Retirement of a Partner

After studying this lesson, we are confident, you should be competent enough to:
·       Identify adjustments arising due to retirement of a partner.
·       Calculate new and gaining ratio.
·       Make accounting treatment of goodwill in different cases.
·       Make accounting treatment of the revaluation of assets and liabilities and distribution of profit or loss on revaluation among partners.
·       Make accounting treatment of undistributed profit or loss.
·       Determine the amount payable to retiring partner and make payment as per agreement and provisions of law.
·       Make adjustment of partners’ capital account
Salient Points:-
1.  An existing partner may wish to withdraw from a firm for various reasons.
2.  The amount due to a retiring partner will be the total of :-
a.    his capital in the firm
b.    His share in firm’s accumulated profits and losses.
c.    His share of profit or loss on revaluation of assets and liabilities
d.    ;his share of profits till the date of retirement
e.    His remuneration and interest on capital.
f.     His share in firm’s goodwill.
3.  The ratio in which the continuing (remaining) partners have acquired the share from the outgoing partner is called gaining ratio.
4.  Share of goodwill of outgoing partner will be debited to gaining partners in their gaining ratio.
5.  At the retirement of a partner Profit & Loss on Revaluation of Assets and liabilities and balances of accumulated Profits and losses will be distributed among all partners (including outgoing partner) in their old ratio.
6.  The outstanding balance of outgoing partner’s capital A/C may be settled by fully or Partly payment and (or) transferring into his loan account.

