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

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Do it Yourself – I
Distinguish between Gaining Ratio and Sacrificing Ratio in terms of:
1.
Meaning
2.
Effect on Partner’s Share of Profit
3.
Mode of calculation
4.
When to calculate
The following are the differences between Gaining Ratio and Sacrificing Ratio.
Basis
Gaining Ratio
Sacrificing Ratio
1. Meaning
The ratio in which the continuing partners have acquired the share from the
retiring/deceased partner is called the gaining ratio.
The ratio in which the old partners agree to sacrifice their share of profit in favour of the incoming partner is called sacrificing ratio.
2. Effect on Partner’s Share of Profit
Increases the profit share of the continuing partners
Decreases the profit share of the old partners.
3. Mode of calculation
The gain by a partner is equal to:
New Ratio – Old Ratio
The sacrifice by a partner is equal to:
Old Ratio – New Ratio
4. When to Calculate
i.
Admission of a new partner
ii.
When the existing partners decide to change the profit sharing ratio (one of more of them has to sacrifice the profits)
i.
When one/more of the partner(s) retire
ii.
Due to death of one/more of the partner(s)
iii.
When the existing partners decide to change the profit sharing ratio (one of more of them has to sacrifice the profits)
Do It Yourself – II
1. Anita, Jaya and Nisha are partners sharing profits and losses in the ratio of 1 : 1 : 1 Jaya retires from the firm. Anita and Nisha decided to share the profit in future in the ratio 4:3. Calculate the gaining ratio.
We know that Gain in share = New Share – Old Share
Anita
Nisha
New Share
{= \dfrac{4}{7}}
{= \dfrac{3}{7}}
Old Share
{= \dfrac{1}{3}}
{= \dfrac{1}{3}}
Gain in share
{= \dfrac{4}{7} - \dfrac{1}{3}}
{= \dfrac{3}{7} - \dfrac{1}{3}}
{= \dfrac{12 - 7}{21}}
{= \dfrac{9 - 7}{21}}
{= \dfrac{5}{21}}
{= \dfrac{2}{21}}
∴ Gaining Ratio
{= \dfrac{5}{21} : \dfrac{2}{21}}
= 5 : 2
2. Azad, Vijay and Amit are partners sharing profits and losses in the proportion of \dfrac{1}{4}, \dfrac{1}{8} and \dfrac{10}{16}. Calculate the new profit sharing ratio between continuing partners if (a) Azad retires; (b) Vijay retires; (c) Amit retires.
The continuing partners acquire the share of retiring partners in the old profit sharing ratio, and there is no need to compute the new profit sharing ratio among them, as it will be same as the old profit sharing ratio among them.
Old Profit Sharing Ratio
{= \dfrac{1}{4} : \dfrac{1}{8} : \dfrac{10}{16}}
= 2:1:5
(a) When Azad retires
Vijay and Amit will share the profits and losses in the ratio 1:5
(a) When Vijay retires
Azad and Amit will share the profits and losses in the ratio 2:5
(a) When Amit retires
Azad and Vijay will share the profits and losses in the ratio 2:1
3. Calculate the gaining ratio in each of the above situations.
The ratio in which the continuing partners have acquired the share from the retiring partner is in their old profit sharing ratio. So, the gaining ratio of the remaining partners will be the same as their old profit sharing ratio among them and there is no need to compute the gaining ratio. So,
(a) When Azad retires
Gaining ratio of Vijay and Amit will be 1:5
(a) When Vijay retires
Gaining ratio of Azad and Amit will be 2:5
(a) When Amit retires
Gaining ratio of Azad and Vijay will be 2:1
4. Anu, Prabha and Milli are partners. Anu retires. Calculate the future profit sharing ratio of continuing partners and gaining ratio if they agree to acquire her share : (a) in the ratio of 5:3; (b) equally.
As no information is provided regarding the old profit sharing ratio, we assume that Anu, Prabha and Milli are equal partners i.e. their profit and losses sharing ratio is 1:1:1. Their future profit sharing ratio and gaining ratios will be as follows in each of the given cases:
(a) When Prabha and Milli agree to acquire Anu’s share in the ratio of 5:3
Prabha
Milli
Gain in Share
{= \dfrac{1}{3} × \dfrac{5}{8}}
{= \dfrac{1}{3} × \dfrac{3}{8}}
{= \dfrac{5}{24}}
{= \dfrac{3}{24}}
New Share
{= \dfrac{1}{3} + \dfrac{5}{24}}
{= \dfrac{1}{3} + \dfrac{3}{24}}
{= \dfrac{8 + 5}{24}}
{= \dfrac{8 + 3}{24}}
{= \dfrac{13}{24}}
{= \dfrac{11}{24}}
New Ratio
{= \dfrac{13}{24} : \dfrac{11}{24}}
= 13 : 11
(b) When Prabha and Milli agree to acquire Anu’s share equally i.e. 1:1:
The old profit sharing ratio of Prabha and Milli is 1:1. The ratio in which both Prabha and Milli have acquired the share from the retiring partner Anu is in their old profit sharing ratio i.e. 1:1. So, the future sharing ratio and the gaining ratio will same as their old profit sharing ratio i.e. 1:1
5. Rahul, Robin and Rajesh are partners sharing profits in the ratio of 3 : 2 : 1. Calculate the new profit sharing ratio of the remaining partners if (i) Rahul retires; (ii) Robin retires; (iii) Rajesh retires.
