Partnership and LLP Accounts — Retirement of a Partner
Learning Outcomes
- Learn how to compute the gaining ratio and observe the use of such gaining ratio.
- Be familiar with the accounting treatment in relation to revaluation of assets and liabilities.
- Learn the accounting entries to be passed for transfer of reserves standing in the balance sheet to partners' capital accounts.
- Learn the technique of keeping records if the balance due to the retiring partner is transferred to loan account.
- Familiarize with the term Joint Life Policy.
- Learn how to keep records for payment of premium in relation to Joint Life Policy. Also observe the accounting treatment in relation to such Joint Life Policy in case of retirement of a partner.
4.1 Introduction
- A partner may retire from the partnership firm because of old age, illness, etc.
- Generally, the business of the partnership firm may not come to an end when one of the partners retires. Other partners may continue to run the business of the firm.
- Readjustment takes place in case of retirement of a partner likewise the case of admission of a partner.
KNOWLEDGE NUGGET
- Retirement: Partner leaves the firm due to old age, illness, etc.
- Continuing Partners: Gain in terms of profit sharing ratio
- Adjustments Required: Revaluation of assets, goodwill, reserves, Joint Life Policy
- Final Payment: Determined after all adjustments and discharged
4.2 Calculation of Gaining Ratio
- On retirement of a partner, the continuing partners will gain in terms of profit sharing ratio.
- The calculation of gaining ratio or benefit ratio is done as follows:
- (i) When the new ratio is given: Gaining ratio = New share — Old share
- (ii) When the new ratio is not given: Gaining ratio = Old profit sharing ratio
GAINING RATIO — OBSERVE THE TABLE
| Ratio between Remaining Partners | New Ratio | Gaining or Benefit Ratio |
|---|---|---|
| 1. When new ratio is given | As given in the examination problem | New Ratio — Old ratio |
| 2. When new ratio is not given | The same old ratios between them | The same old ratios between them |
| 3. When gaining ratio is given | Old ratio + Gaining ratio | As given in the question |
Calculation of New Profit Sharing Ratio
CASE 1: When nothing is given
Example: Alok, Bhaskar and Chetan are partners sharing in the ratio 3:2:1. Calculate new ratio if:
- (a) If Alok retires → New ratio = 2:1
- (b) If Bhaskar retires → New ratio = 3:1
- (c) If Chetan retires → New ratio = 3:2
CASE 2: When gains are specifically given
Formula: New Share = Old Share + Gain
Example: Aarav, Banta and Chunnum (3:2:1). Aarav retires. Banta takes 2/6th, Chunnum takes 1/6th.
- Banta's New Share = 2/6 + 2/6 = 4/6
- Chunnum's New Share = 1/6 + 1/6 = 2/6
- New ratio = 2:1
CASE 3: When acquisition ratio is given
Example: Deepu, Tasha and Honey (3:2:1). Tasha retires. His share acquired by Deepu and Honey in ratio 2:1.
- Deepu's gain = 2/6 × 2/3 = 4/18
- Honey's gain = 2/6 × 1/3 = 2/18
- Deepu's new = 3/6 + 4/18 = 13/18
- Honey's new = 1/6 + 2/18 = 5/18
- New ratio = 13:5
4.3 Revaluation of Assets and Liabilities on Retirement of a Partner
- On retirement of a partner, it is required to revalue assets and liabilities just as in the case of admission of a partner.
- If there is revaluation profit, it should be distributed amongst all partners (including retiring partner) at the existing profit sharing ratio.
- If there is loss on revaluation, it is also distributed to all partners at the existing profit sharing ratio.
JOURNAL ENTRIES — REVALUATION ON RETIREMENT
When revalued figures will appear in Balance Sheet:
- Revaluation A/c Dr.
- To Partners' Capital A/cs (Profit)
- OR
- Partners' Capital A/cs Dr.
- To Revaluation A/c (Loss)
When revalued figures will NOT appear in Balance Sheet:
- Continuing partners' Capital A/cs Dr. (in gaining ratio)
- To Retiring Partner's Capital A/c
4.4 Reserve
- On the retirement of a partner, any undistributed profit or reserve standing at the Balance Sheet is to be credited to the Partners' Capital Accounts in the old profit sharing ratio.
EXAMPLE
A, B and C (5:3:2). A retires. B and C continue at 3:2. Reserve = ₹10,000.
