in the previous profit sharing ratio.
Example: Amir, Jamir and Samir are in partnership sharing profits and losses at the ratio of 3:2:1. Now Amir wants to retire and Jamir and Samir want to continue at the ratio of 3:2. In this case, Jamir gains 8/30th of share of partnership (3/5 less 2/6) whereas Samir gains 7/30th (2/5 less 1/6) share of the partnership. So gaining ratio between Jamir and Samir is 8:7. On the other hand, if Jamir and Samir would decide to continue sharing profits and losses at the ratio of 2:1, then Jamir would gain 2/6th share of partnership i.e. [(2/3)-(2/6)], and Samir would gain 1/6th share of partnership i.e. [(1/3)-(1/6)]. So it appears that in such a case gaining ratio of Jamir and Samir would be 2:1. i.e., the existing profit sharing ratio between them.
Thus, on the retirement or death of a partner, his share in the profit would be taken by the remaining partners. In other words, they get additional share which is obviously a gain or benefit. The calculation of gaining ratio or benefit ratio is done as follows:
(i) When the new ratio is given, gaining ratio is calculated by deducting their new share of profits from the old share.
(ii) When the new profit sharing ratio is not given and the remaining partners share the future profits in the same ratio as before, the gaining ratio would be the old profit sharing ratio.
Observe the following table:
Calculation of New Profit Sharing Ratio
Case 1: When nothing is given about the new profit sharing ratio of the remaining partners: Under this situation the calculation of new ratio is done by striking out the share of the retiring partner.
Example : Alok, Bhaskar and Chetan are partners sharing in the ratio 3:2:1. Calculate new ratio if:
(a) If Alok retires.
(b) If Bhaskar retires.
(c) If Chetan retires.
Solution: Old Profit ratio = 3:2:1
(a) If Alok retires new profit ratio will be 2:1
(b) If Bhaskar retires new profit ratio will be 3:1
(c) If Chetan retires new profit ratio will be 3:2
Case 2: When gains of the continuing partners are specifically given in the question: In such a case, the new shares of the continuing partners are calculated by adding their respective gain to their old share.
New share = Old share + Gain
Example: Aarav, Banta and Chunmun are partners sharing in the ratio 3:2:1. Aarav retires and his share is taken over by the remaining partners as follow
Banta takes 2/6th from Aarav.
Chunmun takes 1/6th from Aarav.
Calculate new ratio.
Solution: Banta’s New Share = Banta’s old share + Banta’s gain = 2/6 + 2/6 = 4/6 Chunmun’s New Share = Chunmun’s old share + Chunmun’s gain = 1/6 + 1/6 = 2/6
So the new share = 4/6: 2/6 = 2:1
Case 3: When the ratio in which the remaining partners acquire the share of the outgoing partner is given:
Deepu , tasha and honey are partners sharing profits in the ratio 3:2:1. Tasha retires and his share was acquired by deepu and honey in the ratio 2:1. Calculate new ratio.
Share acquired by Deepu = 2/6 × 2/3 = 4/18
Share acquired by Honey = 2/6 × 1/3 = 2/18
Deepu’s new Share = Deepu ‘s old share + Deepu’s gain = 3/6 + 4/18 = 13/18
Honey’s new Share = Honey’s old share + Honey’s gain = 1/6+ 2/18 = 5/18
New Ratio = 13:5
Calculation of Gaining Ratio
A, B and C are partners sharing profits and losses in the ratio of 1/2, 3/10 and 1/5 respectively. B retires from the firm and A&C decide to share future profits and losses in the ratio of 3:2.
W, A , B and C are partners sharing profits and losses in the ratio of 1/3, 1/6, 1/3 and 1/6 respectively. B retires and W, A and C decide to share future profits and losses equally.
A , B and C are partners sharing profits and losses in the ratio of 25:15:9. B retires and it is decided that profits sharing ratio between A&C will be the same as existing between B and C.