The continuing partners acquire the share of retiring partners in the old profit sharing ratio, and there is no need to compute the new profit sharing ratio among them, as it will be same as the old profit sharing ratio among them. Also, the gaining ratio of the remaining partners will be the same as their old profit sharing ratio among them. So,
(i) When Rahul retires
New Profit sharing ratio of Robin and Rajesh will be 2:1
(ii) When Robin retires
New Profit sharing ratio of Rahul and Rajesh will be 3:1
(ii) When Rajesh retires
New Profit sharing ratio of Rahul and Robin will be 3:2
6. Puja, Priya, Pratistha are partners sharing profits and losses in the ratio of 5 : 3 : 2. Priya retires. Her share is taken by Priya Puja and Pratistha in the ratio of 2 : 1. Calculate the new profit sharing ratio.
Priya’s share is \dfrac{3}{10}. This is taken by both Puja and Pratishtha in the ratio 2:1
We calculate the new sharing as New Share = Old Share + Gain in Share
Puja’s gain in share
{= \dfrac{3}{10} × \dfrac{2}{3}}
{= \dfrac{2}{10}}
Puja’s new share
{= \dfrac{5}{10} + \dfrac{2}{10}}
{= \dfrac{5 + 2}{10}}
{= \dfrac{7}{10}}
Pratistha’s gain in share
{= \dfrac{3}{10} × \dfrac{1}{3}}
{= \dfrac{1}{10}}
Pratistha’s new share
{= \dfrac{2}{10} + \dfrac{1}{5}}
{= \dfrac{2 + 2}{10}}
{= \dfrac{4}{10}}
New Profit Sharing Ratio
{= \dfrac{7}{10}:\dfrac{4}{10}}
= 7 : 4
7. Ashok, Anil and Ajay are partners sharing profits and losses in the ratio of \dfrac{1}{2}, \dfrac{3}{10} and \dfrac{1}{5}. Anil retires from the firm. Ashok and Ajay decide to share future profits and losses in the ratio of 3 : 2. Calculate the gaining ratio.
Old Profit Sharing Ratio
{= \dfrac{1}{2} : \dfrac{3}{10} : \dfrac{1}{5}}
{= \dfrac{5}{10} : \dfrac{3}{10} : \dfrac{2}{10}}
We know that Gain in Share = New Share – Old Share
Ashok
Ajay
New Share
\dfrac{3}{5}
\dfrac{2}{5}
Old Share
\dfrac{5}{10}
\dfrac{2}{10}
Gain in Share
{= \dfrac{3}{5} -\dfrac{5}{10}}
{= \dfrac{2}{5} - \dfrac{2}{10}}
{= \dfrac{6 - 5}{10}}
{= \dfrac{4 - 2}{10}}
{= \dfrac{1}{10}}
{= \dfrac{2}{10}}
∴ Gaining Ratio
{= \dfrac{1}{10} : \dfrac{2}{10}}
= 1:2
Test your Understanding – I
Choose the correct option in the following questions:
1. Abhishek, Rajat and Vivek are partners sharing profits in the ratio of 5:3:2. If Vivek retires, the New Profit Sharing Ratio between Abhishek and Rajat will be–
(a)
3:2
(b)
5:3 ✔
(c)
5:2
(d)
None of these
2. The old profit sharing ratio among Rajender, Satish and Tejpal were 2:2:1. The New Profit Sharing Ratio after Satish’s retirement is 3:2. The gaining ratio is–
(a)
3:2
(b)
2:1
(c)
1:1 ✔
(d)
2:2
3. Anand, Bahadur and Chander are partners. Sharing Profit equally On Chander’s retirement, his share is acquired by Anand and Bahadur in the ratio of 3:2. The New Profit Sharing Ratio between Anand and Bahadur will be–
(a)
8:7 ✔
(b)
4:5
(c)
3:2
(d)
2:3
4. In the absence of any information regarding the acquisition of share in profit of the retiring/deceased partner by the remaining partners, it is assumed that they will acquire his/her share:-
(a)
Old Profit Sharing Ratio ✔
(b)
New Profit Sharing Ratio
(c)
Equal Ratio
(d)
None of these
Test your Understanding – II
Choose the correct option in the following questions:
1. On retirement/death of a partner, the retiring/deceased partner’s capital account will be credited with
(a)
his/her share of goodwill. ✔
(b)
goodwill of the firm.
(c)
shares of goodwill of remaining partners.
(d)
none of these.
2. Gobind, Hari and Pratap are partners. On retirement of Gobind, the goodwill already appears in the Balance Sheet at ₹ 24,000. The goodwill will be written-off
(a)
by debiting all partners’ capital accounts in their old profit sharing ratio. ✔
(b)
by debiting remaining partners’ capital accounts in their new profit sharing ratio.
(c)
by debiting retiring partners’ capital accounts from his share of goodwill.
(d)
none of these.
3. Chaman, Raman and Suman are partners sharing profits in the ratio of 5:3:2. Raman retires, the new profit sharing ratio between Chaman and Suman will be 1:1. The goodwill of the firm is valued at ₹ 1,00,000 Raman’s share of goodwill will be adjusted
(a)
by debiting Chaman’s Capital account and Suman’s Capital Account with ₹ 15,000 each.
(b)
by debiting Chaman’s Capital account and Suman’s Capital Account with ₹ 21,429 and 8,571 respectively.
