Retirement of Partner Accounts

Retirement of Partner

Retirement of Partner Accounts

A Partner may retire from the partnership firm (because of old age, illness, or any other reason) etc.

The Partnership Firm may not come to an end when one of the partners retires, and other partners may continue to run the business of the firm. In such case, readjustment takes place as in case of admission of a partner.

On retirement, Assets and Liabilities are revalued, value of goodwill is raised and surrender value of joint life policy, if any, is taken into account.

Revaluation Profit and Reserves are transferred to Capital Account and Current Accounts of Partners’ Accounts.

Gaining Ratio

Gaining Ratio Computation on Retirement of Partner

On retirement of a partner, the continuing partners will gain in terms of Profit Sharing Ratio.

Gaining Ratio is the difference between New Profit Sharing Ratio and Old Profit Sharing Ratio.

Gaining Ratio = New Profit Sharing Ratio – Old Profit Sharing Ratio

Or New Profit Sharing Ratio = Old Profit Sharing Ratio + Gaining Ratio

Sometimes, the Old Profit Sharing Ratio acts as a Gaining Ratio between the existing partners if nothing is mentioned about New Profit Sharing Ratio.

Ex. : X, Y and Z were sharing Profits and Losses in the Ratio of 5:3:2 and Y retires, the new ratio X:Z is 3:2. Compute Gaining ratio of continuing partners.

Gaining Ratio = (New Ratio – Old Ratio) : X gains (3/5– 5/10)  = 1/10, Z gains (2/5– 2/10) = 2/10.

So, the Gaining Ratio X: Z is (1/10) : (2/10), i.e. 1:2.

Ex : P, Q and R are in partnership sharing ratio of 3:2:1. P  retires.  Q and R want to continue sharing ratio of 2:1. Find the Gaining Ratio.

Gaining Ratio = (New Ratio – Old Ratio) – Q: (2/3– 2/6) = 2/6, R : (1/3 – 1/6) = 1/6. So, Gaining ratio Q: R = 2/6:1/6= 2:1

Accounting of Goodwill

Accounting of Goodwill on Retirement of Partner

Goodwill raised in full value but not shown in the books

Goodwill raised Goodwill A/c    Dr To Partners’ Capital A/c (In the old sharing ratio)Goodwill written off Partners’ Capital A/c   Dr To Goodwill A/c   (In the new sharing ratio, to continuing Partners)

Only retiring partners share is brought or raised

Goodwill A/c    Dr    To Retiring Partners’ Capital A/c (Share of goodwill of retiring partner)Goodwill A/c    Dr To Partners’ Capital A/c (Share of goodwill of retiring partner  transferred to continuing Partners) in the  gaining ratio.

Ex: R, S and T are partners sharing ratio @ 4:3:2. S retires and goodwill is valued Rs. 27,000. No goodwill is shown in the books of the firm. R and T continue sharing @ 5:3. Show Journal Entries for Goodwill A/c

Old Ratio R: S:T  is 4:3:2, New ratio – R :T is 5:3. Gaining Ratio = New Ratio – Old Ratio

Gaining Ratio : R : (5/8 – 4/9) = 13/72, T:  (3/8 – 2/9) = 11/72, Gaining ratio of R: T=  13/72:11/72= 13:11

Journal Entries

Case 1 : When goodwill account is raised but written off

Goodwill credited to partners in old ratio : R:S:T 4:3:2. R- (27000×4/9)= 12,000, S – (27000×3/9)= 9,000, T- (27000×2/9)= 6,000

Goodwill transferred to continuing partners in new ratio : R:T -5:3. R- (27000×5/8)= 16,875, T – (27000×3/8)= 10,125

Goodwill A/c  Dr   27000                                                                                                          Dr.                                                                                                          27,000                                                                                                       To R’s Capital  A/c  12,000                                                                                                                                                                                                                                                                          12,000         To S’s Capital  A/c     9,000                                                                                                                                                                                                                                                                         9,000        To T’s Capital  A/c  6,000 (Goodwill created in old sharing ratio)                                                                                                                                                                                                                                                            6,000R’s Capital  A/c  Dr.  16,875                                                   T’s Capital  A/c  Dr.  10,125                                                   To Goodwill A/c                 27,000 (Goodwill transferred to continuing partner in new ratio)

Case 2 : When only S’ s goodwill account is raised and written off.