Ratio of B and C = 15 : 9 = 5 : 3
Therefore new ratio of A and C should be 5 : 3
A , B and C are partners sharing profits and losses in the ratio of 4/9, 1/3 and 2/9. B retires and surrenders 1/9th of his share in favour of A and remaining in favour of C.
A , B & C are partners sharing profits and losses in the ratio of 1/2 , 3/10 and 1/5 respectively. B retires and his share is taken by A and C in the ratio of 2:1. Then immediately W is admitted for 1/4th share of profit, half of which was gifted by A and remaining share was taken by W equally from A and C.
4.3 REVALUATION OF ASSETS AND LIABILITIES ON RETIREMENT OF A PARTNER
On retirement of a partner, it is required to revalue assets and liabilities just as in the case of admission of a partner. If there is revaluation profit, then such profit should be distributed amongst the existing partners including the retiring partner at the existing profit sharing ratio. On the other hand, if there is loss on revaluation that is also to be distributed to all the partners including the retiring partner at the existing profit sharing ratio. To arrive at, profit or loss on revaluation of assets and liabilities, a Revaluation Account or profit and Loss Adjustment Account is opened. Revaluation Account or profit and Loss Adjustment Account is closed automatically by transfer of profit or loss balance to the Partners’ Capital Accounts.
If it is decided that revalued figures of assets and liabilities will not appear in the balance sheet of the continuing partners, then a journal entry should be passed with the amount payable or chargeable to the retiring partner which the continuing partners will share at the ratio of gain. In the first instance, the journal entry for distribution of profit or loss on revaluation which will appear in the balance sheet also is as follows:
Revaluation A/c Dr.
To Partners’ Capital A/cs
(For profit on revaluation)
Partners’ Capital A/cs Dr.
To Revaluation A/c
(For loss on revaluation)
Now see how to deal with a situation where revalued figures will not appear in the Balance Sheet.
If A, B & C share profits and losses equally and there is a revaluation profit of ₹30,000 calculated on A’s retirement, then ₹10,000 becomes due to A which is to be borne by B and C equally. So the journal entry will be as follows:
Alternatively, it is possible to account for the increase in the value of assets or decrease in the value of liabilities by debiting the appropriate asset account or liability account and crediting partners’ capital account at the existing profit sharing ratio. Simultaneously the partners capital accounts are to be debited for such gain at the new profit sharing ratio and the respective assets and liabilities account is to be credited again. So the following journal entries are necessary for ₹10,000 increase in sundry fixed assets and ₹2,000 decrease in trade payables:
In this case it is not necessary to open a separate Revaluation Account. However, the above effect can also be given through Memorandum Revaluation Account as discussed in the case of admission of a partner in unit 3.
On the retirement of a partner any undistributed profit or reserve standing at the Balance Sheet is to be credited to the Partners’ Capital Accounts in the old profit sharing ratio. Alternatively, only the retiring partner’s share may be transferred to his Capital Account if the others continue at the same profit sharing ratio.
For example, A, B and C were in partnership sharing profits and losses at the ratio 5:3: 2. A retired and B and C agreed to share profits and losses at the ratio of 3:2. Reserve balance was ₹10,000. In this case either of the following journal entries can be passed:
Note that alternative (2) has the same implications because B and C continued at the same ratio 3: 2 as they did before A’s retirement.
Take another example: X, Y and Z were equal partners. Z decided to retire. X and Y decided to continue at the ratio of 3: 2. Reserve standing at the date of retirement of Z was ₹9,000. In this case adjustment of Z’s share was not sufficient since the relationship between X and Y was also changed.
This is different from 1: 1. So alternative (1) is to be followed in this case.
If the continuing partners want to show reserve in the Balance Sheet, the journal entry will be:
To Z’s Capital A/c 3,000
(Adjustment entry for Z’s share in reserve)
4.5 FINAL PAYMENT TO A RETIRING PARTNER
The following adjustments are necessary in the Capital A/c:
(i) Transfer of reserve,
(ii) Transfer of goodwill,
(iii) Transfer of profit/loss on revaluation.
After adjustment of the above mentioned items, the Capital Account balance standing to the credit of the retiring partner represents amount to be paid to him.