(c)
by debiting only Suman’s Capital Account with ₹ 30,000. ✔
(d)
by debiting Raman’s Capital account with ₹ 30,000.
4. On retirement/death of a partner, the remaining partner(s) who have gained due to change in profit sharing ratio should compensate the
(a)
retiring partners only.
(b)
remaining partners (who have sacrificed) as well as retiring partners. ✔
(c)
remaining partners only (who have sacrificed).
(d)
none of these.
Do it Yourself – III
Vijay, Ajay and Mohan are friends. They passed B. Com. (Hons) from Delhi University in June, 2016. They decided to start the business of computer hardware.
On Ist of August, 2016, they introduced the capital of ₹ 50,000, ₹ 30,000 and ₹ 20,000 respectively and started the business in partnership at Delhi. The profit sharing ratio decided between there was 4:2:1. The business was running successfully. But on Ist February, 2017, due to certain unavoidable circumstances and family circumstances, Ajay decided to settle in Pune and decided to retires from the partnership on 31st March, 2017; with the consent of partners, Ajay retires as on 31st March, 2017, the position of assets and liabilities are as follows:
Balance Sheet of Vijay, Ajay and Mohan as on March 31, 2017
Liabilities
Amount
Assets
Amount
Capital Accounts:
Goodwill
56,000
Vijay
1,80,000
Land and Buildings
1,20,000
Ajay
1,20,000
Machinery
1,59,000
Mohan
1,00,000
4,00,000
Motor Van
31,000
Bills Payable
12,000
Stock
90,000
General Reserve
42,000
Debtors
66,000
Creditors
90,000
Cash at bank
22,000
5,44,000
5,44,000
On the date of retirement, the following adjustments were to be made:
1.
Firm’s goodwill was valued at ₹ 1,48,000.
2.
Assets and Liabilities are to be valued as under: Stock ₹ 72,000; Land and Buildings ₹ 1,35,600; Debtors ₹ 63,000; Machinery ₹ 1,50,000; Creditors ₹ 84,000.
3.
Vijay to bring ₹ 1,20,000 and Mohan ₹ 30,000 as additional capital.
4.
Ajay was to be paid ₹ 97,200 in cash and the balance of his Capital Account to be transferred to his Loan Account Work out the amount due to Ajay and state as to how will you settle his account?

Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
To Stock A/c
18,000
By Land and Building A/c
15,600
To Debtors A/c
3,000
By Creditors A/c
6,000
To Machinery A/c
9,000
By Loss Transferred to:
Vijay’s Capital A/c
4,800
Ajay’s Capital A/c
2,400
Mohan’s Capital A/c
1,200
8,400
30,000
30,000
Date
Particulars
J.F.
Amount

Vijay
Amount

Ajay
Amount

Mohan
Date
Particulars
J.F.
Amount

Vijay
Amount

Ajay
Amount

Mohan
To Goodwill A/c
32,000
16,000
8,000
By Balance b/d
1,80,000
1,20,000
1,00,000
To Loss on Revaluation A/c
4,800
2,000
1,200
By General Reserve A/c
24,000
12,000
6,000
To Ajay’s Capital A/c
33,829
8,457
By Cash A/c
1,20,000
30,000
To Cash A/c
97,200
By Vijay’s Capital A/c
33,829
To Ajay’s Loan A/c
58,686
By Mohan’s Capital A/c
8,457
To Balance c/d
2,53,371
1,18,343
3,24,000
1,74,286
1,36,000
3,24,000
1,74,286
1,36,000
Working Notes:
We’ll first calculate Ajay’s share of goodwill. This goodwill amount will be borne by both Vijay and Mohan in accordance with their gaining ratio. As the original sharing ratio is 4:2:1, when Ajay retires, the sharing ratio of both Vijay and Mohan will still be the same i.e. 4:1. So, the goodwill need to be borne by both Vijay and Mohan in the ratio 4:1
Goodwill
Firm’s Goodwill
= ₹ 1,48,000
Ajay’s share of goodwill
{= ₹~1,48,000 × \dfrac{2}{7}}
= ₹ 42,286
Vijay’s contribution
{= ₹~42,286 × \dfrac{4}{5}}
= ₹ 33,829
Mohan’s contribution
{= ₹~42,286 × \dfrac{1}{5}}
= ₹ 8,457
Revaluation/Reassessment
Reduction in the value of Stock
= ₹ 90,000 – ₹ 72,000
= ₹ 18,000
Increase in the value of Land and Building
= ₹ 1,35,600 – ₹ 1,20,000
= ₹ 15,600
Reduction in the value of Debtors
= ₹ 66,000 – ₹ 63,000
= ₹ 3,000
Reduction in the value of Machinery
= ₹ 1,59,000 – ₹ 1,50,000
= ₹ 9,000
Reduction in the amount of Creditors
= ₹ 90,000 – 84,000
= ₹ 6,000
Do it Yourself – IV
The Balance Sheet of A, B and C who were sharing the profits in proportion to their capitals stood as on March 31, 2017.
