Reconstitution of a Partnership Firm – Retirement/Death of a Partner – Class 12 Accountancy Chapter 3 Notes & NCERT PDF

Introduction

A partner may leave a firm by retirement or by death. Either way the old partnership ends and the remaining partners carry on the business under a new agreement. Before the outgoing partner (or the executors of a deceased partner) can be paid, the firm must work out exactly what is due. That amount includes the partner's capital, current account balance, share of goodwill, share of accumulated profits (reserves), share of revaluation profit, and for death, the share of profit up to the date of death. Losses and drawings are then subtracted. This chapter is a favourite in board exams because it combines ratios, journal entries and ledger accounts in one question.

Key Concepts

3.1 Ascertaining the Amount Due. The amount due is the credit balance of the partner's capital account after all adjustments. Credits include capital, current account, share of goodwill, reserves, revaluation gain, salary, commission and interest on capital. Debits include drawings, interest on drawings, and shares of revaluation loss and accumulated losses.

3.2 New Profit Sharing Ratio. The continuing partners' new shares equal their old shares plus the portion of the retiring partner's share they acquire. If nothing is stated, they are assumed to take it in their old ratio, so the new ratio is simply their old ratio.

3.3 Gaining Ratio. Gaining ratio = new share minus old share, for each continuing partner. Goodwill is adjusted in this ratio. It is the opposite of the sacrificing ratio used at admission.

3.4 Treatment of Goodwill. The retiring partner is compensated for their share of goodwill by the gaining partners (3.4.1). The entry is: gaining partners' capital accounts Dr, to retiring partner's capital account. Any goodwill already in the books is first written off among all partners in the old ratio. Hidden goodwill (3.4.2): if the firm agrees to pay a lump sum larger than the adjusted capital balance, the excess is the retiring partner's share of goodwill.

3.5 Revaluation of Assets and Liabilities. A Revaluation Account records increases and decreases in the values of assets and liabilities. The net profit or loss is shared by all partners, including the retiring one, in the old ratio.

3.6 Accumulated Profits and Losses. General reserve, workmen compensation reserve (the excess over the claim) and the credit balance of Profit and Loss are credited to all partners in the old ratio. The debit balance of Profit and Loss and deferred revenue expenditure are debited to them in the same ratio.

3.7 Disposal of Amount Due. The amount may be paid in cash immediately, transferred to the retiring partner's loan account, or paid partly in cash and the rest in instalments with interest. Interest on the loan is credited to the loan account, and each payment is debited to it.

3.8 Adjustment of Partners' Capitals. When the new firm's total capital is fixed, each continuing partner's required capital equals the total multiplied by their new share. Any shortfall is brought in and any excess is withdrawn.

3.9 Death of a Partner. Death can happen mid-year, so the deceased partner's claim also includes their profit share up to the date of death. This is calculated from last year's profit, the average profit, or sales. It is recorded through the Profit and Loss Suspense Account. The final balance goes to the Executor's Account.

Worked Examples

Example 1 - New ratio (3.2).

Example 2 - Gaining ratio (3.3).

Example 3 - Goodwill (Illustration 6).

Example 4 - Hidden goodwill (3.4.2).

Example 5 - Loan in instalments (Illustration 11).

Example 6 - Deceased partner's profit (3.9).

Key-Facts Sheet

Board Exam Focus

Key Terms

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