Reconstitution of a Partnership Firm: Retirement/Death of a Partner | CBSE Class 12 Accountancy Notes

This note covers retirement and death of a partner, new profit sharing and gaining ratios, goodwill, revaluation of assets and liabilities, accumulated profits and losses, profit up to departure, settlement of claims, loan instalments, capital adjustments and executors’ accounts.

What changes when a partner retires or dies?

Reconstitution changes the relationship between partners while the remaining partners continue the business on changed terms. On retirement or death, the existing partnership deed comes to an end and a new deed needs to be framed for the continuing partners.

The central accounting task is to determine the amount due to the outgoing partner. In retirement, settlement is with that partner. In death, settlement is with the deceased partner’s legal representatives or executors. The opening capital balance alone does not measure the final claim.

Which items increase or reduce the claim?

These adjustments distinguish the partner’s rights in past earnings and changes in asset values from the arrangement for future profits. Interest, salary and commission enter the calculation where the applicable terms provide for them; they are not automatic additions in every question.

How should the work be organised?

1. Identify the old ratio, new ratio and gaining ratio.
2. Adjust goodwill, asset and liability values, and unrecorded items.
3. Transfer accumulated profits and losses in the old ratio.
4. Determine profit or loss and other entitlements up to departure.
5. Calculate the final claim, record settlement and adjust continuing partners’ capitals if required.

Maintain a separate working for each adjustment before combining them in the capital accounts. A goodwill credit, a reserve credit and a payment are different transactions, even when all affect the same outgoing partner’s account.

How are the new profit sharing ratio and gaining ratio calculated?

Definition: The new profit sharing ratio is the ratio in which continuing partners share future profits. The gaining ratio expresses the proportions in which they acquire the outgoing partner’s share.

New share = Old share + Acquired share

Gaining share = New share − Old share

When there is no information about acquisition of the outgoing partner’s share, the remaining partners are assumed to acquire it in their old ratio. Remove the outgoing partner from that ratio and compare the remaining partners’ shares with each other.

For Asha, Deepti and Nisha, whose old ratio is 3:2:1, Deepti’s retirement leaves Asha and Nisha sharing 3:1 unless they decide otherwise. Their fractions of future total profit are therefore 3/4 and 1/4, rather than 3/6 and 1/6.

What if the acquisition ratio is specified?

Worked example 1. Alka, Harpreet and Shreya share profits 3:2:1. Alka retires, and Harpreet and Shreya acquire her share in the ratio 3:2. Calculate their new ratio.

Answer: Harpreet acquires 3/5 × 3/6 = 9/30; Shreya acquires 2/5 × 3/6 = 6/30. Harpreet’s new share is 2/6 + 9/30 = 19/30. Shreya’s is 1/6 + 6/30 = 11/30. Their new ratio is 19:11, while their gaining ratio is 3:2.

What if the new ratio is specified?

Amit, Dinesh and Gagan share profits 5:3:2. Dinesh retires, and Amit and Gagan agree on 3:2. Amit gains 3/5 − 5/10 = 1/10. Gagan gains 2/5 − 2/10 = 2/10. The gaining ratio is 1:2.

The new shares add to one, while the gains together equal Dinesh’s old share of 3/10. These checks help distinguish fractions of the firm’s total profit from fractions of the outgoing partner’s share. A continuing partner may also sacrifice instead of gaining.

How is goodwill adjusted when it does not appear in the books?

The outgoing partner is entitled to a share of goodwill because the firm’s goodwill has been earned through the efforts of the existing partners. Its value is determined according to their agreement. Gaining partners compensate the outgoing partner through their capital accounts.

Goodwill share = Firm goodwill × Old profit share

Debit the gaining partners’ capital accounts individually and credit the retiring partner’s capital account. Divide the outgoing partner’s goodwill share in the gaining ratio. Under this method, the adjustment does not require opening a Goodwill Account.

Worked example 2. Keshav, Nirmal and Pankaj share profits 4:3:2. Nirmal retires; goodwill is ₹72,000. Keshav and Pankaj will share future profits 5:3. Calculate the adjustment.

Answer: Nirmal’s share is ₹72,000 × 3/9 = ₹24,000. Keshav gains 5/8 − 4/9 = 13/72; Pankaj gains 3/8 − 2/9 = 11/72. Their gaining ratio is 13:11. Debit Keshav’s Capital ₹13,000 and Pankaj’s Capital ₹11,000; credit Nirmal’s Capital ₹24,000.

Can a continuing partner receive goodwill compensation?