Alternative 1: Transfer reserve to all partners in old ratio.
- Reserve A/c Dr. ₹10,000
- To A's Capital A/c ₹5,000
- To B's Capital A/c ₹3,000
- To C's Capital A/c ₹2,000
Alternative 2: Transfer only retiring partner's share.
- Reserve A/c Dr. ₹5,000
- To A's Capital A/c ₹5,000
4.5 Final Payment to a Retiring Partner
- The following adjustments are necessary in the Capital A/c:
- (i) Transfer of reserve
- (ii) Transfer of goodwill
- (iii) Transfer of profit/loss on revaluation
- After adjustment, the Capital Account balance represents amount due to retiring partner.
JOURNAL ENTRIES — FINAL PAYMENT
When paid immediately:
- Retiring Partner's Capital A/c Dr.
- To Bank A/c
When part kept as loan:
- Retiring Partner's Capital A/c Dr.
- To Retiring Partner's Loan A/c
- To Bank A/c
Illustration 1
A and B are partners in a business sharing profit and losses as A-3/5th and B-2/5th. B retires from the business owing to illness and A takes it over.
SOLUTION
Balance Sheet of A as on 1st January, 2022
| Liabilities | Amount (₹) | Assets | Amount (₹) |
|---|---|---|---|
| A's Capital Account | 16,300 | Plant and Machinery | 18,500 |
| B's Loan Account | 29,200 | Inventories | 13,600 |
| Trade payables | 7,500 | Trade receivables | 15,000 |
| Less: Provision for Bad Debts | (750) | ||
| Balance at Bank | 6,000 | ||
| Cash in hand | 500 | ||
| Total | 52,850 | Total | 52,850 |
Illustration 2
F, G and K were partners in LLP sharing profits and losses at the 2:2:1. K wants to retire on 31.12.2022.
SOLUTION — Balance Sheet after K's Retirement
| Liabilities | Amount (₹) | Assets | Amount (₹) |
|---|---|---|---|
| Capital Accounts: | Sundry Fixed Assets | 1,80,000 | |
| F | 1,98,000 | Inventories | 60,000 |
| G | 1,32,000 | Trade receivables | 65,000 |
| Trade payables | 50,000 | Bank | 75,000 |
| Total | 3,80,000 | Total | 3,80,000 |
4.7 Joint Life Policy
- A partnership firm may decide to take a Joint Life Insurance Policy on the lives of all partners.
- The objective is to minimize the financial hardships in the event of payment of a large sum to the legal representatives of a deceased partner or to the retiring partner.
THREE METHODS OF ACCOUNTING FOR JOINT LIFE POLICY
- 1. Premium treated as expense: Premium is charged to Profit and Loss Account every year. Amount received becomes a gain.
- 2. Premium treated as asset: Premium debited to policy account. Excess over surrender value is transferred to P&L. Amount received in excess of surrender value is a gain.
- 3. Joint Policy Reserve Account: Premium paid debited to policy account. Equal amount transferred from P&L to Policy Reserve Account. Policy account shown at surrender value.
JOINT LIFE POLICY — KEY POINTS
- Objective: Minimize financial hardship on death/retirement of partner
- On Retirement: Surrender value of JLP is to be raised in books
- If surrender value > book value: Only excess amount transferred to revaluation account
- JLP Reserve: Distributed to partners in old profit sharing ratio
Illustration 7
Red, White and Black shared profits and losses in the ratio of 5:3:2. They took out a joint life Policy in 2018 for ₹50,000, a premium of ₹3,000 being paid annually. Black retires on 15th April, 2022. Prepare ledger accounts assuming no Joint Life Policy Account is maintained.
SOLUTION
Joint Life Policy Premium Account (transferred to P&L each year)
Joint Life Policy Account (on retirement)
| Particulars | Amount (₹) | Particulars | Amount (₹) |
|---|---|---|---|
| To Capital Accounts (Transfer): | By Bank A/c | 3,600 | |
| Red (5/10) | 1,800 | ||
| White (3/10) | 1,080 | ||
| Black (2/10) | 720 | ||
| Total | 3,600 | Total | 3,600 |
Illustration 8
Red, White and Black shared profits and losses in the ratio of 5:3:2. They took out a joint life Policy in 2018 for ₹50,000. Black retires on 15th April, 2022. Prepare ledger accounts assuming Joint Life Policy Account is maintained on surrender value basis.
