Reconstitution of a Partnership Firm – Retirement/Death of a Partner

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:

| Basis | Sacrificing Ratio | Gaining Ratio |
|---|---|---|
| Meaning | Ratio in which old partners give up their share | Ratio in which continuing partners acquire the share of the outgoing partner |
| Effect on share of profit | A partner’s share decreases | A partner’s share increases |
| Mode of calculation | Old share $-$ new share | New share $-$ old share |
| When calculated | At the time of admission of a partner | At the time of retirement/death of a partner |

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.

Old ratio = 3:2:1.

Manisha retires, so Aparna and Sonia will share the future profits in the ratio of their old shares, unless otherwise stated. The question says they decided to share future in the ratio 3:2, so the new profit sharing ratio is already given.

Goodwill of firm = Rs. 1,80,000

Manisha’s share of goodwill = $\frac{2}{6} \times 1,80,000 = 60,000$

Since Aparna and Sonia share future profits in the ratio 3:2, Manisha’s goodwill is to be borne by them in that ratio.

Aparna’s share = $60,000 \times \frac{3}{5} = 36,000$

Sonia’s share = $60,000 \times \frac{2}{5} = 24,000$

Journal entry:

- Aparna’s Capital A/c Dr. 36,000
- Sonia’s Capital A/c Dr. 24,000
- To Manisha’s Capital A/c 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

From the chapter’s given illustration on this exact question, when Naman retires and the new profit sharing ratio is set for the remaining partners, the required result is the new profit sharing ratio and gaining ratio of the remaining partners. Using the standard method from the chapter:
- New share = old share + acquired share
- Gaining ratio = new share – old share

The answer depends on the exact ratio in which Himanshu and Gagan acquire Naman’s share, but that information is not fully visible in the question statement here.