Business of a partnership firm may not come to an end due to death of a partner as it is known as Reconstitution of Partnership. Other partners shall continue to run the business of the firm. The problems arising on the death of a partner are similar to those arising on retirement. Assets and liabilities have to be revalued and the resultant profit or loss has to be transferred to the capital accounts of all partners including the deceased partner. Goodwill is dealt with exactly in the way already discussed in the case of retirement in the earlier unit. Treatment of joint life policy will also be same as in the case of retirement. However, in case of death of a partner, the firm would get the joint policy value.
5.2 Right of Outgoing Partner in Certain Cases to Share Subsequent Profits
As per provisions of Section 37 of the Indian Partnership Act., "Where any member of a firm has died or otherwise ceased to be a partner, and the surviving or continuing partners carry on the business of the firm with the property of the firm without any final settlement of accounts as between them and the outgoing partner or his estate, then, in the absence of a contract to the contrary, the outgoing partner or his estate is entitled at the option of himself or his representatives to such share of the profits made since he ceased to be a partner as may be attributable to the use of his share of the property of the firm or to interest at the rate of six per cent per annum on the amount of his share in the property of the firm.
Provided that whereby contract between the partners an option is given to surviving or continuing partners to purchase the interest of a deceased or outgoing partner, and that option is duly exercised, the estate of the deceased partner, or the outgoing partner or his estate, as the case may be, is not entitled to any further or other share of profits; but if any partner assuming to act in exercise of the option does not in all material respects comply with the terms thereof, he is liable to account under the foregoing provisions of this section. This way, the outgoing partner has the option to receive, interest at the rate of 6% p.a. or the share of profit earned on the unsettled amounts for the period till his dues are settled by the firm in the absence of any contract made to the contrary".
It may be noted that the outgoing partner is not bound to make election until the share of the profit that would be payable to him has been ascertained.
For example, A, B and C are in a partnership business-sharing profits and losses equally. C retires on 31st October, 2017. The capitals of the partners, after all necessary adjustments stood at ₹ 50,000, ₹ 75,000 and ₹1,20,000 respectively. A and B continued to carry on the business further without settling the accounts of C. Final payment to C is made on February 1,2018. The profit made during the period of three months amounts to ₹ 28,000.
Under Section 37 of the Partnership Act, C can exercise any of the following two options.
(i) Share in subsequent profits of firm:
(ii) Interest at 6% p.a.
Since, (i) option is beneficial for C, he will necessarily go for his proportionate share in profits.
5.3 Amount Payable to Legal Representatives of Dead Partner
When the partner dies the amount payable to him/her is paid to his/her legal representatives. The representatives are entitled to the followings:
(a) The amount standing to the credit to the capital account of the deceased partner
(b) Interest on capital, if provided in the partnership deed upto the dateof death:
(c) Share of goodwill of the firm;
(d) Share of undistributed profit or reserves;
(e) Share of profit on the revaluation of assets and liabilities;
(f) Share of profit upto the date of death;
(g) Share of Joint Life Policy.
Calculation of profit upto the date of death of a partner.
Such Profit is calculated through P&L Suspense account. After ascertaining the amount due to the deceased partner, it should be credited to his Executor's Account.
If the death of a partner occurs during the year, the representatives of the deceased partner are entitled to his/her share of profits earned till the date of his/her death. Such profit is ascertained by any of the following methods:
(i) Time Basis
(ii) Turnover or Sales Basis
(i) Time Basis
In this case, it is assumed that profit has been earned uniformly throughout the year. For example: The total profit of previous year is ₹ 2,25,000 and a partner dies three months after the close of previous year, the profit of three months is ₹ 31,250 i.e. 1,25,000 x 3/12, if the deceased partner took 2/10 share of profit, his/her share of profit till the date of death is ₹ 6,250 i.e. ₹ 31,250 x 2/10
(ii) Turnover or Sales Basis
In this method, we have to take into consideration the profit and the total sales of the last year. Thereafter the profit up to the date of death is estimated on the basis of the sale of the last year. Profit is assumed to be earned uniformly at the same rate. Legal representatives:
(ii) Interest on drawings
(iii) Share of loss on the revaluation of assets and liabilities;
(iv) Share of loss that have occurred till the date of his/her death.
Arun, Tarun and Neha are partners sharing profits in the ratio of 3:2: 1. Neha dies on 31st May 2016. Sales for the year 2015-2016 amounted to ₹ 4,00,000 and the profit on sales is ₹ 60,000. Accounts are closed on 31 March every year. Sales from 1st April 2016 to 31st May 2016 is ₹ 1,00,000.
Calculate the deceased partner's share in the profit upto the date of death.