Yes. A continuing partner whose new share is smaller than the old share has made a sacrifice. The gaining partner compensates that partner as well as the outgoing partner. Calculate each change before deciding which accounts to debit or credit.

Deepa, Neeru and Shilpa share profits 5:3:2. Neeru retires, Deepa and Shilpa adopt 2:3, and goodwill is ₹1,20,000. Deepa sacrifices 5/10 − 2/5 = 1/10. Shilpa gains 3/5 − 2/10 = 4/10.

The ₹48,000 debit equals ₹1,20,000 × 4/10. Neeru receives her old 3/10 share, while Deepa receives compensation for sacrificing 1/10. The total credit is ₹36,000 + ₹12,000 = ₹48,000.

How are existing goodwill and hidden goodwill treated?

When existing goodwill appears in the books, write it off against all partners’ capital accounts in their old profit sharing ratio, including the outgoing partner. This removes the old book value before the outgoing partner’s share of the current valuation is adjusted.

How are the two goodwill adjustments kept separate?

Worked example 3. Hanny, Pammy and Sunny share profits 3:2:1. Book goodwill is ₹60,000. Pammy retires when goodwill is valued at ₹84,000, and Hanny and Sunny adopt 2:1.

Answer: Write off ₹60,000 by debiting Hanny ₹30,000, Pammy ₹20,000 and Sunny ₹10,000, and crediting Goodwill ₹60,000. Pammy’s current goodwill share is ₹84,000 × 2/6 = ₹28,000. Hanny gains 2/3 − 3/6 = 1/6; Sunny gains 1/3 − 1/6 = 1/6. Debit their capitals ₹14,000 each and credit Pammy’s Capital ₹28,000.

Pammy has both a debit for the old goodwill and a credit for the current goodwill entitlement. Treating ₹84,000 as Pammy’s personal entitlement would confuse the firm’s valuation with one partner’s share. Using the new ratio for the write-off would allocate an old balance incorrectly.

What does a lump sum settlement reveal?

Hidden goodwill arises where an agreed lump sum exceeds the retiring partner’s adjusted capital claim. First incorporate reserves, accumulated losses, revaluation and other relevant adjustments. The excess of the settlement over that adjusted amount represents the partner’s share of goodwill.

Hidden goodwill share = Agreed settlement − Adjusted claim

P, Q and R share profits 3:2:1. R’s adjusted capital is ₹60,000, but P and Q agree to pay ₹75,000. R’s hidden goodwill share is ₹75,000 − ₹60,000 = ₹15,000.

Assuming no change in the continuing partners’ own ratio, P and Q gain 3:2. Debit P’s Capital ₹9,000 and Q’s Capital ₹6,000; credit R’s Capital ₹15,000. The ₹15,000 is R’s goodwill share, not the valuation of the entire firm’s goodwill.

How are assets and liabilities revalued on retirement or death?

A Revaluation Account records changes needed to bring assets and liabilities to the agreed values. It also records assets and liabilities previously omitted from the books. The resulting profit or loss belongs to all the old partners, including the retiring or deceased partner.

Which journal entries record the changes?

Transfer a revaluation profit by debiting Revaluation and crediting all partners’ capitals in the old ratio. For a loss, debit all partners’ capitals in the old ratio and credit Revaluation. This transfer closes the Revaluation Account.

Worked example 4. Mitali, Indu and Geeta share profits 5:3:2. On Geeta’s retirement, machinery changes from ₹1,50,000 to ₹1,40,000; patents from ₹30,000 to ₹40,000; buildings from ₹1,00,000 to ₹1,25,000. Calculate revaluation profit.

Answer: Machinery falls ₹10,000; patents rise ₹10,000; buildings rise ₹25,000. Net profit is ₹10,000 + ₹25,000 − ₹10,000 = ₹25,000. Credit Mitali’s Capital ₹12,500, Indu’s Capital ₹7,500 and Geeta’s Capital ₹5,000.

How does the Revaluation Account balance?

The account records the change in value, not each asset’s entire revised value. The balance sheet will show the revised machinery, patents and buildings; the partners’ capital accounts receive the resulting profit allocation.

How are accumulated profits and losses distributed?

Accumulated profits, including general reserve, belong to the partners who earned them before reconstitution. The outgoing partner therefore receives a share. Accumulated losses similarly belong to the old partnership and reduce the claims of all its partners.

Transfer reserves by debiting Reserves Account and crediting all partners’ capital accounts in the old profit sharing ratio. For an accumulated debit balance of Profit and Loss Account, debit all partners’ capitals in the old ratio and credit Profit and Loss Account.