Balance Sheet as on March 31, 2017
Liabilities
Amount
Assets
Amount
Bills Payable
6,250
Land and Building
12,000
Sundry Creditors
10,000
Debtors
10,500
General Reserve
2,750
Less: Provision
500
10,000
Capitals
for bad debts
A
20,000
Bills receivables
7,000
B
15,000
Stock
15,500
C
15,000
50,000
Plant and Machinery
11,500
Cash at bank
13,000
69,000
69,000
B retired on the date of Balance Sheet and the following adjustments were to be made:
(a)
Stock was depreciated by 10%
(b)
Factory building was appreciated by 12%
(c)
Provision for doubtful debtos to be created up to 5%
(d)
Provision for legal charges to be made at ₹ 265
(e)
The goodwill of the firm to be fixed at ₹ 10,000
(f)
The capital of the new firm to be fixed at ₹ 30,000. The continuing parners decided to keep their capitals in the new profit sharing ratio of 3:2.
Work out the final balances in capital accounts of the firm, and the amounts to be brought in and/or withdrawn by A and C to make their capitals proportionate to then new profit sharing ratio.
Books of A,B and C
Journal
Date
Particulars
L.F.
Debit
Amount
Credit
Amount
Reserve Fund A/c
Dr.
2,750
A’s Capital A/c
1,100
B’s Capital A/c
875
C’s Capital A/c
875
(Being General Reserve fund distributed amoung the partners)
Revaluation A/c
Dr.
1,840
To Stock A/c
1,550
To Provision for Doubtful Debts A/c
25
To Provision for Legal Charges A/c
265
(Being Depreciation of Assets & Additional Expenses on Revaluation)
Land and Building A/c
Dr.
1,440
To Revaluation A/c
1440
(Being Appreciation in the Land and Building asset on revaluation)
A’s Capital A/c
Dr.
160
B’s Capital A/c
Dr.
120
C’s Capital A/c
Dr.
120
To Revaluation A/c
400
(Being Loss on revaluation transferred to the partners’ capital accounts)
A’s Capital A/c
Dr.
2,000
C’s Capital A/c
Dr.
1,000
To B’s Capital A/c
3,000
(Being B’s share of goodwill transferred from A and C’s capital in their gaining ratio)
B’s Capital A/c
Dr.
18,705
B’s Loan A/c
18,705
(Being the capital of retiring partner B is transferred to his Loan account)
A’s Capital A/c
Dr.
940
To Bank A/c
940
(Being the surplus capital of A withdrawn)
C’s Capital A/c
Dr.
2,705
To Bank A/c
2,705
(Being the surplus capital of C withdrawn)
Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
To Stock A/c
1,550
By Land and Building A/c
1,440
To Provision for
25
By Revaluation of Loss
Doubtful Debts A/c
By A’s Capital A/c
160
To Provision for
265
By B’s Capital A/c
120
Legal Charges A/c
By C’s Capital A/c
120
400
1,840
1,840
Date
Particulars
J.F.
A
Amount
B
Amount
C
Amount
Date
Particulars
J.F.
A
Amount
B
Amount
C
Amount
To Revaluation A/c
160
120
120
By Balance b/d
20,000
15,000
15,000
To B’s Capital A/c
2,200
1,000
By Reserve Fund A/c
1,100
825
825
To B’s Loan A/c
18,705
By A’s Capital A/c
2,000
To Bank A/c
940
2,705
By C’s Capital A/c
1,000
To Balance c/d
18,000
12,000
21,100
18,825
15,825
21,100
18,825
15,825
Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
To Balance b/d
13,000
By A’s Capital A/c
940
By C’s Capital A/c
2,705
By Balance c/d
9,355
13,000
13,000
Balance Sheet
as on March 2017
Liabilities
Amount
Assets
Amount
Bills Payable
6,250
Land and Building
12,000
Sundry Creditors
10,000
Appreciation
1,440
13,440
Reserve for Legal Charges
265
Debtors
10,500
B’s Loan
18,705
Provision for Bad Debts
525
9,975
Capitals
Bills Receivable
7,000
A
18,000
Stock
15,500
B
12,000
30,000
Depreciation
1,550
13,950
Plant and Machinery
11,500
Bank
9,355
65,220
65,220
Working Notes:
Ratios
Old Ratio
(of A, B and C)
= 20,000:15,000:15,000
= 4:3:3
New Ratio
(of A and C)
= 3:2
Gain in Share
A
{= \dfrac{3}{5} - \dfrac{4}{10}}
{= \dfrac{3}{5} - \dfrac{2}{5}}
{= \dfrac{1}{5}}
B
{= \dfrac{2}{5} - \dfrac{1}{10}}
{= \dfrac{4 - 3}{10}}