Q.1         What is meant by retirement of a partner?
Ans.     Retirement of a partner is one of the modes of reconstituting the firm in which old partnership comes to an end and a new partner among the continuing (remaining) partners (i.e., partners other than the outgoing partner) comes into existence.
Q.2         ‘How can a partner retire from the firm?
Ans.        A partner may retire from the firm;
               i)    in accordance with the terms of agreement; or
               ii)   with the consent of all other partners; or          
               iii) where the partnership is at will, by giving a notice in writing to all the partners of his intention to retire.
Q.3         What do you understand by ‘Gaining Ratio*?
Ans.        Gaining Ratio means the ratio by which the share in profit stands increased. It is computed by deducting old ratio from the new ratio.
Q.4         What do you understand by ‘Gaining Partner’?
Ans         Gaining Partner is a partner whose share in profit stands increased as a result of change in partnership.
Q.5         Distinguish between Sacrificing Ratio and Gaining Ratio.
Ans.     Distinction between Sacrificing Ratio and Gaining Ratio
Q.6         Give two circumstances in which gaining ratio is computed. Ans.     Gaining Ratio is computed in the following circumstances: (i) When a partner retires or dies. (ii) When there is a change in profit-sharing ratio.
Q.7         Why is it necessary to revalue assets and reassess liabilities at the time of retirement of a partner ?
Ans.        At the time of retirement or death of a partner, assets are revalued and liabilities are reassessed so that the profit or loss arising on account of such revaluation upto  the  date of retirement or death of a partner may be ascertained and adjusted in all partners’ capital accounts in their old profit-sharing ratio.       
Q.8         Why is it necessary to distribute Reserves Accumulated, Profits and Losses at the time of retirement or death of a partner?
Ans.        Reserves, accumulated profits and losses existing in the books of account as on the date of retirement or death are transferred to the Capital Accounts (or Current Accounts) of all the partners (including outgoing or deceased partner) in their old profit-sharing ratio so that the due share of an outgoing partner in reserves, accumulated profits/losses gets adjusted in his Capital or Current Account.
Q.9         What are the adjustments required on the retirement or death of a partner?
Ans.        At the time of the retirement or death of a partner, adjustments are made for the following:
               (i)   Adjustment in regard to goodwill.
               (ii) Adjustment in regard to revaluation of assets and reassessment of liabilities.
               (iii)           Adjustment in regard to undistributed profits.
               (iv)            Adjustment in regard to the Joint Life Policy and individual policies.
Q.10       X wants to retire from the firm. The profit on revaluation of assets on the date of retirement is Rs. 10,000. X is of the view that it be distributed among all the partners in their profit-sharing ratio whereas Y and Z are of the view that this profit be divided between Y and Z in new profit-sharing ratio. Who is correct in this case?
Ans.        X is correct because according to the Partnership Act a retiring partner is entitled to share the profit upto the date of his retirement. Since the profit on revaluation arises before a partner retires, he is entitled to the profit.
Q.11       How is goodwill adjusted in the books of a firm -when a partner retires from partnership?
Ans.        When a partner retires (or dies), his share of profit is taken over by the remaining partners. The remaining partners then compensate the retiring or deceased partner in the form of goodwill in their gaining ratio. The following entry is recorded for this purpose:
               Remaining Partners’ Capital A/cs                ...Dr.                                                           [Gaining Ratio]
                      To Retiring/Deceased Partner’s Capital A/c     [With his share of goodwill]
               If goodwill (or Premium) account already appears in the old Balance Sheet, it should be written off by recording the following entry :
                      All Partners’ Capital/Current A/cs       ...Dr.                           [Old Ratio]
                                 To Goodwill (or Premium) A/c
Q.12       X, V and Z are partners sharing profits and losses in the ratio of 3 : 2 :1. Z retires and the following Journal entry is passed in respect of Goodwill:
                      Y’s Capital A/c ...Dr.                     20,000
                      To X’s Capital A/c                                                                               10,000
                      To  Z’s Capital A/c                                                                               10,000
               The value of goodwill is Rs. 60,000. What is the new profit-sharing ratio between X and Y?
Ans.        Without calculating the gaining ratio, the amount to be adjusted in respect of goodwill can be calculated directly with the help of following statement:
               Particulars                                                                    X(Rs.)          V(Rs.)       Z(Rs.)
               Right of goodwill before retirement (3:2:1)                 30,000          20,000      10,000
               (Old Ratio) Right of goodwill after retirement             20,000          40,000             —
               (Balancing Figure) (New Ratio)                                             
               Net Adjustment                                                        (-) 10,000    (+) 20,000 (-) 10,000
               The new ratio between X and Y is 1 : 2.
Q.13       State the ratio in which profit or loss on revaluation will be shared by the partners when a partner retires.         ;
Ans.        Profit or loss on revaluation of assets/liabilities will be shared by the partners (including the retiring partner) hi their old profit-sharing ratio.
Q.14       How is the account of retiring partner settled?
Ans.        The retiring partner account is settled either by making payment in cash or by promising the retiring partner to pay in installments along with interest or by making payment partly in call and partly transferring to his loan account. The -following Journal entry is passed:
                      Retiring Partner’s Capital A/c  ...Dr.
                                 To Cash*                                    [If paid in cash]
                                 To Retiring Partner’s Loan                     [If transferred to loan]
6 to 8 marks    questions
Q.1   The balance sheet of X, V, Z who was sharing profits in proportion of capital as follows :- 
         Particulars                                      Amount    Particulars                                        Amount
         Sunday creditors                                1,000    Cash at bank                                      15,600
         Capitals                                           25,000    Debtors                                  5,000    4,900
             X                                                  20,000    Less provision                                        100
             Y                                                  15,000                                                           
             Z                                                   67,000    Stock                                                 10,000
         P/M                                                  11,500
         Furniture                                          25,000
                                                                  67,000                                                              67,000
         Y retires arid the following adjustment of the assets and liabilities has been made before the ascertainment of the amount payable by the firm to Y
         1.            That the stock be depreciated by 5%
         2.            That the provision for doubtful debts be increased to 5% on debtors.
