Reconstitution of a Partnership Firm – Retirement/Death of a Partner — NCERT Solutions

A partner can retire from a firm in these ways:

1. With the consent of all the other partners.
2. In accordance with an express agreement among the partners.
3. By giving notice in writing, if the partnership is at will.

At the time of retirement of a partner, the following matters need adjustment:

1. Treatment of goodwill
2. Revaluation of assets and liabilities
3. Adjustment of unrecorded assets and liabilities
4. Distribution of accumulated profits or losses
5. Ascertainment of share of profit or loss up to the date of retirement
6. Adjustment of capital, if required
7. Settlement of the amount due to the retiring partner

Sacrificing ratio and gaining ratio are different as follows:

At the time of retirement or death of a partner, the firm revalues assets and reassesses liabilities because some assets may not be shown at their current values, some liabilities may be shown at values different from the actual obligation, and some unrecorded assets and liabilities may have to be brought into the books. This ensures that the retiring or deceased partner gets his fair share of the real gain or loss of the firm up to that date.

A retiring or deceased partner is entitled to a share of goodwill because the goodwill of the firm has been earned by the business with the efforts of all the partners, including the outgoing partner. Therefore, when the remaining partners continue the business and gain from the outgoing partner’s share, they must compensate him or his legal representatives for his share in the goodwill.

The amount due to a retiring partner may be paid in any of these ways:

1. In full in cash immediately.
2. The whole amount may be treated as a loan to the firm.
3. Partly paid in cash and the remaining balance treated as loan.
4. In instalments, with or without interest, as agreed.

If the amount is paid in instalments, the loan account is reduced step by step along with interest, and the balance remains as a liability until fully paid.

The amount payable to a deceased partner is computed by including his claim for:

• Balance in capital account
• Share of goodwill
• Share of accumulated profits
• Share of gain on revaluation of assets and liabilities
• Share of profit up to the date of death
• Interest on capital, if applicable
• Salary or commission, if any, due up to the date of death

and by deducting, if applicable:

• Debit balance of current account
• Share of goodwill to be written off
• Share of accumulated losses
• Share of loss on revaluation
• Share of loss up to the date of death
• Drawings up to the date of death
• Interest on drawings, if any

The final balance is transferred to the Executors’ Account.

The treatment of goodwill at the time of retirement or death depends on whether goodwill already appears in the books:

1. If goodwill does not appear in the books:

• The retiring/deceased partner is credited for his share of goodwill.
• The continuing partners’ capital accounts are debited in their gaining ratio.
• Entry:

Gaining Partners’ Capital A/c Dr.
To Retiring/Deceased Partner’s Capital A/c

2. If goodwill already appears in the books:

• First, the existing goodwill is written off by debiting all partners’ capital accounts in their old profit sharing ratio.
• Then the retiring/deceased partner’s share of goodwill is adjusted by debiting the gaining partners’ capital accounts in their gaining ratio and crediting the outgoing partner’s capital account.

3. If a continuing partner also sacrifices in the new profit-sharing arrangement:

• That partner’s capital account is also credited to the extent of sacrifice, while the partner who gains bears the compensation.

A deceased partner’s share in profits up to the date of death may be computed by any of these methods mentioned in the chapter:

1. On the basis of last year’s profit

• Profit for the year is taken.
• It is apportioned for the period from the last balance sheet date to the date of death.

2. On the basis of average profits of past years

• Average profit of the past few years is calculated.
• Then the deceased partner’s share is worked out for the relevant period.

3. On the basis of sales

• If the agreement provides, profit is estimated from sales.
• The profit for the period is calculated from the ratio of sales and then divided according to the deceased partner’s share.

In all cases, the deceased partner’s share is credited to his Capital Account, and later transferred to the Executors’ Account.

Manisha’s share of goodwill = her old share of profit × goodwill of firm.

Old ratio = $3:2:1$, so Manisha’s share $= \frac{2}{6} = \frac{1}{3}$.

Goodwill of firm = Rs. $1,80,000$

So, Manisha’s share of goodwill $= 1,80,000 \times \frac{1}{3} = Rs.\,60,000$

New ratio of Aparna and Sonia = $3:2$

Old shares of Aparna and Sonia were:

• Aparna = $\frac{3}{6} = \frac{1}{2}$
• Sonia = $\frac{1}{6}$

Manisha’s share is taken by Aparna and Sonia in the ratio of their gaining ratio.
Since their new ratio is $3:2$, their gaining ratio is:

• Aparna’s gain $= \frac{3}{5} - \frac{1}{2} = \frac{6-5}{10} = \frac{1}{10}$
• Sonia’s gain $= \frac{2}{5} - \frac{1}{6} = \frac{12-5}{30} = \frac{7}{30}$

So gaining ratio = $\frac{1}{10} : \frac{7}{30} = 3:7$

Therefore, Manisha’s goodwill is adjusted in the ratio $3:7$:

• Aparna’s Capital A/c Dr. $60,000 \times \frac{3}{10} = Rs.\,18,000$
• Sonia’s Capital A/c Dr. $60,000 \times \frac{7}{10} = Rs.\,42,000$
• To Manisha’s Capital A/c Rs. 60,000

Old ratio = 2:3:5.

Goodwill already appears in the books at Rs. 60,000, so first it must be written off in the old ratio:

• Sangeeta = $60,000 \times \frac{2}{10} = 12,000$
• Saroj = $60,000 \times \frac{3}{10} = 18,000$
• Shanti = $60,000 \times \frac{5}{10} = 30,000$

Then Sangeeta’s share of current goodwill is:

$\frac{2}{10} \times 90,000 = 18,000$

Saroj and Shanti will share future profits equally, so new ratio = 1:1.

Their old shares were $\frac{3}{10}$ and $\frac{5}{10}$, so their gaining ratio is:

• Saroj: $\frac{1}{2} - \frac{3}{10} = \frac{2}{10}$
• Shanti: $\frac{1}{2} - \frac{5}{10} = 0$

So only Saroj gains in the new arrangement.

Since the goodwill in the books is written off and then the retiring partner is compensated, the journal entries are:

1. Goodwill written off

• Sangeeta’s Capital A/c Dr. 12,000
• Saroj’s Capital A/c Dr. 18,000
• Shanti’s Capital A/c Dr. 30,000
• To Goodwill A/c 60,000

2. Sangeeta’s share of goodwill adjusted

• Saroj’s Capital A/c Dr. 18,000
• To Sangeeta’s Capital A/c 18,000

The chapter shows the required treatment on retirement: we must record revaluation of assets and liabilities, goodwill adjustment, accumulated profits/losses, and share of profit up to the date of retirement.

From the given data:

• Building increases by 20%: $1,00,000 \times 20\% = Rs.\,20,000$
• Plant and Machinery decreases by 10%: $40,000 \times 10\% = Rs.\,4,000$
• Provision for doubtful debts on debtors: $20,000 \times 5\% = Rs.\,1,000$
• Stock reduced to Rs. 18,000: loss = $20,000 - 18,000 = Rs.\,2,000$
• Investments increased to Rs. 35,000: gain = $35,000 - 30,000 = Rs.\,5,000$

So revaluation profit/loss is computed from these changes. Naman’s retirement also requires adjusting his share in goodwill and his share of accumulated profits and profit till retirement, as explained in the chapter.

However, the question as given here does not ask for the full numerical solution or the exact journal entries; it is the first part of a numerical exercise. The correct handling is to pass the standard retirement entries based on the above adjustments.