Reconstitution of Partnership - Retirement and Death

Ascertaining The Amount Due To Retiring/Deceased Partner

When a partner retires from the firm or dies, the existing partnership comes to an end, and the firm is reconstituted with the remaining partners. A key accounting task is to ascertain the amount due to the retiring partner or the legal representatives of the deceased partner. This amount represents their share in the firm's assets and accumulated profits, adjusted for their liabilities and accumulated losses, up to the date of retirement or death.

The amount due is determined by preparing the retiring/deceased partner's Capital Account (or Current Account if capitals are fixed), incorporating all relevant adjustments.

Components of the Amount Due:

The retiring/deceased partner is entitled to:

• Credit Balance of Capital Account: Their initial or adjusted capital contribution.
• Credit Balance of Current Account (if fixed capital method): Balance of their current account.
• Share of Accumulated Profits and Reserves: Their share in undistributed profits and general reserves existing on the date of retirement/death.
• Share of Profit on Revaluation of Assets and Reassessment of Liabilities: Their share in the profit from revaluation up to the date of retirement/death.
• Share of Goodwill: Their share in the firm's goodwill on the date of retirement/death, as they contributed to earning it.
• Share of Profit up to the date of Retirement/Death: If retirement/death occurs during the accounting year, the deceased/retiring partner is entitled to a share of the profit earned from the beginning of the year up to the date of their leaving. This profit is usually estimated based on previous year's profit or average profits.
• Interest on Capital up to the date of Retirement/Death: If allowed by the Partnership Deed, interest is calculated on their capital for the period they were partners in the current year.
• Salary or Commission up to the date of Retirement/Death: If entitled, their portion of salary or commission is calculated for the period they were partners.

The following amounts are deducted from the above:

• Debit Balance of Capital/Current Account (if any).
• Drawings up to the date of Retirement/Death: Amount drawn by the partner during the current year up to the date of leaving.
• Interest on Drawings up to the date of Retirement/Death: If charged by the Deed.
• Share of Accumulated Losses: Their share in undistributed losses (e.g., P&L A/c debit balance, Advertisement Suspense A/c) existing on the date of retirement/death.
• Share of Loss on Revaluation: Their share in the loss from revaluation.
• Share of Loss up to the date of Retirement/Death: If the firm incurred a loss up to the date of leaving.

By adjusting all these items in the retiring/deceased partner's Capital Account, the final amount due to them is ascertained. This amount is then transferred to the Retiring Partner's Loan Account or the Deceased Partner's Executor's Account for settlement.

Journal Entry for transferring amount due:

This liability will then be settled as per the agreement or legal provisions.

New Profit Sharing Ratio

When a partner retires or dies, the profit sharing ratio among the remaining partners changes. The remaining partners share the retiring/deceased partner's share of profit. The New Profit Sharing Ratio (NPSR) is the ratio in which the continuing partners will share future profits and losses.

The method of calculating NPSR depends on how the continuing partners acquire the retiring/deceased partner's share. Several cases are possible:

Case 1: The Retiring/Deceased Partner's Share is Acquired by the Continuing Partners in their Existing Profit Sharing Ratio (or no information is given).

It is assumed that the continuing partners take the retiring/deceased partner's share in their existing profit sharing ratio among themselves.

Steps:

1. Add the retiring/deceased partner's share to the existing share of each continuing partner in their existing ratio.

Answer:

Case 2: The Retiring/Deceased Partner's Share is Acquired by the Continuing Partners in a Specified Ratio.

The ratio in which the remaining partners take over the retiring/deceased partner's share is explicitly given.

Steps:

1. Calculate the share acquired by each continuing partner (Retiring Partner's Share multiplied by their share in the specified acquiring ratio).
2. Add the acquired share to each continuing partner's old share to get their new share.

Answer:

Case 3: New Profit Sharing Ratio is Directly Given.

Sometimes, the problem directly states the new profit sharing ratio among the continuing partners. In this case, no calculation is needed for NPSR.

Answer:

Calculating the NPSR is the first step after identifying the retiring/deceased partner, as it forms the basis for subsequent adjustments (like gaining ratio and capital adjustments).

Gaining Ratio

The Gaining Ratio is the ratio in which the continuing partners acquire the retiring/deceased partner's share of profit. It represents the increase in the share of future profits for each continuing partner. This ratio is important for accounting for goodwill and sometimes for revaluation profit/loss.

The continuing partners who gain a share of profit (i.e., whose new share is greater than their old share) need to compensate the retiring/deceased partner for their share of goodwill. This compensation is provided in the gaining ratio.

Calculation of Gaining Ratio:

Gain by a Continuing Partner = New Share - Old Share

The gaining ratio is the ratio of the amounts of gain made by each continuing partner. Only continuing partners can have a gain.

Answer:

Answer:

Answer:

The Gaining Ratio is used to calculate the amount of compensation each gaining partner must pay to the sacrificing partner(s) for goodwill (in admission) or to the retiring/deceased partner for their share of goodwill (in retirement/death).

Accounting for Goodwill on Retirement/Death:

On retirement or death, the retiring/deceased partner is entitled to their share of the firm's goodwill. The continuing partners, who gain future profits, compensate the retiring/deceased partner for this share. This compensation is borne by the gaining partners in their Gaining Ratio.