SOLUTION
Joint Life Policy Account (Surrender Value Basis)
| Particulars | Amount (₹) | Particulars | Amount (₹) |
|---|---|---|---|
| 10th June, 2018 To Bank A/c | 3,000 | 31st Dec., 2018 By Profit and Loss A/c | 3,000 |
| 1st Jan., 2020 To Balance b/d | 900 | 31st Dec., 2020 By Profit and Loss A/c | 1,900 |
| 10th June, 2020 To Bank A/c | 3,000 | 31st Dec., 2020 By Balance c/d | 2,000 |
| 3,900 | 3,900 | ||
| 1st Jan., 2021 To Balance b/d | 2,000 | 31st Dec., 2021 By Profit and Loss A/c | 1,400 |
| 10th June, 2021 To Bank A/c | 3,000 | 31st Dec., 2021 By Balance c/d | 3,600 |
| 5,000 | 5,000 | ||
| 1st Jan., 2022 To Balance b/d | 3,600 | 15th April, 2022 By Bank | 3,600 |
| Total | 3,600 | Total | 3,600 |
Summary
- Re-adjustment takes place in case of retirement of a partner likewise the case of admission of a partner.
- Whenever a partner retires, the continuing partners make gain in terms of profit sharing ratio.
- On retirement, it is required to revalue assets and liabilities just as in the case of admission of a partner.
- Profit/Loss on revaluation is distributed amongst all partners (including retiring partner) at the existing profit sharing ratio.
- Any undistributed profit or reserve is credited to Partners' Capital Accounts in the old profit sharing ratio.
- Following adjustments are necessary in the Capital A/c:
- (i) Transfer of reserve
- (ii) Transfer of goodwill
- (iii) Transfer of profit/loss on revaluation
- There are three methods for treating premium paid on Joint Life Policy:
- 1. Premium treated as expense
- 2. Premium treated as asset (surrender value basis)
- 3. Joint Life Policy Reserve created
- On retirement, the surrender value of the Joint Life Policy is to be raised in the books of accounts.
Test Your Knowledge
True and False
- 1. Business of a partnership has to be closed if any one of the partners retires. False
- 2. At the time of retirement of a partner no special treatment is required for any reserves appearing in the Balance Sheet. False
- 3. After retirement of a partner, profit sharing ratio of continuing partners remains the same. False
- 4. If any partner wants to retire from the business, he must retire on 1st day of the accounting year. False
- 5. Retiring partner has to forego his share of goodwill in the firm. False
- 6. If a partner retires in between the accounting year then he is not entitled to any profit from the date of beginning of the year till his date of retirement. False
- 7. If the firm has taken any joint life policy then it is to be surrendered at the time of retirement of a partner. True
- 8. Any joint life policy reserve appearing in the Balance Sheet is credited to all the partners in their old profit sharing ratio. True
- 9. No revaluation account is necessary on retirement of a partner. False
- 10. Profit on revaluation is credited to continuing partners, retiring partner is not entitled to any profit on revaluation. False
Multiple Choice Questions
| 1. C, D and E are partners sharing profits and losses in the proportion of 1/2, 1/3 and 1/6. D retired and the new ratio between C and E is 3:2. Reserve of ₹12,000 is divided among the partners in the ratio: | (a) 2,000:4,000:6,000. (b) 5,000:5,000:2,000. (c) 6,000:4,000:2,000. |
| 2. A, B and C take a Joint Life Policy. After five years B retires. Old ratio 2:2:1. After retirement A and C decide to share equally. They had JLP of ₹2,50,000 with surrender value ₹50,000. What will be treatment if JLP premium is fully charged to revenue? | (a) ₹50,000 credited to all partners in old ratio. (b) ₹2,50,000 credited to all partners in old ratio. (c) No treatment is required. |
| 3. A, B and C take a JLP. After five years B retires. Old ratio 2:2:1. After retirement A and C share equally. JLP ₹2,50,000, surrender value ₹50,000. Treatment if JLP is maintained at surrender value? | (a) ₹50,000 credited to all partners in old ratio. (b) ₹2,50,000 credited to all partners in old ratio. (c) No treatment is required. |
| 4. A, B and C (2:2:1). On retirement of B, goodwill valued ₹30,000. Find contribution of A and C to compensate B. | (a) ₹20,000 and ₹10,000. (b) ₹8,000 and ₹4,000. (c) They will not contribute anything. |