S’s Share of Goodwill : 27000 x 3/9 = 9000

Goodwill transferred to continuing partners in gaining ratio: R:T – 13:11- R: 9,000 x (13/24) = 4875, T: 9,000 x (11/24) = 4125

Goodwill A/c  Dr.    9,000                                                                   To S’s Capital A/c     9,000 (Goodwill created for retiring partner’s hare)R’s Capital  A/c     Dr.   4,875                                               T’s Capital  A/c      Dr.    4,125                                                   To Goodwill A/c                       9,000 (Share of goodwill for retiring partner transferred to continuing partner in gaining ratio)

Revaluation on Retirement

Accounting entries  on Retirement of Partner

On retirement of a partner, revalued assets and liabilities are to be recorded and  resulting Gain / Loss to be distributed among the partners (including the retiring partner) at the old ratio.

Loss on Revaluation Revaluation A/c  Dr       To Partners’ Capital A/c  CrGain on Revaluation Partners’ Capital A/c  Dr          To Revaluation A/c 

When revaluation Account does not appear in Balance Sheet

Ex 1. A, B, C share profits and losses equally. A retires. Revaluation profit amounts to Rs.60,000. Show Journal Entries

Amount Due to A, =(60,000/3) = Rs.20,000. This amount is to be borne by B and C equally

B’s Capital A/c  Dr 10,000

C’s Capital A/c  Dr 10,000

       To A’s Capital A/c       20,000

Ex 2. A, B and C are partner’s equally sharing Profit or Loss. A retires, on revaluation, there is an increase in fixed assets of Rs.15,000 and decrease of Rs.3,000 in sundry creditors: Show the journal entries.

Step 1 : Revaluation gain  on Old ratio : On revaluation, there is increase in asset – Rs 15000, and decrease in Liabilities – Rs 3000. So, total revaluation gain = 15000+3000 = 18,000, which is to be distributed to all Partners equally( old sharing ratio), i.e 18000/3= 6000 to each partner

Step 2 : Distribution of Revaluation gain  on New ratio : the Gain is to be distributed to continuing partners in old ration between them. B: 18000/ 2 =9000, C: 18000/ 2 =9000,

Journal Entries

Revaluation gain  on Old Ratio Fixed Assets A/c  Dr 15000 Sundry Creditors  Dr   3000        To A’s capital A/c          6,000        To B’s capital A/c          6,000        To C’s capital A/c          6,000Revaluation gain  on New Ratio B’s capital A/c   Dr        9,000 C’s capital A/c   Dr        9,000          To Fixed Assets A/c  15000          To Sundry Creditors    3000  

Reserve Fund

Reserve Fund Accounting entries on Retirement of Partner

On retirement of a partner, undistributed profit or reserve standing at the Balance Sheet is to be credited to the Partners’ Capital Accounts in the old profit sharing ratio.

Alternatively, only the retiring partner’s share may be transferred to his Capital account, if the other partner’s continue at the same profit sharing ratio.

Ex. 1: X, Y and Z were in partnership sharing profits and losses at the ratio 3:2:1. X retired and Y and Z agreed to continue at the ratio  2:1. Reserve balance was Rs.12,000. Show the journal entries

Distribution of Revaluation gain to all partners in old ratio 3:2:1- X: (12000x 3/6)=6000, Y: (12000x 2/6)=4000, Z: (12000x 1/6)=2000,

Journal Entries :

Reserve A/c  Dr  12000         To X’s Capital A/c.          6000         To Y’s Capital A/c.          4000         To Z’s Capital A/c.          2000Reserve A/c  Dr  6000     To X’s Capital A/c.          6000  

In this case, Y and Z continued at the same ratio 3:2 as they did before A’s retirement.

Ex 2: X, Y and Z were equal partners. Z decided to retire. X and Y decided to continue at the ratio of 3:2. Reserve standing at the date of retirement of Z was Rs.18,000. Show Journal Entries

Calculation of Gaining Ratio : X : 3/5 – 1/3= 4/15,  Y : 2/5 – 1/3= 1/15, Gaining Ratio = X: Y = (4/15) : (1/15) = 4 : 1.