{= \dfrac{1}{10}}
Gaining Ratio
{= \dfrac{1}{5}:\dfrac{1}{10}}
{= \dfrac{2}{10}:\dfrac{1}{10}}
= 2:1
Distribution of General Reserve
A’s Share
{= ₹~2,750 × \dfrac{4}{10}}
= ₹ 1,100
B’s Share
{= ₹~2,750 × \dfrac{3}{10}}
= ₹ 825
C’s Share
{= ₹~2,750 × \dfrac{3}{10}}
= ₹ 825
Goodwill
Goodwill
= 10,000
B’s share of goodwill
{= ₹~10,000 × \dfrac{3}{10}}
= ₹ 3,000
Contribution to B’s goodwill
By A
{= ₹~3,000 × \dfrac{2}{3}}
= ₹ 2,000
By C
{= ₹~3,000 × \dfrac{1}{3}}
= ₹ 1,000
Revaluation
Depreciation on Stock
{= ₹~15,500 × \dfrac{10}{100}}
= ₹ 1,550
Total Provision for Doubtful Debts
{= ₹~10,500 × \dfrac{5}{100}}
= ₹ 525
Existing Provision for Doubtful Debts
= ₹ 500
Additional Provision for Doubtful Debts
= ₹ 525 – ₹ 500
= ₹ 25
Appreciation on Factory Building
{= ₹~12,000 × \dfrac{12}{100}}
= ₹ 1,440
Profit/Loss after Revaluation
= Appreciation on Factor Building – Depreciation on Stock – Additoinal Provision for Doubtful Debts – Legal Charges
= 1,440 – ₹ 1,550 – ₹ 25 – ₹ 265
= (₹ 400) (Loss)
Share of Revaluation Loss
A
{= ₹ 400 × \dfrac{4}{10}}
= ₹ 160
B
{= ₹~400 × \dfrac{3}{10}}
= ₹ 100
C
{= ₹~400 × \dfrac{3}{10}}
= ₹ 100
Capitals after Revaluation
A
= Old Capital + Reserve Fund – Loss on Revaluation – B’s Capital
= ₹ 20,000 + ₹ 1,100 – ₹ 160 – ₹ 2,000
= ₹ 18,940
B
= Old Capital + Share of Reserve Fund + Goodwill Contribution from A + Goodwill contribution from C – Loss on Revaluation
= ₹ 15,000 + ₹ 825 + ₹ 2,000 + ₹ 1,000 – ₹ 120
= ₹ 18,705
C
= Old Capital + Reserve Fund – Loss on Revaluation – B’s Capital
= ₹ 15,000 + ₹ 825 – ₹ 120 – ₹ 1,000
= ₹ 14,705
New Total Capital
= ₹ 30,000
New Profit Sharing Ratio
= 3:2
A’s New Capital Share
{= ₹~30,000 × \dfrac{3}{5}}
= ₹ 18,000
C’s New Capital Share
{= ₹~30,000 × \dfrac{2}{5}}
= ₹ 12,000
A’s Capital surplus
= ₹ 18,940 – ₹ 18,000
= ₹ 940
C’s Capital surplus
= ₹ 14,705 – ₹ 12,000
= ₹ 2,705
2. R, S and M were carrying on business in partnership sharing profits in the ratio of 3:2:1, respectively. On March 31, 2017, Balance Sheet of the firm stood as follows :
Balance Sheet as on March 31, 2017
Liabilities
Amount
Assets
Amount
Sundry Creditors
16,000
Building
23,000
Capitals
Debtors
7,000
R
20,000
Stock
12,000
S
7,500
Patents
8,000
M
12,500
40,000
Bank
6,000
56,000
56,000
Shyam retired on the above mentioned date on the following terms :
(a)
Buildings to be appreciated by ₹ 8,800.
(b)
Provision for doubtful debts to be made @ 5% on debtors.
(c)
Goodwill of the firm to be valued at ₹ 9,000.
(d)
₹ 5,000 to be paid to S immediately and the balance due to him to be treated as a loan carrying interest @ 6% per annum.

Prepare the balance sheet of the reconstituted firm.
Books of R,S and M
Journal
Date
Particulars
L.F.
Debit
Amount
Credit
Amount
Building A/c
Dr.
8,800
To Revaluation A/c
8,800
(Being Appreciation in the Building asset on revaluation)
Revaluation A/c
Dr.
350
To Provision for Doubtful Debts A/c
350
(Being provision for doubtful debts after revaluation)
R’s Capital A/c
Dr.
4,225
S’s Capital A/c
Dr.
2,817
M’s Capital A/c
Dr.
1,408
To Revaluation A/c
8,450
(Being profit on revaluation transferred to the partners’ capital accounts)
R’s Capital A/c
Dr.
2,250
M’s Capital A/c
Dr.
750
To S’s Capital A/c
3,000
(Being share of S’s goodwill borne by the the continuing partners R and M)
S’s Capital A/c
Dr.
5,000
To Bank A/c
5,000
(Being amout paid to the retiring partner S)
Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
To Provision for Doubtful Debts A/c
350
By Building A/c
8,800
Profit on Revaluation Transferred
To R’s Capital A/c
4,225
To S’s Capital A/c
2,817
To M’s Capital A/c
1,408
8,450
8,800
8,800
Date
Particulars
J.F.
R
Amount
S
Amount
M
Amount
Date
Particulars
J.F.
