According to the Partnership Act 1932 Section 32 (i), a partner can retire under the following circumstances :
(i) When a partner wants to retire as per the agreement.
(ii) When other partner or partners have no objection on his/her
retirement.
(iii) When the partnership is at the sweet will and a partner gives a written notice to retire.
A partner may retire under any circumstances but the accounting procedure will be the same in all cases.
Adjustment at the time of retirement
1. Profit sharing ratio of partners.
2. Goodwill.
3. Assets and liabilities.
4. Reserves and undivided profits and losses.
5. Profits or losses till the date of retirement or death.
6. Statement of account of the retiring partner.
Calculation of ratio
Ratio of Profit and Loss of the Remaining Partners : After the retirement of a partner, the remaining partners may divide profit and loss in the old ratio. They can also change their profit sharing ratio. In case, there is no hint of change in profit sharing ratio, the remaining partners can divide profit or loss in old ratio. Students should not change the profit sharing ratio of partners in case no hint is given.
Sometimes, it so happens that the share of the retiring partner is given to one of the continuing partners or his share is divided among all the continuing partners in a specific ratio. Under the circumstances, the gaining ratio is added to the old ratio of continuing partners.
Cash payment to Retiring Partner for Acquiring his Share by the Continuing Partner : Generally, the continuing partners pay cash equivalent to his share. In this case, an agreement is made that the continuing partners will pay the retiring partner in cash in proportion to share taken by them.
Goodwill : The methods for recording goodwill at the time of retirement of a partner are as follows:
First Case
When Goodwill Account is raised at full value :
Goodwill A/c Dr
To All Partners Capital A/c
(Being goodwill raised at full value at the retirement of a partner).
Second case
When Goodwill is raised at the Value of the Retiring Partner:
Goodwill A/c Dr
To Retiring Partner’s Capital A/c
(Being goodwill account raised with the share of retiring partner)
Third Case
When Goodwill Account is first raised and than withdrawn:
Goodwill A/c Dr
To All Partner’s Capital A/c
(Being goodwill account raised with full value of all the partners at the retirement of a partner)
(ii) Remaining Partner’s Capital
A/c Dr
To Goodwill A/c
(Being goodwill withdrawn in the old ratio)
Fourth Case
When goodwill Account is first raised and then withdrawn at the value of Retiring Partner:
(i) Goodwill A/c Dr.
To Retiring Partner’s Capital A/c
(Being goodwill account raised with the share of retiring partner)
(ii) When goodwill raised at the value of the Retiring Partner withdrawn:
Remaining Partners’ Capital A/c
To Goodwill A/c
(Being Goodwill A/c written off in the gaining ratio of remaining partners)
Changing Ratio : If the continuing partners divide among themselves the share of retiring partners in the old ratio, there will be no change in the profit earning ratio. In case of change in the profit sharing ratio among the continuing partners, their gaining ratio will also be calculated.
Fifth Case
In this case Goodwill account is not opened at the retirement of a partner. On the contrary, the amount of goodwill of the share of the retiring partner is debited to the continuing partners and credited to the capital account of retiring partner. The amounts are debited to the capital accounts of continuing partners in their profit and loss gaining ratio. In this case, the following entry will be made:
Remaining Partners’ Capital A/c
To Retiring Partner’s Capital A/c
(Being retiring partner’s share of goodwill debited to the remaining partners in gaining ratio and credited to the account of the retiring partner)
When the amount of Goodwill has been shown in the Balance Sheet even before retirement of a partner : Students must understand by now that valuation of goodwill is done at the time of retirement of a partner. If goodwill is already shown in the books of the partnership firm, it is compared with the present value of goodwill. On comparing with the existing goodwill and the present value of goodwill, it will be seen that…
(i) Present value of goodwill is equal to existing goodwill.
(ii) Present value of goodwill is more than the existing value.
(iii) Present value of goodwill is less than the existing value.
When the Present Value of Goodwill is Equal to the Existing Value of Goodwill : When there is no difference between the present value and the existing value of goodwill at the time of the retirement of a partner, there is no question of making an entry.
When the present Value of Goodwill is more than Appearing in the Books : When goodwill appears in the books at a lower value, the following entry is made with the difference :
Goodwill A/c Dr.
To All Partner’s Capital A/c
(Being increase in the value of goodwill credited to Capital Accounts of all the partners in their old profit sharing ratio)
(iii) When Goodwill Appears at a Higher Value : When the value of goodwill appearing in the books is on the higher side, the following entry is made in the books of accounts with the difference :
All Partner’s Capital A/c Dr
To Goodwill A/c
(Being the value of goodwill decreased to its present value at the retirement of the partner)
Assets and liabilities
When a partner retires from partnership, the assets and liabilities of the firm are revalued. On this occasion, the partnership firm will be shown in future at existing value of present value method of accounting treatment.
(i) When Assets and Liabilities in Future are to be shown at Old Values: If the continuing partners decide among themselves that the assets and liabilities of the partnership firm will be shown at the old value after the retirement of a partner, a few additional entries will have to be made in the books of accounts. These additional entries are made contrary to the revaluation entries or the heads which were debited previously will be credited now.
(a) Assets and liabilities will be revalued pertaining to the retiring partner only in view of profit or loss of his share. After that all the assets and liabilities are shown at the real value. Therefore, Memorandum Profit or Loss Adjustment Account is opened.
(b) After making adjustment entries in a Memorandum Account its balance is transferred to capital accounts of all the partner’s in the old ratio. After that Contra entry is made and the balance of this account is transferred to capital accounts of remaining partners in new ratio.