What is the reserve adjustment?

Inder, Gajender and Harinder share profits 3:2:1. When Inder retires, the balance sheet contains a General Reserve of ₹90,000. Inder’s share is ₹90,000 × 3/6 = ₹45,000; Gajender’s is ₹30,000; Harinder’s is ₹15,000.

The reserve debit removes the balance from its separate account, while the capital credits allocate the same total among its owners. The transaction itself does not pay cash to Inder. His eventual payment depends on the completed capital account and settlement terms.

Why must the old ratio be used?

The new ratio governs future profits after reconstitution. It does not redistribute earnings accumulated before the partner’s departure. Likewise, the gaining ratio is relevant to compensation for acquired profit shares, rather than division of the existing reserve.

Keep reserve distribution separate from revaluation. A reserve is an accumulated balance already in the books; revaluation profit or loss results from current adjustments to assets and liabilities. Both affect capital accounts in the old ratio, but arise from different accounting records.

How is profit up to retirement or death estimated?

Retirement may occur during an accounting year, and death may occur at any time. The outgoing partner’s claim then includes profit or loss from the last balance sheet date to departure. Interest on capital, drawings and interest on drawings also require adjustment where applicable.

Preparing final accounts for the intervening period can be cumbersome. The agreement may therefore provide for estimating profit from the previous year’s profit, the average of earlier years, or sales during the intervening period.

How does the time basis work?

Profit share = Annual profit × Months/12 × Old share

Worked example 5. Bakul, Champak and Darshan share profits 5:4:1. Profit for the year ended 31 March 2017 is ₹1,00,000. Champak dies on 30 June 2017. Estimate his profit share for April to June at the previous year’s rate.

Answer: The period is three months. Champak’s share is ₹1,00,000 × 3/12 × 4/10 = ₹10,000. Debit Profit and Loss Suspense A/c ₹10,000 and credit Champak’s Capital A/c ₹10,000.

If the agreed basis is average profit, use that average in place of the previous year’s profit. The same example gives earlier profits of ₹1,36,000, ₹1,54,000 and ₹1,00,000. Their total is ₹3,90,000 and average is ₹1,30,000.

On that alternative basis, Champak’s share is ₹1,30,000 × 3/12 × 4/10 = ₹13,000. These are alternative estimates, so do not add the ₹10,000 and ₹13,000 amounts together.

How does the sales basis work?

Use the agreed past relationship between profit and sales. With reference profit ₹1,00,000 and sales ₹8,00,000, the profit rate is 1/8. Sales of ₹1,50,000 during April to June yield estimated firm profit of ₹18,750.

Champak’s share is ₹18,750 × 4/10 = ₹7,500. Debit Profit and Loss Suspense ₹7,500 and credit Champak’s Capital ₹7,500. The debit and credit must be equal.

The suspense balance can subsequently be transferred by debiting the gaining partners’ capitals in their gaining ratio and crediting Profit and Loss Suspense. Alternatively, credit the outgoing partner’s capital directly by debiting the gaining partners’ capitals.

How is the amount due to a retiring partner settled?

The partnership deed determines the agreed settlement method. The retiring partner may receive the whole amount immediately, accept instalments with or without interest, or receive part immediately and leave the remainder payable later. Calculate the final entitlement before recording its disposal.

Which entries close the capital account?

Converting the balance into a loan closes the outgoing partner’s capital account but leaves an obligation of the firm. The loan balance appears on the liabilities side of the balance sheet until repayment. It is not treated as a continuing partner’s capital.

How are later interest and payments recorded?

For interest on the outstanding loan, debit Interest Account and credit the retiring partner’s Loan Account. For each payment, debit that Loan Account and credit Cash or Bank. Repeat these entries over the agreed repayment period.

Under the stated rule of Section 37 of the Indian Partnership Act, 1932, in the absence of an agreement, the outgoing partner has an option between interest at 6% per annum until payment and the share of profits earned through use of that partner’s money.

Distinguish this default rule from an agreed loan rate. A question specifying its own rate and instalment arrangement must be solved on those terms. The amount of interest depends on the unpaid balance and the applicable period, not simply on the original capital account balance throughout.

How is a retiring partner’s loan account prepared?

Read whether instalments are plus interest or including interest. In the first arrangement, divide the principal into the specified instalments and add each period’s interest. In the second, part of the stated payment meets interest and only the remainder reduces principal.