R
Amount
S
Amount
M
Amount
To S’s Capital A/c
2,250
750
By Balance b’d
20,000
7,500
12,500
To Cash A/c
5,000
By Revaluation A/c
4,225
2,817
1,408
To S’s Loan A/c
8,317
By R’s Capital A/c
2,250
To Balance c/d
21,975
13,158
24,225
13,317
13,908
24,225
13,317
13,908
Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
To Balance b/d
6,000
By S’s Capital A/c
5,000
By Balance c/d
1,000
6,000
6,000
Balance Sheet as on March 31, 2017
Liabilities
Amount
Assets
Amount
Creditors
16,000
Building
23,000
S’s Loan
8,317
Appreciation
8,800
31,800
Capital
Debtors
7,000
R
21,975
Provision for
350
6,650
M
13,158
35,133
Doubtful Debts
Stock
12,000
Patents
8,000
Bank
1,000
59,450
59,450
Working Notes:
Revaluation Share:
Building Appreciation
= ₹ 8,800
Provision for doubtful Debts
{= ₹~7,000 × \dfrac{5}{100}}
= ₹ 350
Profit after revaluation
= ₹ 8,800 – ₹ 350
= ₹ 8,450
R’s share
{= ₹~8,450 × \dfrac{3}{6}}
= ₹ 4,225
S’s share
{= ₹~8,450 × \dfrac{2}{6}}
= ₹ 2,817
M’s share
{= ₹~8,450 × \dfrac{1}{6}}
= ₹ 1,408
Goodwill Contribution
Goodwill of S
{= ₹~9,000 × \dfrac{2}{6}}
= ₹ 3,000
R’s contribution to S’s goodwill
{= ₹~3,000 × \dfrac{3}{4}}
= ₹ 2,250
M’s contribution to S’s goodwill
{= ₹~3,000 × \dfrac{1}{4}}
= ₹ 750
S’s Capital after revaluation
= Old Capital + Revaluation Profit + Goodwill contribution from R + Goodwill contribution from M
= ₹ 7,500 + ₹ 2,817 + ₹ 2,250 + ₹ 750
= ₹ 13,317
Amount paid to S
= ₹ 5,000
Remaining capital to be paid as Loan
= Capital – Amount Paid
= ₹ 8,317
Do it Yourself – V
On December 31, 2015, the Balance Sheet of Pinki, Qureshi and Rakesh showed as under :
Balance Sheet as on December 2015
Liabilities
Amount
Assets
Amount
General Reserve
20,000
Buildings
26,000
Capitals:
Investments
15,000
Pinki
15,000
Debtors
15,000
Qureshi
10,000
Bills Receivable
6,000
Rakesh
10,000
35,000
Stock
12,000
Sundry Creditors
25,000
Cash
6,000
80,000
80,000
The partnership deed provides that the profit be shared in the ratio of 2:1:1 and that in the event of death of a partner, his executors be entitled to be paid out :
(a)
The capital of his credit at the date of last Balance Sheet.
(b)
His proportion of reserves at the date of last Balance Sheet.
(c)
His proportion of profits to the date of death based on the average profits of the last three completed years, plus 10%, and
(d)
By way of goodwill, his proportion of the total profits for the three preceding years. The net profit for the last three years were:
2013
16,000
2014
16,000
2015
15,400
Rakesh died on April 1, 2015. He had withdrawn ₹ 5,000 to the date of his death. The investment were sold at par and R’s Executors were paid off. Prepare Rakesh’s Capital Account that of his executors.
Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
To Drawings A/c
5,000
By Balance b/d
10,000
To Rakesh’s Executor’s A/c
22,936
By Reserve Fund A/c
5,000
By Profit and Loss (Suspense) A/c
1086
By Pinki’s Capital A/c
7,900
By Qureshi’s Capital A/c
3,950
27,936
27,936
Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
To Balance c/d
22,936
By Rakesh’s Capital A/c
22,936
22,936
22,936
Working Notes:
Average Profit
(Based on last 3 years)
{= \dfrac{₹~16,000 + ₹~16,000 + ₹~15,400}{3}}
{= \dfrac{₹~47,400}{3}}
= ₹ 15,800
Profit to be distributed
= Average Profit + 10% of Average Profit
= ₹ 15,800 + 10% of ₹ 15,800
{= ₹~15,800 + ₹~15,800 × \dfrac{10}{100}}
= ₹ 15,800 + ₹ 1,580
= ₹ 17,380
Duration for which profit to be considered
= 3 months
Rakesh’s share of profit
{= ₹~17,380 × \dfrac{1}{4} × \dfrac{3}{12}}
= ₹ 1,086
Goodwill
Goodwill amount
= Last 3 years profit
= ₹ 47,400
Rakesh’s share of goodwill
{= ₹~47,400 × \dfrac{1}{4}}
= ₹ 11,850
Contribution to Goodwill
Pinki
{= ₹~11,850 × \dfrac{2}{4}}
= ₹ 7,900
Qureshi
{= ₹~11,850 × \dfrac{1}{4}}
= ₹ 3,950
Short Answer Questions
1. What are the different ways in which a partner can retire from the firm?
The following are the different ways in which a partner can retire from a firm.
i.
Through Mutual consent of the other partners: The partner willing to retire expresess his desire to the other partners. Once they all approve and provide the consent, he/she can retire.
ii.
Through Provision in the Partnership Deed: In some cases, there will be a provision included in the partnership deed while preparing it. Through such provision, the partner can declare his retirement by submitting a notice to the other partners.
iii.
By Submitting a Written notice: This is applicable when the partnership is at will. Here, the partner can send a notice to the other partners and inform about his decision to retire from the firm.
2. Write the various matters that need adjustments at the time of retirement of a partners.
The various matters that need adjustments at the time of retirement of a partners are as follows:
1.
Calculation of new profit sharing ratio and gaining ratio
2.
Calculation of goodwill and prepare the necessary entries in the books.
3.
Revaluation of assets and re-assessment of the liabilities
4.
Adjustment in respect of unrecorded assets and liabilities
5.
Distribution of accumulated profits and losses among all the partners
6.
Ascertainment of share of profit or loss till the date of retirement/death
7.
Adjustment of capital, if necessary
8.
Settlement of the amounts due to retired/deceased partner
3. Distinguish between sacrificing ratio and gaining ratio.
The following are the differences between the sacrificing ratio and gaining ratio
Basis
Sacrificing Ratio
Gaining Ratio
Definition
The ratio in which the old partners are willing to sacrifice their share of profits/losses in favour of the on-boarding new partner
The ratio in which the continuing partners gain the share of profits and losses from the retiring/deceased partner
Objective
To ascertain the share of profit/losses sacrificed by the existing partners in favour of the on-boarding new partner(s). The new partner(s) pays the goodwill to the existing partners in this ratio.