         3.            That a provision of RS.750 be made in respect of outstanding legal charges.
         4.            That the land and building be appreciated by 20%.
         5.            That the goodwill of the entire firm be fixed at Rs. 16,200 and V share of the same be adjusted  into the account of X and Z (No good will account is to be raised)
         6.            That X and Z decide to share future profits of the firm in equal proportions
         7.            That the entire capital of the new firm at Rs. 48000 between X and Z in· equal proportion. For            the purpose, actual cash is to be brought in or paid off.
         You are required to prepare the revolution account; partner’s capital account and bank account and revised balance sheet after V’s retirement also indicate the gaining rates.
         Solution 1
         Dr.                                             Revaluation A/c                                                           Cr.
         Particulars                                             Rs.    Assets                                                     Rs.
         To stock A/c                                         500    By land and building                           5,000
         To provision for doubtful debts a/c      150
         To outstanding
         Legal charges                                        750
         To profit transferred to
         Capital A/c                                                    
             X                                    1500
             Y                                    1200
             Z                                       900        3,600
                                                                    5,000                                                                5,000            
         Dr.                                             Partner’s Capital Accounts                                          Cr.
         Particulars               ARs.    B Rs.      C Rs.    Particulars                      A Rs.    B Rs.     C Rs.
         To Y’s Cap A/c       1350         —       1050    By bal b/d                     25,000 25,000         15,000
         To Y’s loan A/c             -     2600              -    By Rev. A/c                     1500    1250  900
         To bal C/d           251150            -     11850    By X’s Cap A/c                     -    1350      -
                                                                                 By X’s cap A/c                       
                                                                                 (G/W)                                    -    4050      -
                                       26500   26600     15900                                          26500  26600         15900
         To bank A/c            1150            -              -    By bal b/d                      25150           -         11850
         To Bal C/d            24000            -     24000    By Bank                                 -           -         12150
                                       25150            -     24000                                          25150  24000         25150                                                             
         Dr.                                                                  Bank A/c                                                 Cr.
         To Bal B/d                                       15,600    By X’s cap A/c                                   1,150
         To Z’s Capital A/c                          12,150    By bal c/d                                          26,600
                                                                  27,750                                                              27,750
         Liabilities                                              Rs.    Assets                                                     Rs.
         Sundry Creditors                               7,000    Cash at bank                                      26,600
         Outstanding legal charges                     750    Sundry debtors (5000-250)                 4,750
         Y’s Loan                                          26,600    Stock                                                   9,500
         Capital                                                            Plan & Machinery                             11,500
             X                                  24000                     Land & Building                                30,000
             Z                                   24000      48,000
                                                                  83,250                                                              83,250
Q.2   The Balance Sheet of A, B and C on 31st December 2007 was as under :
as at 31.12.2007
         Liabilities                                       Amount    Assets                                              Amount
         A’s Capital                                      400,00    Buildings                                           20,000
         B’s Capital                                      30,000    Motor Car                                         18,000
         C’s Capital                                      20,000    Stock                                                 20,000
         General Reserve                              17,000    Investments                                              1,20,000
         Sundry Creditors                          1,23,000    Debtors                                             40,000
                                                                                Patents                                               12,000
                                                               2,30,000                                                                     2,30,000
         The partners share profits in the ratio of 8 : 4 : 5. C retires from the firm on the same date subject to the following term S and conditions:
         i)            20% of the General Reserve is to remain’ as a reserve for bad and doubtful debts. ;
         ii)           Motor)r Car is to be decreased by 5%.
         iii)          Stock is to be revalued at Rs.17, 500.
         iv)          Goodwill is valued at’ 2 ½ years purchase of the average profits of last 3 years.
                        Profits were; 2001: Rs.11,000;  200l: Rs. 16,000 and 2003: Rs.24,000.
         C.  was paid in July  A and B  borrowed the necessary amount from the Bank on the security of Motor Car and stock to payoff  C.
         Prepare Revaluation Account, Capital Accounts and Balance Sheet of A and B.
         Particulars                                             Rs.    Particulars                                               Rs.
         To Motor Cars A/C                              900    By Loss transferred to                    
         To Stock A/C                                     2,500    A’s Capital A/c Rs.               1,600            
                                                                                B’s Capital A/c Rs.                   800            
                                                                                C’s Capital A/c Rs.                1,000    3,400
                                                                    3,400                                                                3,400
Particulars                        ARs.    B Rs.      C Rs.    Particulars                      A Rs.    B Rs.     C Rs.
To C’s Capital A/c          8,334    4,166              -    By Balance b/d             40,000 30,000         20,000
To Revaluation A/c (Loss) 1,600     800      1,000    By General Reserve  A/c 6,400   3,200         4,000
To Bank A/c                            -            -    35,500    By A’s Capital A/c                -           -         8,334
Balance c/d                   36,466  28,234              -    By B’s Capital A/c                -           -         4,166
                                      46,400  33,200    36,500                                         46,400 33,200         36,500
                                                                                 By Balance b/d             36,466 28,234      -