Loan interest = Unpaid principal × Rate × Time

Worked example 6. Mahinder retires from the firm of Amrinder, Mahinder and Joginder with ₹60,000 due. Payment is in four equal yearly principal instalments, plus interest at 12% per annum on the unpaid balance. Payments occur at each year end.

Answer: Annual principal repayment is ₹60,000 ÷ 4 = ₹15,000. Interest is calculated separately each year, so the total payments fall as the outstanding principal falls.

What appears on each side of the ledger?

In Year I, credit Mahinder’s Loan Account with ₹60,000 transferred from capital and ₹7,200 interest. Debit it with Bank ₹22,200 and Balance c/d ₹45,000. Each side totals ₹67,200. Bring the ₹45,000 balance down on the credit side for Year II.

Year II totals ₹50,400 on each side, comprising opening balance ₹45,000 plus interest ₹5,400, matched by payment ₹20,400 and closing balance ₹30,000. Year III totals ₹33,600; Year IV closes at ₹16,800 with no balance remaining.

For comparison, if the first payment were ₹20,000 including interest under the alternative arrangement, the first closing balance would be ₹60,000 + ₹7,200 − ₹20,000 = ₹47,200. Confusing these two payment instructions produces a different loan balance from the first year onward.

How are continuing partners’ capitals adjusted?

After goodwill, revaluation and accumulated balances have been adjusted, continuing partners may agree to bring their capitals into their new profit sharing ratio. Compare each partner’s adjusted capital with the required capital before recording cash introduced or withdrawn.

Required capital = Total agreed capital × New share

What if total capital is specified?

Mohit and Sohan continue in the ratio 2:1 with adjusted capitals of ₹82,000 and ₹41,000. If total capital is fixed at ₹1,20,000, their required capitals are ₹80,000 and ₹40,000. They withdraw ₹2,000 and ₹1,000 respectively.

Debit Mohit’s Capital ₹2,000 and Sohan’s Capital ₹1,000; credit Cash ₹3,000. Their capital balances then match the agreed total and the new ratio. The starting balances for this calculation must already include the retirement adjustments.

What if total capital is not specified?

Worked example 7. Asha, Deepa and Lata share profits 3:2:1. Deepa retires. Asha’s and Lata’s adjusted capitals are ₹1,60,000 and ₹80,000. They agree to adjust capitals in their new ratio, with no other total capital specified.

Answer: Their new ratio is 3:1. Total capital is ₹1,60,000 + ₹80,000 = ₹2,40,000. Required capitals are ₹1,80,000 and ₹60,000. Asha introduces ₹20,000 and Lata withdraws ₹20,000. Debit Bank and credit Asha’s Capital ₹20,000; debit Lata’s Capital and credit Bank ₹20,000.

What if continuing partners finance the retirement payment?

Lalit, Pankaj and Rahul share profits 4:3:3. On Lalit’s retirement, adjusted capitals are ₹70,000, ₹60,000 and ₹50,000. Pankaj and Rahul agree to bring in Lalit’s ₹70,000 claim while equalising their capitals in their continuing ratio of 1:1.

Total capital becomes ₹60,000 + ₹50,000 + ₹70,000 = ₹1,80,000. Each requires ₹90,000. Pankaj brings ₹30,000 and Rahul ₹40,000. Debit Bank ₹70,000 and credit their capitals accordingly, then debit Lalit’s Capital and credit Bank ₹70,000 for payment.

How is a deceased partner’s claim transferred to the executor?

The adjustments for death of a partner resemble retirement adjustments. Determine the deceased partner’s share of goodwill, reserves, revaluation and intervening profit, together with other amounts due. Transfer the final capital balance to the Executor’s Account for settlement.

How is the final claim assembled?

Worked example 8. Anil, Bhanu and Chandu share profits 5:3:2. Anil dies on 1 October 2017. His capital on 31 March is ₹30,000 and the firm’s reserve is ₹6,000. Goodwill is 2½ years’ purchase of average profits of ₹13,000, ₹12,000, ₹20,000 and ₹15,000.

Patents change from ₹11,000 to ₹8,000, machinery from ₹30,000 to ₹28,000, and buildings from ₹20,000 to ₹25,000. Profit accrues at the previous annual rate of ₹15,000. Interest on capital is 10% per annum. Half the claim is payable immediately.

Answer: Average profit is ₹60,000 ÷ 4 = ₹15,000, so goodwill is ₹37,500 and Anil’s share is ₹18,750. Revaluation is ₹5,000 − ₹3,000 − ₹2,000 = nil. His reserve share is ₹3,000, six-month profit share ₹3,750, and interest ₹1,500. His total claim is ₹57,000.