To ascertain the share of profits/losses gained by the continuing partners from the retiring/deceased partner. The continuing partners contribute to the retiring/deceased partner’s goodwill in their gaining ratio.
Calculation
Sacrificing Ratio = Old Ratio – New Ratio
Gaining Ratio = New Ratio – Old Ratio
Occurrence
At the time of admission of a new partner(s)
At the time of retirement/death of an existing partner
Result
The existing partner(s) profit sharing ratio is reduced
The continuing partner(s) profit sharing ratio is increased
4. Why do firm revaluate assets and reassess their liabilities on retirement or on the event of death of a partner.
Firms do the revaluation of assets and reassess their liabilities on retirement or on the event of death of a partner.
1.
To ascertain the true value of assets. The book value of assets might be different from the actual value. As these assets were recorded a while ago, their current value might be different. This ensures that they are valued at a fair value each partner is justified as the assets are neither overvalued nor undervalued.
2.
To ascertain the true value of the liabilties. This also ensures that the retiring partner or deceased partner’s executors are compensated with what they are entitled for.
3.
To identify any unrecorded assets or liabilities and to record them so that the retiring partner or deceased partner’s executors are compensated with what they are entitled for.
4.
It is a legal obligation and a fair practice to do so
5. Why a retiring/deceased partner is entitled to a share of goodwill of the firm.
A retiring/deceased partner is entitled to a share of goodwill of the firm due to the following reason.
Goodwill of the firm is an intangible assets and builds over the life of the firm through the efforts of all the existing partners. Hence, at the time of retirement or death of a partner, goodwill is valued as per the agreement among the partners. Once the goodwill is valued, the deceased partner is compensated for his/her share of goodwill by the continuing partners in their gaining ratio.
Long Answer Questions
1. Explain the modes of payment to a retiring partner.
The following are the modes of payment to a retiring partner.
1.
The outgoing partner is paid immediately in lumpsum as per the terms of the partnership deed. In this case, the following journal entries are made.
Retiring Partner’s Capital A/c
Dr.
To Cash/Bank A/c
(Being the retiring partner paid in lumpsum cash)
2.
When the firm is not able to pay in cash, the retiring partner is paid in installments. In this case, the retiring partner’s capital account is transferred to his/her loan account. The payments are done in equal installments till the loan amount is paid off. In this case, the retiring partner will be paid with an interest on his loan amount as agreement in the partnership deed. In the absence of any agreement, Section 37 of the Indian Partnership Act, 1932 is applicable, which states that the outgoing partner has an option to receive either interest @ 6% p.a. In this case, the following journal entries are made.
Retiring Partner’s Capital A/c
Dr.
To Retiring Partner’s Loan A/c
(Being the retiring partner’s capital account transferred to his loan account @ _____ % p.a. interest)
3.
When the firm compensates the retiring partner partly in cash/cheque, the rest of the amount is paid to the retiring partner in installments. In this case, the retiring partner’s remaining capital amount is transferred to his/loan account. The payments for the remaining capital amount are done in equal installments till the loan amount is paid off. In this case, the retiring partner will be paid with an interest on his loan amount as agreement in the partnership deed. In the absence of any agreement, Section 37 of the Indian Partnership Act, 1932 is applicable, which states that the outgoing partner has an option to receive either interest @ 6% p.a. In this case, the following journal entries are made.
Retiring Partner’s Capital A/c
Dr.
To Cash/Bank A/c
To Retiring Partner’s Loan A/c
(Being the retiring partner is partly paid in cash and the balance transferred to his loan account @ _____ % p.a. interest))
2. How will you compute the amount payable to a deceased partner?
We’ll compute the amount payable to a deceased partner as follows:
1. Consider the following amounts due to the legal representatives/executors of the deceased partner. All these amounts should be credited to the deceased partner’s Capital account.
a.
Credit Balance of his/her capital account
b.
Credit Balance of his/her current account (if any)
c.
His/her share of Goodwill
d.
His/her share of accumulated profits (reserves)
e.
His/her share in the gain of revaluation of assets and liabilities
f.
His/her share of profits up to the date of death
g.
If interest is involved on his/her capital, it is considered up to the date of his/her death.
h.
If any salary/commission is due to him, it should also be considered.
2. Consider the following amounts to be charged to the deceased partner’s account. All these amounts should be debited from the deceased partner’s capital account.
a.
Debit balance of his/her current account (if any)
b.
His/her share of goodwill to be written off, if required
c.
His/her share of accumulated losses.
d.
His/her share of loss on revaluation of assets and re-assesment of the liabilities.
e.
His/her share of loss until the date of death
f.
His/her drawings till the date of death
e.
If there’re any drawings, the interest on the drawings upto the date of death should be calculated and charged
Date
Particulars
J.F.
Amount
Date
Particulars
J.F.
Amount
By Balance b/d
To Profit and Loss (Suspense) A/c
By Profit and Loss (Suspense) A/c
(Share of loss up to the date of death)
(Share of profit up to the date of death)
To Revaluation A/c (loss)
By Revaluation A/c
To Goodwill A/c
By Goodwill A/c
To Accumulated Losses A/c
By Reserves and Profits A/c
To Interest on Drawings A/c
By Interest on Capital A/c
To Partner’s executor’s A/c
By Salary A/c
(Balancing Figure)
By Commission A/c
 
 
The deceased partner’s legal executor is entitiled for the balancing figure in case the credit side is more than the debit side.