| 5. A, B and C (2:2:1) with capital ₹50,000, ₹50,000, ₹25,000. B retires. Reserve ₹15,000. Goodwill ₹30,000. Profit on revaluation ₹7,050. Amount transferred to B's loan account? | (a) ₹70,820. (b) ₹50,820. (c) ₹25,820. |
| 6. A, B and C (3:2:1). C retires. Goodwill valued ₹60,000. Amount payable to retiring partner on account of goodwill? | (a) ₹30,000. (b) ₹20,000. (c) ₹10,000. |
| 7. A, B and C (3:2:1). A retires. Goodwill ₹24,000. Treatment for goodwill? | (a) Credited to Revaluation Account at ₹24,000. (b) Adjusted through partners' capital accounts in gaining/sacrificing ratio. (c) Only A's capital account credited with ₹12,000. |
| 8. Balances of A(₹2,00,000), B(₹3,00,000), C(₹2,00,000). A retires. B and C share equally. Goodwill ₹1,40,000. No goodwill account raised. | (a) Credit Partners' Capital Accounts with old ratio for ₹1,40,000. (b) Credit Partners' Capital Accounts with new ratio for ₹1,40,000. (c) Credit A's Account with ₹40,000 and debit B's Capital Account with ₹10,000 and C's Capital Account with ₹30,000. |
High-Yield Interactive Quiz — Retirement of a Partner
Q1. On retirement of a partner, the continuing partners:
Correct Answer: B. On retirement of a partner, the continuing partners gain in terms of profit sharing ratio as the retiring partner's share is taken over by them.
Q2. Gaining ratio is calculated as:
Correct Answer: B. Gaining Ratio = New Share — Old Share. A positive difference indicates gain.
Q3. Profit on revaluation at the time of retirement is credited to:
Correct Answer: B. Profit on revaluation is distributed amongst all partners including the retiring partner at the existing profit sharing ratio.
Q4. Reserves standing in the Balance Sheet at the time of retirement are transferred to:
Correct Answer: B. Any reserve is credited to Partners' Capital Accounts in the old profit sharing ratio.
Q5. The objective of taking a Joint Life Policy is:
Correct Answer: B. The objective of taking a Joint Life Policy is to minimize financial hardships in the event of payment of a large sum to the legal representatives of a deceased partner or to the retiring partner.
Q6. When the new ratio is not given on retirement of a partner, the gaining ratio is:
Correct Answer: B. When the new profit sharing ratio is not given and the remaining partners share future profits in the same ratio as before, the gaining ratio would be the old profit sharing ratio.
Q7. A, B and C are partners sharing in ratio 3:2:1. B retires. A and C decide to share profits in ratio 3:2. What is the gaining ratio of A and C?
Correct Answer: B. A's gain = 3/5 — 3/6 = 18/30 — 15/30 = 3/30. C's gain = 2/5 — 1/6 = 12/30 — 5/30 = 7/30. Gaining ratio = 3:7 or 8:7 (multiplying by 10/3).
Q8. Under the surrender value method of Joint Life Policy, the policy account is shown at:
Correct Answer: B. Under the surrender value method, the policy account is brought down to its surrender value and appears at that value in the Balance Sheet.
Q9. When a retiring partner's amount is transferred to a loan account, the entry is:
Correct Answer: B. When the retiring partner agrees to retain some portion of his claim as loan, the entry is: Retiring Partner's Capital A/c Dr. To Retiring Partner's Loan A/c.
Q10. On retirement, the final amount due to the retiring partner is determined after:
Correct Answer: D. The following adjustments are necessary in the Capital A/c: (i) Transfer of reserve, (ii) Transfer of goodwill, (iii) Transfer of profit/loss on revaluation.
Q11. A, B and C are partners sharing in ratio 4:3:2. B retires. A and C decide to share future profits equally. What is the gaining ratio?
Correct Answer: B. A's gain = 1/2 — 4/9 = 9/18 — 8/18 = 1/18. C's gain = 1/2 — 2/9 = 9/18 — 4/18 = 5/18. Gaining ratio = 1:5 or 2:5 (multiplying by 2).
Q12. If the Joint Life Policy premium is treated as an expense, the amount received on maturity/surrender is:
Correct Answer: B. When premium is treated as an expense, the complete amount received from the insurance company becomes a gain and is credited to Partners' Capital Accounts.