Journal Entry:

This entry adjusts the capital accounts without cash changing hands for goodwill. It increases the retiring/deceased partner's amount due and reduces the capital/current accounts of the gaining partners.

(Note: If goodwill already exists in the books, it is typically written off among all partners, including the retiring/deceased partner, in their old profit sharing ratio first, before making the above adjustment for the retiring/deceased partner's share of goodwill).

Disposal Of Amount Due To Retiring Partner

Once the final amount due to the retiring partner is ascertained by preparing their Capital Account (incorporating all adjustments), this amount needs to be settled. The settlement can be done in various ways as per the terms of the partnership deed or agreement between the partners.

The amount due is initially transferred to the Retiring Partner's Loan Account.

Journal Entry for transferring amount due:

The Retiring Partner's Loan Account is a liability and appears on the Liabilities side of the Balance Sheet of the reconstituted firm.

Methods of Settlement:

1. Payment in Lump Sum:

The entire amount due to the retiring partner is paid immediately in cash or by cheque.

Journal Entry:

2. Payment in Instalments:

The amount due is not paid immediately but in installments over a period, usually with interest on the outstanding balance. The Retiring Partner's Loan Account balance reduces with each installment paid.

Journal Entries:

• For Interest on Loan (at the end of each period): (Interest is a charge against profit).

  Date	Particulars	LF	Debit (₹)	Credit (₹)
  (End of Period)	Interest on Loan A/c Dr.		[Amount of Interest]
  	To Retiring Partner's Loan A/c			[Amount of Interest]
  	(Being interest due on retiring partner's loan)

  (Interest on Loan A/c is transferred to P&L A/c).
• For Payment of Instalment (Principal + Interest):

  Date	Particulars	LF	Debit (₹)	Credit (₹)
  (Date of Payment)	Retiring Partner's Loan A/c Dr.		[Amount of Instalment]
  	To Cash/Bank A/c			[Amount of Instalment]
  	(Being loan instalment paid to retiring partner)

3. Part Payment in Cash and Balance as Loan:

A portion of the amount due is paid immediately, and the remaining balance is treated as a loan, settled in instalments with interest.

Journal Entries:

• For Cash Payment: Debit Retiring Partner's Capital/Current A/c, Credit Cash/Bank A/c.
• For Transferring Balance to Loan A/c: Debit Retiring Partner's Capital/Current A/c, Credit Retiring Partner's Loan A/c (for the remaining balance).

The Retiring Partner's Loan Account is prepared to show the balance due and track payments. The closing balance of the Loan Account is shown in the Balance Sheet.

Death Of A Partner

The death of a partner also leads to the reconstitution of the partnership firm with the remaining partners. Legally, the partnership is dissolved, but the remaining partners may agree to continue the business under a new partnership agreement. The accounting treatment on the death of a partner is very similar to retirement, but there are some key differences.

Key Differences from Retirement:

1. Date of Leaving:

In retirement, the date is known and planned. In death, it is sudden and can occur any time during the accounting year.

2. Settlement with Legal Representative:

The amount due to the deceased partner is paid to their legal representatives (executor, administrator). The amount due is transferred to the Deceased Partner's Executor's Account.

3. Calculation of Share of Profit/Loss up to Date of Death:

Since death can occur mid-year, the deceased partner's share of profit or loss needs to be calculated for the period from the last Balance Sheet date to the date of death. This is usually estimated based on:

• Time Basis: Based on the average profit of the last few years or the profit of the previous year, calculated proportionally for the period from the start of the year to the date of death.

  $Share\ of\ Profit = Average/Previous\ Year's\ Profit \times \frac{Period\ up\ to\ Death}{12\ months} \times Deceased\ Partner's\ Share$

• Sales Basis: Based on the sales from the beginning of the year up to the date of death and the profit margin (or ratio of profit to sales) of the previous year.

  $Share\ of\ Profit = Sales\ up\ to\ Death \times \frac{Profit\ Ratio\ (based\ on\ previous\ year)}{100} \times Deceased\ Partner's\ Share$

Accounting Treatment for Share of Profit up to Date of Death:

The deceased partner's share of profit is credited to their Capital Account. The corresponding debit is typically made to Profit and Loss Suspense Account.

The Profit and Loss Suspense Account is an asset in the Balance Sheet (unless it represents a loss, in which case it's shown on the liabilities side as a negative balance or deducted from capital fund). It is closed in the next accounting period when actual results are ascertained or is written off among the remaining partners in their gaining ratio.

4. Accounting for Goodwill:

The deceased partner's share of goodwill is calculated and adjusted in the same way as retirement (gaining partners compensating the deceased partner's account in gaining ratio).

5. Accounting for Joint Life Policy:

Firms often take out Joint Life Policies (JLP) on the lives of partners. On the death of any partner, the policy matures, and the firm receives the sum assured (or surrender value if surrendered earlier). The amount received is distributed among all partners (including the deceased partner) in their profit sharing ratio. Accounting for JLP depends on the method used (treating premium as expense, or creating JLP Asset account).

After calculating all these adjustments, the deceased partner's Capital Account is prepared to ascertain the total amount due, which is then transferred to their Executor's Account for settlement. Settlement of the Executor's Account follows similar procedures as settling a retiring partner's loan (lump sum, instalments with interest).

The reconstitution process on retirement or death requires careful calculation and adjustment of various items to arrive at the correct amount due to the outgoing partner and to determine the new financial position of the continuing firm.