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ACCOUNTANCY Chapter 3: Reconstitution of a Partnership Firm – Retirement and Death of a Partner
(1) 03 RECONSTITUTION OF A PARTNERSHIP FIRM-RETIRMENT AND DEATH OF A PARTNER Reconstitution of a Partnership Firm – Retirement and Death of a Partner According to section 32(1) of the Indian Partnership Act, 1932: A partner may retire in any of the following ways: 1. With the consent of all the partners. 2. In accordance with an express agreement by the partners. 3. Where the partnership is at will, by giving notice in writing to all the other partners of his intention to retire. Retirement means one or more partners may leave the firm and it is the end of an existing agreement between the partners (one of the ways of reconstitution of partnership firm) but it does not mean the end of the business. Accounting treatment/ Adjustments to be made at the time of Retirement of a partner: 1. Calculation of New Profit-Sharing Ratio and Gaining Ratio. 2. Treatment of Goodwil. 3. Treatment of Accumulated Profit/ Losses and Reserves. 4. Revaluation of Assets and Reassessment of Liabilities. 5. Preparation of Balance Sheet. Calculation of New Profit Sharing Ratio: The ratio of remaining partners is known as New Profit Sharing Ratio, in which they will share the future profits. When a partner retires from the firm, the remaining partners acquired share of retiring partner either in their old ratio or in specified ratio. New Profit Sharing Ratio = Old Ratio + Gaining Ratio Calculation of Gaining Ratio: It is the ratio in which retiring partner’s share is acquired by the remaining partner. Gaining Ratio = New Ratio – Old Ratio Case:-1 When New profit sharing ratio of continuing partners is not given, in such a situation, it is assumed that they will share profits in their old ratio. Example: A, B and C are partners sharing profit in the ratio of 3 : 2 : 1. If A retires from the firm. Calculate New and Gaining Ratio. The New and Gaining ratio between B and C will be 2:1. Solution: Total share of profits = 1
(2) 03 RECONSTITUTION OF A PARTNERSHIP FIRM-RETIRMENT AND DEATH OF A PARTNER Remaining share after A’s retirement = 1- 3/6 = 3/6 New Profit sharing Ratio: B = 2/6 × 6/3(reciprocal of the remaining share) = 2/3 C = 1/6 × 6/3(reciprocal of the remaining share) = 1/3 Therefore New Profit sharing Ratio = 2 : 1 Gaining Ratio = New Ratio – Old Ratio B’s gaining share = 2/3 – 2/6 = (4-2)/6 = 2/6 C’s gaining share = 1/3 - 1/6 = (2-1)/6 = 1/6 Therefore gaining ratio = 2 : 1 Case:- 2 When new profit sharing ratio of continuing partner is given. Example: A, B and C are partners sharing profit in the ratio of 3 : 2 : 1. If A retires from the firm. The New ratio between B and C will be 3 : 2. Calculate gaining ratio. Solution: Gaining Ratio = (New Ratio – Old Ratio) B’s Gaining share = 3/5 – 2/6 = (18- 10)/30 = 8/30 C’s gaining share = 2/5 – 1/6 = (12- 5)/30 = 7/30 Gaining Ratio between B and C = 8 : 7 Case:- 3 When continuing partners acquire retiring partner’s share in some specified proportion. Example: A, B and C are partners sharing profits in the ratio of 15 : 12 : 3. A gets retirement from the firm and his share is taken by remaining partners equally. Calculate New and Gaining Ratio. Solution: A retire and his share = 15/30 This share of A is taken by B and C equally B’s gaining share = 15/30 × 1/2 = 15/60 C’s gaining share = 15/30 × 1/2 = 15/60 Gaining Ratio = 1:1 New Profit sharing ratio = Old share + gaining share B’s new share = 12/30 + 15/60 = (24+ 15)/60 = 39/60 C’s new share = 3/30 + 15/60 = (6+ 15)/60 = 21/60 Therefore New Profit sharing Ratio = 39:21 = 13:7 Case:- 4 When Retiring Partner sells his share to the Continuing partners.
(3) 03 RECONSTITUTION OF A PARTNERSHIP FIRM-RETIRMENT AND DEATH OF A PARTNER Example: X, Y and Z are partners sharing profits in the ratio of 5 : 3 : 2. Y retires and sells his share of goodwill to X for ₹ 12,000 and to Z for ₹ 8,000. Calculate gaining ratio and new ratio of X and Z. Solution: Gaining share of X and Z is ₹ 12,000 and ₹ 8,000 = 3 : 2 It means X and Z has acquired Y’s share in 3:2. X’s gaining share = 3/10 × 3/5 = 9/50 Z’s gaining share = 3/10 × 2/5 = 6/50 New profit sharing ratio: X’s new share = 5/10 + 9/50 = (25+ 9)/ 50 = 34/50 Z’s new share = 2/10 + 6/50 = (10+ 6)/50 = 16/50 New Ratio = 34:16 = 17 : 8 Treatment of Goodwill: ● At the time of retirement of a partner, he/she will get his/her capital, profit, reserves etc. and also goodwill. ● The goodwill of retiring partner will be calculated and will be adjusted among remaining partners in gaining ratio. ● Retiring Partner’s share of goodwill = Total Goodwill of the firm × Retiring Partner’s share Journal Entries for Goodwill: Gaining Partner’s Capital A/c Dr. To Retiring Partner’s Capital A/c/ Sacrificing Partner’s Capital A/c (Being retiring partners share of goodwill is adjusted in the gaining ratio through the Capital accounts of the partners) Note: Goodwill given in the Balance Sheet of the firm should be debited all old partners in their old ratio. (Same treatment as in case of change in profit sharing ratio and admission of a partner) Hidden Goodwill: When goodwill is not given (in adjustment), in such a case following steps to be used to calculate the Hidden Goodwill. Step 1. Calculation of actual amount due to the retiring partner. Step 2. Calculation of total amount to be paid to retiring partner. Step 3. Hidden Goodwill = Step 2 – Step 1 Note: Amount of hidden goodwill is equal to the goodwill of retiring partner. The treatment of hidden goodwill is same like the treatment of goodwill discussed above. Treatment of Accumulated Profits/Losses and Reserves: At the time of retirement of a partner, all the accumulated profits/Losses and Reserves are to be distributed to the old partners in their old profit-sharing Ratio.