Journal Entry

Reserve A/c  Dr 18,000     To X’s Capital A/c        6000     To Y’s Capital A/c        6000     To Z’s Capital A/c        6000 (Reserve credited to Partner Capital A/c on retirement of Z,  in old ratio -1:1:1)When the continuing partners want to show reserve in Balance Sheet X’s Capital A/c.    Dr 4800 Y’s Capital A/c.    Dr 1200          To Z’s Capital A/c.    Dr 6000 (Z’s share of reserve to continuing partner in gaining ratio 4:1, X:6000´4/5= 4800, Y: 6000´1/5 =1200)

Final Payment to Retiring Partner

Final Payment Accounting entries on Retirement of Partner

On Retirement of Partner,adjustments entries are made for Transfer of Reserve, Transfer of Goodwill &  Transfer of Gain/loss on revaluation. After making the adjustments, the Balance standing to the credit of the Capital A/c of retiring partner should be paid to him.

Ex. A and B are partners in a business, sharing profit and losses as A : 3/5th and B -:2/5th. Their Balance Sheet as on 1st January, 2010 reveals :

LIABILITIES : Capital – (A:25000, B: 15,000), Reserve – 15,000, Sundry Creditors – 2500 : Total 57500

ASSETS : Plant & machinery – 25000, Stock – 11000, Debtors 14000, Bank – 6000, Cash 1,500 : Total 57500

B retires from the business and A takes it over. The goodwill of the firm is valued at Rs.25,000. Depreciate Plant and Machinery by 10% and Stock by 15%, Make Bad debts provision for Debtors @ 5% and a discount reserve against creditors @ 2%

 Show Opening Balance Sheet of A and the Journal Entries of the firm

Accounting Entries

Goodwill A/c      Dr 25000          To  A’s Capital A/c   15000          To   B’s Capital A/c   10000 (Credited to all partners in old ratio 3:2  A: 25000 x 3/5= 15000, B: 25000 x 2/5= 10000)Reserve A/c     Dr 15000     To  A’s Capital A/c      9000     To   B’s Capital A/c      6000 (Transfer of reserve to A and B’s Capital Account in the old profit sharing ratio 3 : 2 A: 15000 x 3/5= 9000, B: 15000 x 2/5= 6000)
Profit and Loss Adjustment A/c   Dr   4850 To Plant and Machinery A/c            2500 To Stock A/c                                    1650 To Provision for Bad Debts A/c             700 [Reduction in the values of stock (@ 15% on 11000 =1650) & provision for doubtful debts( @ 5% of 14000 =700]Reserve for Discount on Creditors A/c Dr   50  To Profit and Loss Adjustment A/c                   50 (Creation of reserve for discount on creditors @2% of 2,500)
A’s Capital A/c    Dr     2880 B’s Capital A/c    Dr     1920         To Profit and Loss Adjustment A/c  4800 (Transfer of  revaluation loss Rs.4,800 (4,850 – 50) to Capital Accounts in old 3 : 2). A : 4800X3/5= 2880, B : 4800X2/5= 1920B’s Capital A/c  Dr  29,080 To B’s Loan A/c                  29,080 (Transfer of B’s Capital Account to his Loan A/c (10,000+6,000+15,000)-1,920]  

Partners’ Capital Account

Dr.    Cr.
To P& L Adjustment A/c2,8801,920By Balance b/d25,00015,000
To B’s Loan A/c29,080By Goodwill A/c15,00010,000
To A’s Capital A/c46,120By Reserve A/c9,0006,000
 49,00031,000 49,00031,000

Balance Sheet of A as on 1st January, 2009

A’s Capital Accounts [(25.000+9,000+15,000)-2880]46,120Goodwill  25,000
B’s Loan Account29,080Plant and Machinery 25000 – Depn 250022,500
Sundry Creditors 2500 – Reserve for Discount 50 =  24502,450Stock (Rs.11,000 – 1,650)9,350
  Debtors 14000 – provision  70013,300
  Balance at Bank6,000
  Cash in Hand1,500
 77,650 77,650

Note: As the Business has been sold to A, the goodwill has been raised and it will appear in the Balance Sheet of A.      

Partner’s Loan Repayment

Partners Loan repayment entries on Partners Retirement

Sometimes a partner’s loan carries Interest and the loan is to be paid off in installments, including Interest

Ex: A partner’s loan stands at Rs.60,000 and that it has to be paid in three annual equal installments carrying interest at 6% p. a.