Solution: Profit from 1st April 2016 to 31st May 2016 on the basis of sales:
If sales are ₹ 4,00,000, profit is ₹ 60,000
If the sales are ₹ 1,00,000 profit is: 60,000/4,00,000 x 1,00,000
Neha's share = 15,000 x 1/6 = ₹2,500
Alternatively profit is calculated as
Sale upto date of death = 1,00,000
Profit = 1,00,000 x 15/100 = ₹15,000
The above adjustments are made in the capital account of the deceased partner and then the balance in the capital account is transferred to an account opened in the name of his/her executor. The payment of the amount of the deceased partner depends on the agreement. In the absence of an agreement, the legal representative of a deceased partner is entitled to interest @ 6% p.a. on the amount due from the date of death till the date of final payment
5.4 Special Transactions In Case Of Death: Joint Life Policy
In case of Partnership, Partners generally get Joint Life Policy(JLP) in name of all partners. If partner expires, then partners are entitled for share in JLP.
Method 1: If Joint Life Policy does not appears in the Balance Sheet, then the firm will gain on the death of a partner. For example, A, B and C are in partnership sharing profits and losses at the ratio of 5:3:2. They took a Joint Life Policy of ₹ 1,00,000. Now, if A dies, the firm will receive ₹1,00,000 from the insurance company. The journal entries will appear as follows:
The journal entries will appear as follows:
Method 2: If Joint Life Policy appears in the Balance Sheet at surrender value, then the firm will gain on the death of a partner. For example, A, B and C are in partnership sharing profits and losses at the ratio of 5:3:2. They took a Joint Life Policy of ₹1,00,000 which is appearing in the Balance Sheet at the surrender value of ₹ 10,000. Now, if A dies, the firm will receive ₹1,00,000 from the insurance company.
The journal entries will appear as follows:
Method 3: If Joint Life Policy appears in the Balance Sheet at surrender value along with Joint Life Policy Reserve, then the firm will gain on the death of a partner and reserve will be distributed among partners. For example, A, B and C are in partnership sharing profits and losses at the ratio of 5:3:2. They took a Joint Life Policy of ₹1,00,000 which is appearing in the Balance Sheet at the surrender value of ' 10,000,along with JLP reserve. Now, if A dies, the firm will receive ₹1,00,000 from the insurance company.
The journal entries will appear as follows:
5.5 Special Transactions in Case of Death: Separate Life Policy
Instead of taking one joint life policy in the names of all the partners, the partners may take individual policies on the lives of respective partners. The premium paid is charged to profit and loss account. On the death of a partner then only the amount for which the deceased partner was insured would be recovered from the insurance company. The policies of the surviving partners will continue to survive but the surrender value of the policies of the surviving partners would also be taken into account for the purpose of calculating the amount payable to the legal representatives of the deceased partner. In other words the legal representatives would be entitled to receive share in surrender value equivalent to the profit sharing ratio of the deceased.
Bank A/c Dr. (Assured value)
To Separate Life Policy of Deceased partner A/c
(Policy value received on death of a partner)
Separate Life Policy of Deceased Partner A/c Dr. (Assured value)
Separate Life Policy of Remaining Partners A/c Dr (Surrender value)
To Executor's A/c (Total value distributed in profit sharing ratio)
To Remaining partners A/c (Total value distributed in profit sharing ratio)
(Being the total of assured value of deceased partner's life policy and surrender value of other partners' life policy(s) distributed in the profit and loss sharing ratio)
Example:Sona, Gabbu and Amit are partners PSR 3:1:1
If amit dies, then, Amit's executives will get 3,00,000x1/5 and 1/5(10,000+20,000)=60,000+6,000
5.6 Special Transactions in Case of Death: Payment of Deceased Partner's Share
The basic distinction between retirement and death of a partner relates to finalisation of amount payable to the Executor of the deceased partner. Although, revaluation of goodwill is done in the same way as it has been done in case of retirement, in addition, the executor of the deceased partner is entitled to share of profit upto the date of death.
For example, A, B and C are in partnership sharing profits and losses at the ratio of 2:2:1. A died on 15th April, 2016. The firm closes its books of account as on 31st December every year. So the executor of A is entitled for 3V2 months profit. If A's share is immediately paid off then profit for 2016 can be taken as base for calculating 3V2 months profits in the year, 2016. If M/s. A, B & C earned ₹ 96,000 in year 2015, then 3V2 months profit is ₹ 28,000. A's share comes to ₹ 28,000 x 2/5 i.e. ₹ 11,200.
Journal entry is:
Profit and Loss Suspense A/c * Dr. ₹11,200
To A’s Capital A/c ₹11,200
(Share of A 3½ months profit in 2016 is transferred to his Capital Account on death)
*At the end of the year 2016, the Profit & Loss Suspense A/c will be transferred to Profit and Loss A/c.
The following was the Balance Sheet of Om & Co. in which X, Y, Z were partners sharing profits and losses in the ratio of 1:2:2 as on 31.3.2016. Mr. Z died on 31st December, 2016. His account has to be settled under the following terms.
Balance Sheet of Om & Co. as on 31.3.2016
Goodwill is to be calculated at the rate of two years purchase on the basis of average of three years' profits and losses. The profits and losses for the three years were detailed as below:
Profit for the period from 1.4.2016 to 31.12.2016 shall be ascertained proportionately on the basis of average profits and losses of the preceding three years.