Settlement of the account of the retiring partner
After making all the adjustments, the credit balance of the retiring partner will indicate the amount payable to him. This amount can be disposed off in the following three ways:
Give full amount
Transferring the whole amount to Loan Account.
Making part payment and transferring the balance to loan account.
The following entries will be made in all the three cases:
(i) Capital A/c of Retiring
Partner Dr
To Bank A/c
(Being cash paid to the retiring partner)
(ii) Capital A/c of the Retiring
Partner Dr
To Loan A/c of the Retiring Partner
(Being the credit balance of the retiring partner transferred to his loan account.)
(iii) Capital A/c of the Retiring Partner Dr.
To Bank
To Loan A/c of the Retiring
Partner
(Being part of the retiring partner paid him in cash and the balance transferred to his loan account.)
Payment of retiring partner’s loan in instalments
The financial position of the firm run by the remaining partners may feel a set back in case payment is made to the retiring partner. Therefore, it is decided on the basis of mutual consent that the amount payable to the retiring partner may not be paid in one instalment but in small instalments. As a result of this agreement, the partnership account of the retiring partner is transferred to his loan account, and payment of loan is made in easy installments. Provision of a certain rate of interest is also made on the amount payable to the retiring partner. If there is no agreement regarding the rate of interest payable, it is compulsory that the retiring partner is paid interest @ 6% on his loan. The following three methods are adopted to make payment of loan:
(i) According to this method, the amount payable on a definite date is divided into three parts. At the end of each month a certain amount is paid but interest is paid after the payment of all the instalments.
(ii) According to this method, the amount payable is divided into a few years and at the end of the year, interest is charged at a fixed rate and the amount of interest is paid along with the instalment.
(iii) According to this method, payment is made by adding interest to the principal in three equal installments. An annuity table is prepared to ascertain this figure.
Death
When a partner suddenly dies, his account is prepared in the same manner as the case of a retiring partner, such as transfer of reserves and undivided profits, division of goodwill, adjustments of liabilities and assets and transfer of profit or loss from the balance sheet till his death. The only difference, that the amount payable to the retiring partner is either given to him immediately or transferred to his to loan account. But in the case of death of a partner, payment is made either in cash to his heirs or transferred to his heirs.
Joint life policy
If a partner dies, the amount payable to him is handed over to his heirs. But cash payment may affect the financial position of the business. The wayout from this problem is that the firm gets the lives of the partners insured. The firm makes regular payment of the premium and in case of death of a partner, or at the expiry of insurance, the financial condition of business remains stable and as such there is no problem in making payment to the heirs of the deceased partners. Generally the following methods are used for the accounting treatment :
TreatinG Premium as an Expense
According to this method, the amount of premium is treated as an expense and the amount of policy is treated as income. For this, following entries are made :
When Premium is Paid :
Joint Life Policy Premium A/c Dr
To Bank A/c
(For the amount of premium paid)
When the Amount of Premium is Transferred to Profit & Loss Account:
Profit & Loss A/c Dr
To Joint Life Policy Premium A/c
(Being premium transferred to Profit & Loss A/c)
Note : These entries are made every year till the death of a partner or maturity of the Joint Life Policy
When there is death of a partner or Policy is matured:
Insurance Company A/c Dr
To Join Life Policy A/c
(For the claim became due on the death of a partner or on the maturity of the policy)
When the Amount of Policy is Received from the Insurance Company:
Bank A/c Dr
To Insurance Co. A/c
(For the amount of policy received)
On Transferring the Amount Received from the Insurance Company :
Joint Life Policy A/c Dr
To All Partner’s Capital A/c
(For the Joint Life Policy A/c transferred to Cap. A/cs of all partners in old ratio)
When Insurance Premium is treated as an Asset
According to this method, the amount of premium is treated as an asset. At the end of each year, its surrender value is ascertained. Infact, it is the proper value of invested amount. The difference between the amount of premium paid and the amount of surrender value of the policy is debited to profit and loss account. Joint life policy account is shown in the balance sheet at the surrender value. In case of death of a partner at the expiry of policy, insured amount is debited to the insurance company account and joint life policy account is credited. On receipt of the amount of policy from the insurance company, the amount is debited to cash or bank account and the insurance company is credited. In the end, the balance of joint life policy account is transferred to the capital account of partners. Its entries are made as follows:
On Payment of Premium :
Joint Life Policy A/c Dr
To Bank A/c
(For premium paid)
On the Transfer of Difference Between the Amount of Premium Paid and Surrender Value to the Profit & Loss A/c
Profit & Loss A/c Dr
To Joint Life Policy A/c
(For the difference between the premium paid and surrender value to the Profit & Loss A/c)
Note : The above two entries will be made each year till one of the partners is declared dead on policy is matured.
On the Death of a Partner :
Insurance Co. A/c Dr
To Joint Life Policy A/c
(For the amount of Joint Life Policy became due on the death of a partner/at the expiry of policy)
On Receiving the Amount from the Insurance Co. :
Bank A/c Dr
To Insurance Co. A/c
(For the amount of Joint Life Policy A/c received from the insurance Company)
On Transferring the Balance of Joint Life Policy Account to the Capital Account of Partners.
Joint Life Policy A/c
To Capital A/c of All the Partners (For the Joint Life Policy A/c closed by Transferring the Balance of the Capital Accounts of Partners in their Profit Sharing Ratio)
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