3. Explain the treatment of goodwill at the time of retirement or on the event of death of a partner?
The following is the treatment of goodwill at the time of retirement or on the event of death of a partner
The retiring or deceased partner is entitled to his share of goodwill at the time of retirement/death. This is because the good will of the firm has been earned with the efforts of all the existing partners. Hence, at the time of retirement/death of a partner, goodwill is valued as per agreement among the partners. So, the retiring or deceased partner is compensated for his/her share of goodwill by the continuing partners.
The accounting treatment for goodwill in such a situation depends upon whether or not goodwill already appears in the books of the firm.
1. When the goodwill does not appear in the books of the firm:
When goodwill does not appear in the books of the firm, the retiring or deceased partner is compensated by debiting the goodwill account to gaining partners capital accounts (individually) in their gaining ratio. The journal entry in such a scenario will be as follows:
Gaining Partners’s Capital A/c
Dr.
(Individually)
To Retiring Partner’s Capital A/c
(Being share in goodwill of retiring partner adjusted)
2. When the goodwill already appears in the books of the firm:
When the goodwill is already in the books of the firm, then the following two step treatment is carried out:
a.
Write off the goodwill by transaferring it to the partners’ accounts: In this step, we should first writing off the goodwill in the books of account. This is done by distributing the goodwill among all the partners. So, all the partners including the retiring or deceased partner gets their share of goodwill distributed in their old profit sharing ratio. The corresponding journal entries would be as follows:
All partners’s capital A/c
Dr.
(Individually)
To Goodwill A/c
(Being goodwill distributed among all the partners in their profit sharing ratio)
b.
Adjustment of the goodwill through partners’ capital accounts: In this step, the continuing partners’ capital accounts are adjusted with their share of the goodwill distributed in their gaining ratio. The corresponding journal entry would be as follows:
Continuing partners’s capital A/c
Dr.
Individually
To Retiring/deceased partner’s Capital A/c
(Being the continuing partners’ capital accounts adjusted with their share of goodwill to the retiring/deceased partner)
4. Discuss the various methods of computing the share in profits in the event of death of a partner.
Unlike the retirement of a partner which usually takes place at the end of the accounting period, the death of a partner is uncertain and could be somewhere during the accouting period is not yet completed. So, the following are the various methods of computing the share in profits in the event of death of a partner
1. Average Profits Method In this method, we consider the average profit earned by the business in the past few years or last year. The profit during the current year is assumed to be equal to this average profit of the past few years. The deaceased partner’s share of profit is calculated based on this averrage profit.
The time lapse could be in number of months or weeks or days from the start of the accounting period to till the date of death of the deceased partner. The following formula is used to caculate the profit share of the deceased partner.
Profit
{= \dfrac{Average~Profits}{No.~of~Time~Units~in~Accounting~Period} × Lapsed~Time~Units~till~date~of~death × Profit~Share}
Here, Time Unit could be months or weeks or days.
For instance, if the accounting period is one year, the No. of Time Units in the Accounting Period could be 12 Months or 52 weeks or 365/366 days.
If the yearly accounting perod starts on 1st April and a partner is deceased on 2nd June, then the time laps is 2 months (if the time unit is months) or 9 weeks (if the time unit is weeks) or 63 days (if the time unit is days).
For instance, A, B, C and D are partners in a firm sharing the profits in the ratio 1:2:3:4. The profits earned during the past 4 years are ₹ 19,00,000, ₹ 22,00,000, ₹ 25,00,000 and ₹ 30,00,000. The yearly accounting period ends on 31st March and one of the partners D deceased on 30th June.
Average Profits
{= \dfrac{₹~19,00,000 + ₹~22,00,000 + ₹~25,00,000 + ₹~30,00,000}{4}}
{= \dfrac{₹~1,00,00,000}{4}}
= ₹ 24,00,000
Considering that the Time Unit is months,
No. of Time Units in accounting period = 12 (months)
Time lapsed till the date of death of the deceased partner = 3 (months)
∴ Profit
{= \dfrac{₹~24,00,000}{12} × 3 × \dfrac{4}{10}}
= ₹ 2,40,000
2. Sales Basis Method: In this method, the last year’s sales is considered as the basis for calculating the profit. This method is based on the assumption that the net profit margin for the current accounting period is similar to that of the previous account period.
The following formula is used to calculate the deceased partner’s profit from the beginning of the accounting period up to the date of death of the partner.
Profit
{= \dfrac{Profits~in~the~previous~accounting~period}{Sales~in~the~previous~account~period} × Sales~till~up~to~the~date~of~the~death~of~the~deceased~partner~×~His/Her~Profit~Sharing~Ratio}
For instance, A, B, C and D are partners in a firm sharing the profits and the losses in the ratio 1:2:3:4. The sales during the previous year were ₹ 30,00,000 and the profits are ₹ 3,00,000. The partner D deceased on 21st June. The sales from the beginning of the current accounting period up to the death of the partner are ₹ 10,00,000.
For the above scenario, the profit of the deceased partner D is computed as follows:
Profit
{= \dfrac{₹~3,00,000}{₹~30,00,000} × ₹~10,00,000 × \dfrac{4}{10}}
= ₹ 40,000