The profit share is ₹15,000 × 6/12 × 5/10 = ₹3,750. Interest is ₹30,000 × 10/100 × 6/12 = ₹1,500. Bhanu and Chandu bear the goodwill adjustment in 3:2, through capital debits of ₹11,250 and ₹7,500.

How do the capital and executor accounts close?

Anil’s Capital Account has credits of opening capital ₹30,000, reserve ₹3,000, goodwill ₹18,750, Profit and Loss Suspense ₹3,750 and interest on capital ₹1,500. Debit it with ₹57,000 transferred to Anil’s Executor’s Account. Both sides total ₹57,000.

The unpaid ₹28,500 remains due to the executor. Crediting the Executor’s Account records the liability; debiting that account and crediting Bank records the actual payment. These entries should not be confused with the earlier calculation of Anil’s entitlement.

How is the balance sheet of the reconstituted firm completed?

Prepare the revised balance sheet after posting adjustments and settlement entries. Use revised asset values, adjusted liabilities, continuing partners’ final capitals and any unpaid retirement loan or executor’s balance. A capital transfer does not itself create or use cash.

How do the adjustments connect in a complete retirement?

Shyam, Gagan and Ram share profits 2:2:1. Their capitals are ₹80,000, ₹62,500 and ₹75,000; reserve is ₹14,500. Gagan retires, and Shyam and Ram adopt 5:3. Goodwill is valued at ₹70,000.

Machinery falls from ₹85,000 to ₹78,000; stock from ₹42,000 to ₹30,000. Buildings rise from ₹1,22,000 to ₹1,52,000. Bad debts of ₹1,550 are written off against debtors of ₹19,000. Cash ₹8,000, patents ₹9,000, creditors ₹49,000 and Employees’ Provident Fund ₹4,000 remain unchanged.

Revaluation profit is ₹30,000 − ₹7,000 − ₹12,000 − ₹1,550 = ₹9,450. Allocate ₹3,780, ₹3,780 and ₹1,890 to Shyam, Gagan and Ram. The reserve allocation is ₹5,800, ₹5,800 and ₹2,900.

Shyam gains 5/8 − 2/5 = 9/40; Ram gains 3/8 − 1/5 = 7/40. Gagan’s goodwill share is ₹70,000 × 2/5 = ₹28,000, borne by Shyam ₹15,750 and Ram ₹12,250 in the gaining ratio 9:7.

Gagan’s claim is ₹62,500 + ₹3,780 + ₹5,800 + ₹28,000 = ₹1,00,080, transferred to his loan because cash is insufficient. Shyam’s final capital is ₹80,000 + ₹3,780 + ₹5,800 − ₹15,750 = ₹73,830. Ram’s is ₹75,000 + ₹1,890 + ₹2,900 − ₹12,250 = ₹67,540.

What does the final statement show?

The reserve has been distributed and Gagan’s capital replaced by a loan. Goodwill compensation has passed through capital accounts, so no goodwill asset is created by that adjustment. Both sides balance at ₹2,94,450.

Glossary

• Reconstitution — A change in partnership arrangements under which remaining partners continue business on changed terms and conditions.
• New profit sharing ratio — The ratio in which continuing partners agree to share future profits after retirement or death.
• Gaining ratio — The proportions in which continuing partners acquire the outgoing partner’s share of profits.
• Gaining share — The increase calculated by subtracting a continuing partner’s old profit share from the new share.
• Goodwill adjustment — Compensation through capital accounts for the goodwill entitlement associated with a partner’s surrendered profit share.
• Hidden goodwill — The outgoing partner’s goodwill share revealed by settlement exceeding the claim after other necessary adjustments.
• Revaluation Account — An account used to ascertain profit or loss from revised asset and liability values and unrecorded items.
• Accumulated profits — Undistributed profits, including reserves, transferred to old partners’ capital accounts in their old profit sharing ratio.
• Accumulated losses — Earlier losses allocated to all old partners by debiting their capital accounts in the old ratio.
• Profit and Loss Suspense — The account debited when an outgoing partner’s estimated intervening profit share is credited to capital.
• Retiring partner’s loan — An unpaid retirement claim transferred from capital and carried as a liability until settlement.
• Executor’s Account — The account credited with a deceased partner’s final claim and debited for payments to the executor.