The continuing partners may discharge the whole claim at the time of retirement. Then the journal entry will appear as follows:
Retiring Partner’s Capital A/c Dr.
To Bank A/c
Sometimes the retiring partner agrees to retain some portion of his claim in the partnership as loan. The journal entry will be as follows:
Retiring partner’s Capital A/c Dr.
To Retiring Partner’s Loan A/c To Bank A/c
As a rule, the payment is made according to terms of partnership agreement which might provide one of the following alternatives:
(a) Repayment may be made in instalments over a period of time and the interest is paid on outstanding balance which will be treated as a loan of the outgoing partner.
(b) The amount due may be treated as a loan to the firm and in return the firm will either pay interest at a fixed rate or share of the profit of the firm.
(c) An annuity may be paid to a retired partner for life or for an agreed number of years for the life of some dependent.
A and B are partners in a business sharing profit and losses as A-3/5th and B-2/5th. Their balance sheet as on 1st January, 2015 is given below:
B retires from the business owing to illness and A takes it over. The following revaluation was made:
(1) The goodwill of the firm is valued at ₹25,000.
(2) Depreciate Plant & Machinery by 7.5% and Inventories by 15%.
(3) Doubtful debts provision is raised against trade receivables at 5% and a discount reserve against trade payables at 2%.
Journalize the above transactions in the books of the firm and close the Partners’ Accounts as on 1st January 2015. Give also the opening Balance Sheet of A.
F, G and K were partners sharing profits and losses at the 2:2: 1. K wants to retire on 31.12.2015. Given below is the Balance Sheet of the partnership as well as other information:
F and G agree to share profits and losses at the ratio of 3: 2 in future. Value of Goodwill is taken to be ₹ 50,000. Sundry Fixed Assets are revalued upward by ₹30,000 and Inventories by `10,000. Bills Receivable dishonoured ₹5,000 on 31.12.2015 but not recorded in the books. Dishonour of bill was due to insolvency of the customer. F and G agree to bring sufficient cash to discharge claim of K and to make their capital proportionate. Also they wanted to maintain ₹75,000 bank balance for working capital.
Pass necessary journal entries and draft the Balance Sheet of M/s F & G. Also prepare capital accounts of partners and draft the Balance Sheet of Ms/ F & G after K’s retirement.
Adjusting entry for goodwill
Balance Sheet (after K’s retirement)
A, B & C were in partnership sharing profits in the proportions of 5:4:3. The balance sheet of the firm as on 31st March, 2015 was as under:
A had been suffering from ill-health and gave notice that he wished to retire. An agreement was, therefore, entered into as on 31st March, 2015, the terms of which were as follows:
(i) The profit and loss account for the year ended 31st March, 2015 which showed a net profit of ₹48,000 was to be re-opened. B was to be credited with ₹4,000 as bonus, in consideration of the extra work which had devolved upon him during the year. The profit sharing was to be revised from 1st April, 2014, as 3:4:4.
(ii) Goodwill was to be valued at two years’ purchase of the average profits of the preceding five years. The fixtures were to be valued by an independent valuer. A provision of 2% was to be made for doubtful debts and the remaining assets were to be taken at their book values.
The valuations arising out of the above agreement were goodwill ₹56,800 and fixtures ₹ 10,980. B and C agreed, as between themselves, to continue the business, sharing profits in the ratio of 3:2 and decided to eliminate goodwill from the balance sheet, to retain the fixtures on the books at the revised value, and to increase the provision for doubtful debts to 6%.
Submit the journal entries necessary to give effect to the above arrangements and to draw up the capital account of the partners after carrying out all adjusting entries as stated above.
Note: The balance of A’s Capital Account has been transferred to A’s Loan Account. Working Note:
Calculation for adjustment of Amount of Goodwill
K, L & M are partners sharing profits and losses in the ratio 5:3:2. Due to illness, L wanted to retire from the firm on 31.3.2015 and admit his son N in his place.
