Chapter reconstitution-of-a-partnership-firm-retirement-death-of-a-partner: Reconstitution of a Partnership Firm – Retirement/Death of a Partner | Summary

The new profit sharing ratio is the ratio in which the remaining partners will share future profits after the retirement or death of a partner. The new share of each continuing partner equals their old share plus the share acquired from the outgoing partner. The formula is: New Share = Old Share + Acquired Share from Outgoing Partner.

If no specific information is given about how the remaining partners will acquire the retiring partner's share, it is assumed they acquire it in their old profit sharing ratio. Alternatively, the continuing partners may agree on a completely new specified ratio, which then becomes the new profit sharing ratio.

The gaining ratio is the ratio in which the continuing partners have acquired the share from the retiring or deceased partner. It is calculated as: Gaining Share = New Share – Old Share. When the new profit sharing ratio is specified, the gaining ratio must be calculated by subtracting each continuing partner's old share from their new share.

When the continuing partners acquire the retiring partner's share in their old profit sharing ratio, the gaining ratio is the same as their old ratio among themselves, and no separate calculation is needed. The gaining ratio is important because the gaining partners compensate the retiring/deceased partner for goodwill in proportion to their gain.

The retiring or deceased partner is entitled to a share of goodwill because the goodwill was earned through the combined efforts of all existing partners. The goodwill is valued as per agreement, and the retiring/deceased partner is compensated by the continuing partners in their gaining ratio.

If goodwill does not appear in the books, the gaining partners' capital accounts are debited and the retiring partner's capital account is credited. If goodwill already exists in the books, it is first written off by debiting all partners' capital accounts in their old profit sharing ratio, and then the retiring partner's share of current goodwill value is adjusted. Hidden goodwill arises when the amount paid to a retiring partner exceeds the balance due to them based on book values; the excess is treated as the retiring partner's share of goodwill.

At the time of retirement or death, a Revaluation Account is prepared to ascertain the net gain or loss on revaluation of assets and liabilities and to record unrecorded items. Assets that increase in value are debited to the Asset Account and credited to the Revaluation Account; assets that decrease in value are debited to the Revaluation Account and credited to the Asset Account. The reverse applies to liabilities.

The net profit or loss on revaluation is transferred to all partners' capital accounts (including the retiring/deceased partner) in their old profit sharing ratio. This ensures the retiring partner receives their fair share of any appreciation or bears their share of any loss in the value of firm assets that occurred during their tenure.

Accumulated profits (general reserves) and accumulated losses (debit balance in Profit and Loss Account) appearing in the Balance Sheet belong to all partners. On retirement or death of a partner, these must be transferred to all partners' capital accounts in their old profit sharing ratio.

For accumulated profits: the Reserve Account is debited and all partners' capital accounts are credited. For accumulated losses: all partners' capital accounts are debited and the Profit and Loss Account is credited. The retiring/deceased partner is thus given their rightful share of previously undistributed profits or made to bear their share of accumulated losses.

When a partner retires or dies in the middle of the accounting year, their claim includes a share of profit or loss for the period from the last balance sheet date to the date of retirement or death. Three methods are used: (1) on the basis of the previous year's profit proportionately; (2) on the basis of average profit of the last few years proportionately; (3) on the basis of sales for the intervening period.

The journal entry for recording this share is: Profit and Loss Suspense A/c Dr. to Retiring/Deceased Partner's Capital A/c. The Profit and Loss Suspense Account is subsequently closed by transferring its balance to the gaining partners' capital accounts in their gaining ratio.

The amount due to the retiring partner may be paid: (1) in lump sum immediately in cash; (2) by transferring the entire amount to a Retiring Partner's Loan Account; or (3) partly in cash and partly as a loan. Under Section 37 of the Indian Partnership Act, 1932, in the absence of any agreement, the outgoing partner may receive either interest at 6% per annum till payment, or a share of profits earned with their capital.

When the amount is treated as a loan, the Retiring Partner's Loan Account is shown on the liabilities side of the Balance Sheet until fully paid. Instalments may include principal plus interest on the outstanding balance. The entries are repeated each year until the loan is paid off.

After retirement, the remaining partners may decide to adjust their capitals in the new profit sharing ratio. Three situations arise: (1) when the total new capital of the firm is specified by the partners; (2) when the total new capital is not specified and is determined from existing capital balances; (3) when the amount payable to the retiring partner is to be contributed by continuing partners so that their capitals are proportionate to the new ratio.

In each case, the required capital for each continuing partner is computed, compared with the existing balance, and the difference is settled by bringing in or withdrawing cash. Journal entries are passed for cash brought in (debit Cash/Bank; credit Partner's Capital) or withdrawn (debit Partner's Capital; credit Cash/Bank).

The accounting treatment for the death of a partner is similar to retirement, but with a key difference: while retirement typically occurs at the end of an accounting period, death can occur at any time. The claim of the deceased partner is transferred to the Executor's Account (or legal representatives), who are then settled in the same manner as a retiring partner.

The deceased partner's share of profit or loss, interest on capital, and interest on drawings for the intervening period (from the last balance sheet to the date of death) must be computed. Methods include previous year's profit, average of past years' profit, or profit based on sales. The Deceased Partner's Capital Account is closed and the balance transferred to the Executor's Account.

Chapter 3 deals with all accounting aspects related to the reconstitution of a partnership firm on the retirement or death of a partner. The key steps involve calculating the new profit sharing ratio and gaining ratio, treating goodwill fairly between outgoing and continuing partners, revaluing assets and liabilities, distributing accumulated profits and losses, computing profits for the intervening period, and settling the amount due to the retiring partner or their legal representatives.

This chapter is highly important for CBSE board examinations as it involves both conceptual understanding and numerical application across multiple interconnected topics. Students must be thorough with journal entries, preparation of the Revaluation Account, Partners' Capital Accounts, Loan Account, Executor's Account, and the reconstituted Balance Sheet. Mastery of ratio calculations — particularly gaining ratio and new profit sharing ratio — is essential for solving problems correctly.