Retirement or Death of a Partner — Study Notes

1. Introduction

A partner may retire from a firm due to old age, ill health, disagreement, or a desire to start another business. Retirement may take place with the consent of all other partners, by notice as provided in the deed, or in accordance with an agreement among the partners. On retirement, the continuing partners take over the firm and must settle the retiring partner's claim, which includes his share of capital, reserves, revaluation gains, and goodwill.

Death of a partner creates a situation similar to retirement, except that the settlement is made with the legal representatives of the deceased partner. Since the business continues, the amount due to the outgoing partner is computed as on the date of retirement or death, and the continuing partners compensate the outgoing partner for the goodwill and other benefits they have gained.

This chapter explains the calculation of the new profit sharing ratio and gaining ratio, the treatment of goodwill on retirement and death, the revaluation of assets and liabilities, the computation of the amount payable to the outgoing partner, and the treatment of the deceased partner's share of profit up to the date of death.

2. New Profit Sharing Ratio and Gaining Ratio

When a partner retires, his share is acquired by the remaining partners. The new ratio depends on how the retiring partner's share is taken over:

• If nothing is specified, the continuing partners continue in their old ratio and the retiring partner's share is acquired in the old ratio.
• If the continuing partners acquire the retiring partner's share in a specified ratio, the new ratio is computed accordingly.

$$\text{Gaining Ratio} = \text{New Ratio} - \text{Old Ratio}$$

The gaining partners must compensate the retiring partner for the share of goodwill acquired.

3. Treatment of Goodwill on Retirement and Death

On retirement, the retiring partner is entitled to his share of goodwill. Goodwill is valued at the time of retirement and the retiring partner's share is credited to his capital account. The journal entry is:

Gaining Partners' Capital A/c Dr.
    To Retiring Partner's Capital A/c (in gaining ratio)

If goodwill already appears in the books, it is written off among all partners including the retiring partner in the old ratio, and then the new value is adjusted. Alternatively, the existing goodwill is written off and the retiring partner's share of goodwill is adjusted through the gaining partners.

4. Revaluation of Assets and Liabilities

On the retirement or death of a partner, the assets and liabilities are revalued to determine their current values. The profit or loss on revaluation is transferred to all the partners (including the retiring or deceased partner) in the old ratio, because the revaluation relates to the period before retirement.

5. Distribution of Reserves and Accumulated Profits

Reserves and accumulated profits are credited to all partners including the retiring or deceased partner in the old ratio. Similarly, accumulated losses are debited to all partners in the old ratio.

6. Amount Due to the Outgoing Partner

The amount payable to the retiring partner is computed as:

$$\text{Amount Due} = \text{Credit balance of Capital A/c} + \text{Reserves/Profit share} + \text{Goodwill share} + \text{Loan to firm} - \text{Accumulated losses share} - \text{Drawings}$$

The settlement may be made in a lump sum or by transferring the amount to a loan account, which is repaid in instalments with interest.

6.1 Settlement of Retiring Partner's Amount

If the amount is not paid immediately, the balance is transferred to the Retiring Partner's Loan Account. The continuing partners may also bring in cash to pay off the retiring partner, or the firm may borrow the money.

7. Death of a Partner

On the death of a partner, the amount due is calculated up to the date of death. The deceased partner's share of profit up to the date of death is credited to his capital account. The profit up to the date of death may be computed:

$$\text{Share of Profit} = \text{Last Year's Profit} \times \text{Deceased Partner's Share} \times \frac{\text{Months Since Last Accounting}}{\text{12}}$$

Alternatively, it may be based on the average profit of past years or on turnover. The deceased partner's share of goodwill is also credited, and the amount is paid to his legal representatives along with interest on capital, if any.

8. Joint Life Policy

If the firm has a Joint Life Policy on the lives of the partners, the amount received from the insurer on the death of a partner is credited to the partners in the surrender value ratio, and the deceased partner's share is paid to his legal representatives. If the surrender value is treated as an asset, the premium paid is debited to the Joint Life Policy account.

Quick Revision Tables

Table 1: Key Formulas for Retirement and Death

Table 2: Treatment of Items on Retirement/Death

Table 3: Differences Between Retirement and Death

Mind Map

Important Diagrams (SVG)

Diagram 1: Steps for Computing Amount Due to the Retiring Partner

Diagram 2: Accounting Treatment of Goodwill on Retirement

Common Mistakes

1. Crediting the retiring partner's share of goodwill in the old ratio to all partners; it should be credited to him and debited to the gaining partners in the gaining ratio.
2. Sharing revaluation profit or loss only among continuing partners; the retiring partner must share it in the old ratio.
3. Forgetting to compute the deceased partner's share of profit up to the date of death.
4. Using the gaining ratio where the old ratio is required, and vice versa.
5. Failing to write off existing goodwill before valuing the new goodwill.
6. Paying the retiring partner's loan amount without charging or computing interest as per the agreement.
7. Not treating the deceased partner's joint life policy amount correctly; the surrender value must be distributed in the surrender value ratio.

Exam Tips

1. Compute the gaining ratio first and present it as a working note, because the goodwill adjustment depends on it.
2. When a partner retires mid-year, clearly state the assumption used for profit sharing till the date of retirement.
3. Show the retiring partner's capital account in full, listing all additions and deductions separately.
4. For the deceased partner, calculate profit till date of death proportionately using the number of months.
5. Practise the treatment where the retiring partner is paid partly in cash and the balance is transferred to a loan account.
6. Remember that a retiring partner is entitled to his share of reserves even if they are not being distributed in cash.
7. In questions where the new ratio is not given, the continuing partners continue in their old ratio.

Conclusion

Retirement and death of a partner bring the same set of accounting adjustments, differing mainly in the party to whom the settlement is made and the calculation of profit up to the date of death. The retiring or deceased partner is compensated through his share of goodwill, reserves, and revaluation gains, while the continuing partners take over the business in a new profit sharing ratio. Accurate computation of the gaining ratio, careful valuation of goodwill, and correct settlement of the amount due are essential. These skills complete the partner's journey through admission, retirement, and lead directly into the dissolution of the partnership firm.