Computation of Instalments payable

First Year : interest 6% on Rs.60,000 = 3600. So, total payment =20,000  (P)+ 3,600 (I) = 23600. Balance Payable 60000-20000=40000 (P).

2nd Year : Interest on 40000@6%=2400. So, total payment =20,000  (P)+ 2400 (I) = 22400. Balance Payable 40000-20000=20000 (P).

3rd Year : Interest on 20000@6%=1200. So, total payment =20,000  (P)+ 1200 (I) = 21200.

Retiring Partner’s Loan A/c

1 yearTo Cash A/c23,6001 yearBy Capital A/c60,000
 Rs.(20,000 + 3,600)  By Interest A/c.3,600
 To Balance c/d40,000 Rs.60,000 
  63,600  63,600
2 yearTo Cash A/c.22,4002 yearBy Balance b/d40,000
 Rs.(20,000 + 2,400)  By Interest A/c.2,400
 To Balance c/d20,000 Rs.40,000 
  42,400  42,400
3 yearTo Cash A/c21,2003 yearBy Balance b/d20,000
    By interest A/c.1,200
    Rs.20,000 x 
  21,200  21,200

Partner’s Loan Repayment – Problems

Partners Loan repayment Accounting entries on Partners Retirement

Ex : X, Y and Z are partners sharing profits and losses in the ratio of 5:3:2. On 1.1. 2009, Z retires. On that date, the Capital Account of the partners showed credit balance of X Rs.15,000, Y Rs.12,000 and Z Rs.10,000. Goodwill of the firm to be calculated at 2 year’s purchase of the average profits of the last 3 years.

Payment of the Capital and share of Goodwill to the retiring partner shall be made by annual installment of Rs.6,000 each, together with interest for the first years and the balance in the last year, Interest  @ 6% on the unpaid balances.

The Profit for the years 2006, 2007 and 2008 were Rs.6,000, Rs.4,000 and Rs.2,000 respectively. The first installment was paid on 31st December, 2009. Show Z’s Loan Account.

Computation of Goodwill : Average Profits for past 3 years (6,000 + 4,000 + 2,000) /3 = 4,000, Value of Goodwill  @ 2 years purchase of average profit = 4,000 x 2 =8,000, Z’s Share of Goodwill  = 8,000 x 2/10 = 1,600.

Z’s Capital Account

2009  2009  
Jan, 1To Transfer to Z’s Loan A/c.11,600Jan, 1By Balance b/d10,000
    By Goodwill A/c.1,600
  11,600  11,600
2009  2009  
DecTo Cash or Bank A/c6,000Jan, 1By Transfer from Z’s Capital A/c11,600
 To Balance c/d6,296DecBy Interest A/c696
    Rs.11,600 x (6/100) 
  12,296  12,296
2010  2010  
DecTo Cash or Bank A/c6,674Jan, 1By Balance b/d6,296
   DecBy Interest A/c378
    Rs.6,296 x (6/100) 
  6,674  6,674

Goodwill – Problems

Goodwill Accounts on Partner’s  Retirement

The Balance Sheet of A, B, and C who sharing profit and losses of their capitals i.e. 4:3:2 stood as follows as on 31.12.09.

Liabilities: Sundry Creditors- 13800, Capital (A:-40000, B: 30000, C: 20000), Total 103800

Assets : Land and Building – 50000, Plant & Machinery – 17000, Stock 16000, Debtors (10000- Prov for Bad Dbt 200) -9800, Bank 11000, Total 103800

On 31.12.2009, B retires. Assets and Liabilities are revalued to ascertain the amount payable to B.

1. Stock to be written off by 6%. 2. The provision for bad debts upto 5% on sundry debtors. 3. Land and Building be appreciated by 20%. 4. Provision for legal charges 1,540. 5. Goodwill at Rs.21,600.  B’s share of goodwill be adjusted in the accounts of A and C. The future profit sharing ratio A:C is 5:3. 6. The entire capital of the newly constituted firm is fixed as Rs.56,000 between A and C in the proportion of 5:3 after passing entries in the accounts for goodwill.

Show Journal entries and Balance sheet of the newly constituted firm transferring B’s share of capital and goodwill to a separate Loan Account on his name on 1st January.