On retirement of L assets were revalued: Goodwill ₹50,000, furniture ₹10,000 and Inventory in trade ₹30,000. 50% of the amount due to L was paid off in cash and the balance was retained in the firm as capital of N. On admission of the new partner, goodwill has been written off. M is paid off his extra balance to make capital proportionate.
You are required to give: (i)Necessary journal entries; (ii) balance sheet of M/s K, M and N as on 1.4.2015; (iii) capital accounts of partners.
1. Calculation for adjustment of Amount of Goodwill
Dowell & Co. is a partnership firm with partners Mr. A, Mr. B and Mr., C, sharing profits and losses in the ratio of 10:6:4. The balance sheet of the firm as at 31st March, 2015 is as under:
It was mutually agreed that Mr. B will retire from partnership and in his place Mr. D will be admitted as a partner with effect from 1st April, 2015. For this purpose, the following adjustments are to be made:
(a) Goodwill is to be valued at ₹1 lakh but the same will not appear as an asset in the books of the reconstituted firm.
(b) Buildings and plant and machinery are to be depreciated by 5% and 20% respectively. Investments are to be taken over by the retiring partner at ₹15,000. Provision of 20% is to be made on Trade receivables to cover doubtful debts.
(c) In the reconstituted firm, the total capital will be ₹2 lakhs which will be contributed by Mr. A, Mr. C and Mr. D in their new profit sharing ratio, which is 2:2:1.
(i) The surplus funds, if any, will be used for repaying bank overdraft.
(ii) The amount due to retiring partner shall be transferred to his loan account.
(a) Revaluation account;
(b) Partners’ capital accounts;
(c) Bank account; and
(d) Balance sheet of the reconstituted firm as on 1st April, 2015.
4.6 PAYING A PARTNER’S LOAN IN INSTALMENT
Strictly speaking, paying a partner's loan is only a matter of arranging finance. However, sometimes it is stated that the loan is to be paid off in so many equal instalments and that the balance is to carry interest. In such case, what should be done is that the loan should be divided into equal parts. The interest for the period should be calculated and the payment should consist of the instalment on account of the loan plus interest for the period. Suppose a partner's loan stands at ₹30,000 and that it has to be paid in four annual equal instalments and that the loan is to carry interest at 6% per annum. The annual instalment on account of loan comes to ₹ 7,500. For the first year the first interest is ₹1,800 i.e. 6% on ₹30,000. In the first year the amount to be paid will be ₹9,300. Balance of ₹22,500 will now be left. Next year the interest will be ₹1,350. The amount to be paid therefore will be ₹7,500 plust interest viz., ₹8,850. The loan account will appear in the books as under.
M/s X is a partnership firm with the partners A, B and C sharing profits and losses in the ratio of 3:2:5. The balance sheet of the firm as on 30th June 2015, was as under:
It was mutually agreed that B will retire from partnership and in his place D will be admitted as a partner with effect from 1st July, 2015. For this purpose, the following adjustments are to be made:
(a) Goodwill of the firm is to be valued at ₹ 2 lakhs due to the firm's locational advantage but the same will not appear as an asset in the books of the reconstituted firm.
(b) Buildings and plant and machinery are to be valued at 90% and 85% of the respective balance sheet values. Investments are to be taken over by the retiring partner at ₹ 25,000. Trade receivables are considered good only upto 90% of balance sheet figure. Balance be considered bad.
(c) In the reconstituted firm, the total capital will be ₹ 3 lakhs, which will be contributed by A, C and D in their new profit sharing ratio, which is 3:4:3.
(d) The amount due to retiring partner shall be transferred to his loan account.
Prepare Revaluation Account and Partners’ Capital Accounts.
1. Adjustment of goodwill
Goodwill of the firm is valued at ` 2 lakhs
A 3/10-3/10 = 0
B 2/10-0 = 2/10
C 5/10-4/10 = 1/10
Hence, sacrificing ratio of B and C is 2:1. A has not sacrificed any share in profits after retirement of B and admission of D in his place.
Adjustment of D’s share of goodwill through existing partners’ capital accounts in the profit sacrificing ratio:
2. Capital of partners in the reconstituted firm :