During the year ending on 31.3.2016 a car costing ₹40,000 was purchased on 1.4.2015 and debited to traveling expenses account on which depreciation is to be calculated at 20% p.a. This asset is to be brought into account at the depreciated value.
Other values of assets were agreed as follows:
Inventory at ₹ 16,000, building at ₹1,40,000, computers at ₹50,000; investments at ₹6,000. Trade receivables were considered good.
(i) Calculate goodwill and Z's share in the profits of the firm for the period 1.4.2016 to 31.12.2016.
(ii) Prepare revaluation account assuming that other items of assets and liabilities remained the same.
(iii) Prepare partners' capital accounts and balance sheet of the firm Om & Co. as on 31.12.2016
(i) Calculation of goodwill and Z's share of profit
(ii) Revaluation Account
Goodwill calculated at the time of death of partner Z ₹ 48,000
X’s Capital Account Dr. 6,400
Y’s Capital Account Dr. 12,800
To Z’s Capital Account 19,200
(Adjustment for goodwill on the death of Z on the basis of gaining ratio)
The partnership agreement of a firm consisting of three partners - A, B and C (who share profits in proportion of 1/4, 1/4 and 1/4 and whose fixed capitals are ₹10,000; ₹6,000 and ₹4,000 respectively) provides as follows:
(a) That partners be allowed interest at 10 per cent per annum on their fixed capitals, but no interest be allowed on undrawn profits or charged on drawings.
(b) That upon the death of a partner, the goodwill of the firm be valued at two years' purchase of the average net profits (after charging interest on capital) for the three years to 31st December preceding the death of a partner.
(c) That an insurance policy of ₹10,000 each to be taken in individual names of each partner, the premium is to be charged against the profit of the firm.
(d) Upon the death of a partner, he is to be credited with his share of the profits, interest on capitals etc. calculated upon 31st December following his death.
(e) That the share of the partnership policy and goodwill be credited to a deceased partner as on 31st December following his death.
(f) That the partnership books be closed annually on 31st December.
A died on 30th September 2016, the amount standing to the credit of his current account on 31st December, 2015 was '450 and from that date to the date of death he had withdrawn ₹3,000 from the business.
An unrecorded liability of ₹2,000 was discovered on 30th September, 2016. It was decided to record it and be immediately paid off.
The trading result of the firm (before charging interest on capital) had been as follows: 2013 Profit ₹9,640; 2014 Profit ₹6,720; 2015 Loss ₹640; 2016 Profit ₹3,670.
Assuming the surrender value of the policy to be 20 percent of the sum assured.
Prepare an account showing the amount due to A’s legal representative as on 31st December, 2016.
(iv) As unrecorded liability of ₹ 2,000 has been charged to Capital Accounts through Profit and Loss Adjustment Account, no further adjustment in current year’s profit is required.
(v) profit for 2013, 2014 and 2015 have not been adjusted (for valuing goodwill) for unrecorded liability for want of precise information.
The following is the Balance Sheet of M/s. ABC Bros as at 31st December, 2015.
Balance Sheet as at 31st December, 2015
C died on 3rd January, 2016 and the following agreement was to be put into effect.
(a) Assets were to be revalued: Machinery to ₹ 5,850; Furniture to ₹ 2,300; Inventory to ₹ 750.
(b) Goodwill was valued at ₹ 3,000 and was to be credited with his share, without using a Goodwill Account
(c) ₹ 1,000 was to be paid away to the executors of the dead partner on 5th January, 2016.
Required to show:
(i) The Journal Entry for Goodwill adjustment.
(ii) The Revaluation Account and Capital Accounts of the partners.
(iii) Which account would be debited and which account credited if the provision for doubtful debts in the Balance Sheet was to be found unnecessary to maintain at the death of C.
(iii) Provision for Doubtful Debts Account is a credit balance. To close, this account is to be debited. It becomes a gain for the partners. Therefore, either Partners’ Capital Accounts (including C) or Revaluation Account is to be credited.
Statement showing the Required Adjustment for Goodwill
Profit sharing ratio is equal before or after the death of C because nothing has been mentioned in respect of Profit-sharing ratio.
B and N were partners. The partnership deed provides inter alia:
(i) That the accounts be balanced on 31st December each year.
(ii) That the Profit be divided as follows:
B: One-half; N: One-third; and carried to Reserve Account: One-sixth
(iii) That in the event of death of a partner, his executor will be entitled to the following:
(a) the capital to his credit at the date of death;
(b) his proportion of Profit to date of death based on the average Profit of the last three completed years;
(c) his share of goodwill based on three years’ purchases of the average Profit for the three preceding completed years.
Trial Balance on 31st December, 2015
The Profits for the three years were 2013: ₹ 42,000; 2014: ₹ 39,000 and 2015: ₹ 45,000. N died on 1st May, 2016. Show the calculation of N (i) Share of Profits;(ii) Share of Goodwill; (iii) Draw up N’s Executors Account as would appear in the firms’ ledger transferring the amount to the Loan Account.
* Profit sharing ratio between B and N = 1/2; 1/3; = 3: 2, Therefore N’s share of Prot = 2/5