Gaining ratio between A & C : Share of  goodwill of B (the retiring partner) will be adjusted in the account of A & C. So only B’s share in goodwill will be raised and  written off in the account of A & C in the gaining ratio.

Old Ratio A: B:C is 4:3:2, New ratio A: C is 5:3, Gaining ratio (New ratio – Old ratio) : A: (5/8 – 4/9) = 13/72, C:(3/8 – 2/9) =11/72

Gaining ratio of A : C is (13/72) : (11/72) = 13:11

Calculation of Adjusted capital of A & C : After retirement of B, Capital of the firm is fixed at 56,000, which will be shared between A & C in the new ratio, i.e, A: (56,000 x 5/8) = 35,000, C: (56,000 x 3/8) = 21,000, after passing entries in goodwill.

Partners’ Capital A/cs will be adjusted against their new capital balances after passing the entries for goodwill. Excess capital, if any, will be withdrawn, while deficiency, if any, will be brought by partners in cash, as the case may be.

Journal Entries

Land and Building A/c   Dr    10000 To Profit & Loss Adjustment A/c    10000 (Appreciation of land and building by 20% of 50000)Profit & Loss Adjustment A/c  Dr    2800                                                                                                                   Dr. To Stock A/c                                                  960                                     To Provision for bad debts A/c                      300                                   To Provision for legal charges A/c               1540                                 (Adjustment of decrease in value of stock (6% on 16000=960), increase in provision on debtors and legal charges (5% on 10000- 200)= 300,
Profit & Loss Adjustment A/c  Dr 7200           To A’s Capital A/c    3200           To B’s Capital A/c    2400           To C’s Capital A/c    1600 (Profit on revaluation (10000- 2800=7200) transferred on old ratio  4:3:2. A: 7,200 x 4/9=3200,  B: 7,200 x 3/9=2400,  C: 7,200 x 2/9=1600 )Goodwill A/c  Dr  7200 To B’s Capital A/c     7200 B’s share of goodwill raised (21,600 x 3/9) = 7200   A’s Capital  A/c  Dr 3900 C’s Capital  A/c  Dr 3300 To   Goodwill A/c            7200 (B’s share of goodwill transferred to remaining partners in gaining ratio 13:11, A: 7200 x 13/24=3900,  C: 7200 x 11/24=3300)
B’s Capital A/c  Dr 39600 To B’s Loan A/c               39600 (Balance of B’s Capital 30000+2400+7200=39600 transferred to B’s Loan Account.)Bank A/c   2700 To C’s Capital A/c   2700 (Deficit brought by C  (20000+1600)- (3300+21000)=2700, to make 3/8share) 
A’s Capital A/c  Dr    4300 To Bank A/c                          4300 (Surplus withdrawn by A (40000+3200) – (3900+35000)= 4300, to make his Capital balance to 5/8share)  

Partners’ Capital Account

ParticularsA (Dr)B (Dr)C (Dr)ParticularsA (Cr)B (Cr)C (Cr)
To Goodwill A/c3,9003,300By Balance b/d40,00030,00020,000
To Bank A/c4,300By P& L Adjustment A/c3,2002,4001,600
To Balance c/d35,00021,000By Goodwill A/c7,200
To B’s Loan A/c39,600By Bank A/c  2,700
 43,20039,60024,300 43,20039,60024,300

Cash at Bank=  11000 (Opening) + C’s capital (2700) – A’s capital (4300) = 9400

Balance Sheet As on 1st January, 2010

Liabilities Assets 
Capital A/c  A – 35,000, C: 21,00056,000Land and Building 50000+Appreciation @ 20% 1000060,000
 56,000Plant & Machinery17,000
Sundry Creditors13,800Stock 16000 – written off @6%= 96015,040
Provision for legal charges1,540Sundry Debtors 10000- (Prov for Bad Debts 200+300=500) =95009,500
B’s Loan Account39,600Cash at Bank9,400
Total1,10,940 1,10,940

Joint Life Policy

Partners Joint Life Policy Accounts

A partnership firm may decide to take a Joint Insurance policy on the lives of all partners. The firm pays the premium and the amount of policy is payable to the firm on the death of any partner or on the maturity of policy, whichever is earlier.

If premium is treated as expense, Premium paid is debited to profit and loss account each year. Amount received from Insurance Company will be treated as firm’s profit and will be credited to capital accounts of all partners.