         Liabilities                                              Rs.    Assets                                                     Rs.
         Sundry creditors                           1,23,000    Building                                            20,000
         Bank Loan                                        35,500    Motor Card                                       17,100
         Capital A                        36,466                     Stock                                                 17,500
             B                                 28,234      64,700    Investment                                                1,20,000                                                                                                                                       Debtors                                            36,600
                                                                                Patents                                               12,000
                                                               2,23,200                                                                     2,23,200                                   

Q.3   A, Band C were partners in a firm sharing profits equally:   Their Balance Sheet on.31.12.2007 stood  as:


         Liabilities                                              Rs.    Assets                                                     Rs.
         A                       Rs. 30,000                            Goodwill                                           18,000
         B                       Rs. 30,000                            Cash                                                  38,000
         C                       Rs. 25,000              85,000    Debtors                              . 43,000            
         Bills payable                                   20,000    Less: Bad Debt provision     3,000  40,000
         Creditors                                         18,000    Bills Receivable                               25,000
         Workers Compensation Fund             8,000    Land and Building                             60,000
         Employees provide4nt Fund            60,000    Plant and Machinery                         40,000
         General Reserve                              30,000                                                           
                                                               2,21,000                                                                     2,21,000
         It was mutually agreed that C will retire from partnership and for this purpose following terms were      agreed upon.
         i)            Goodwill to be valued on 3 years’ purchase of average profit of last 4 years which were 2004 : Rs.50,000 (loss); 2005 : Rs. 21,000; 2006: Rs.52,000; 2007 : Rs.22,000.
         ii)                       The Provision for Doubtful Debt was raised to Rs. 4,000.
         iii)          To appreciate Land by 15%.
         iv)          To decrease Plant and Machinery by 10%.
         v)                       Create provision of Rs;600 on Creditors.
         vi)          A sum of Rs.5,000 of Bills Payable was not likely to be claimed.
         vii)         The continuing partners decided to show the firm’s capital at 1,00,000 which would be in their new profit sharing ratio which is 2:3. Adjustments to be made in cash
         Make necessary accounts and prepare the Balance Sheet of the new partners.

Ans.3                                                               REVALUATION ACCOUNT
         Particulars                                             Rs.    Particulars                                               Rs.
         To Provision for Debts A/c               1,000    By Land A/c                                        9,000
         To Plant & Machinery A/c                4,000    By Provision on Creditors A/c               600
         To Profit transferred to                                   By Bills Payable A/c                          5,000
             A’s Capital A/c             Rs. 3,200                                                                     
             B’s Capital A/c             Rs. 3,200                                                                     
             C’s Capital A/c             Rs. 3,200  9,600                                                           
                                                                  14,600                                                              14,600

Particulars                        ARs.    B Rs.      C Rs.    Particulars                      A Rs.    B Rs.     C Rs.
To Goodwill A/c             6,000    6,000      6,000    By Balance b/d             30,000 30,000         25,000
To C’s Capital A/c          2,250    9,000              -    By General Reserve     10,000 10,000         10,000
To C’s Loan A/c                     -            -    46,116    By Workmen A/c            2,667   2,667         2,666
                                                                                 Compensation Fund
To Balance c/d              40,000  60,000              -    By Rev. A/c (profit)       3,200   3,200         3,200
                                                                                 By A’s Capital A/c                -           -         2,250
                                                                                 By B’s Capital A/c                -           -         9,000
                                                                                 By Cash A/c (Deficiency) 2,383 29,133      -
                                      48,250  75,000    52,116                                         48,250 75,000         52,116
                                                                                 By Balance b/d             40,000 60,000      -

as at 31.12.07
         Liabilities                                              Rs.    Assets                                                     Rs.
         Bills Payable                                   15,000    Debtors                         Rs.  43,000            
         Creditors                                         17,400    Less: Provision               Rs.  4,000  39,000
         Employees Provident Fund              60,000    Bills Receivables                              25,000
         C’s Loan                                          46,116    Land & Buildings                              69,000
         A’s Capital                      40000                     Plant & Machinery                            36,000
         B’S Capital                      60000   1,00,000    Cash                                                  69,516
                                                               2,38,516                                                                     2,38,516