Common errors and misconceptions

• Misconception: The new ratio and gaining ratio mean the same thing. Correct: The new ratio allocates future total profit; the gaining ratio measures acquired shares.
• Misconception: Every continuing partner gains on retirement. Correct: A continuing partner can sacrifice if the agreed new share is smaller than the old share.
• Misconception: Existing goodwill is written off only against continuing partners. Correct: Debit all old partners, including the outgoing partner, in the old ratio.
• Misconception: Revaluation profit and reserves belong only to the remaining partners. Correct: Distribute them among all old partners in the old profit sharing ratio.
• Misconception: A retiring partner receives the whole goodwill valuation. Correct: The entitlement is that partner’s share of goodwill, with existing book goodwill adjusted separately.
• Misconception: An instalment including interest reduces principal by its full amount. Correct: Interest absorbs part of the payment; only the remainder reduces principal.
• Misconception: Transferring capital to a loan or Executor’s Account pays the claim. Correct: It records an unpaid liability; payment needs a separate cash or bank entry.
• Misconception: The opening capital balance is the final retirement claim. Correct: First adjust goodwill, reserves, revaluation, intervening profit and other applicable entitlements or deductions.

Exam-style questions with model answers

Q1. What is gaining ratio, and how is an individual partner’s gaining share calculated? [2 marks]

1. The gaining ratio expresses the proportions in which continuing partners acquire the retiring or deceased partner’s profit share.
2. Calculate each partner’s gaining share as new share minus old share, then express the positive gains as a ratio.

Q2. Alka, Harpreet and Shreya share profits 3:2:1. Alka retires, and Harpreet and Shreya acquire her share 3:2. Calculate their new profit sharing ratio and distinguish it from their gaining ratio. [3 marks]

1. Alka’s old share is 3/6. Harpreet acquires 3/5 × 3/6 = 9/30, while Shreya acquires 2/5 × 3/6 = 6/30.
2. Harpreet’s new share is 2/6 + 9/30 = 19/30. Shreya’s new share is 1/6 + 6/30 = 11/30.
3. The new profit sharing ratio is 19:11. The gaining ratio remains 3:2 because it describes the acquisition of Alka’s share, rather than the division of total future profit.

Q3. Deepa, Neeru and Shilpa share profits 5:3:2. Neeru retires; Deepa and Shilpa adopt 2:3. Goodwill is valued at ₹1,20,000 and is adjusted through capital accounts. Calculate the changes in shares and give the goodwill entry. [4 marks]

1. Deepa’s change is 2/5 − 5/10 = −1/10, so she sacrifices. Shilpa’s gain is 3/5 − 2/10 = 4/10.
2. Neeru’s goodwill share is ₹1,20,000 × 3/10 = ₹36,000. Deepa’s compensation is ₹1,20,000 × 1/10 = ₹12,000.
3. Debit Shilpa’s Capital A/c ₹48,000; credit Neeru’s Capital A/c ₹36,000 and Deepa’s Capital A/c ₹12,000. Shilpa compensates both partners because her gain includes Neeru’s outgoing share and Deepa’s sacrifice.

Q4. Mitali, Indu and Geeta share profits 5:3:2. Geeta retires. Machinery changes from ₹1,50,000 to ₹1,40,000, patents from ₹30,000 to ₹40,000, and buildings from ₹1,00,000 to ₹1,25,000. Give the revaluation entries and profit allocation. [5 marks]

1. Machinery decreases by ₹10,000. Debit Revaluation A/c ₹10,000 and credit Machinery A/c ₹10,000 to record this reduction.
2. Patents increase by ₹10,000 and buildings by ₹25,000. Debit Patents A/c ₹10,000 and Buildings A/c ₹25,000; credit Revaluation A/c ₹35,000.
3. Revaluation profit is ₹35,000 − ₹10,000 = ₹25,000. It belongs to all three old partners, including Geeta, in their old ratio of 5:3:2.
4. Debit Revaluation A/c ₹25,000; credit Mitali’s Capital ₹12,500, Indu’s Capital ₹7,500 and Geeta’s Capital ₹5,000. After transferring the profit, both sides of Revaluation Account total ₹35,000 and the account closes.

Q5. Mahinder’s retirement claim is ₹60,000, converted into a loan repayable in four equal yearly principal instalments plus interest at 12% per annum on unpaid principal. Payments occur at year end. Calculate all four payments and explain the loan entries. [5 marks]

1. Each principal instalment is ₹60,000 ÷ 4 = ₹15,000. The opening unpaid balances are ₹60,000, ₹45,000, ₹30,000 and ₹15,000.
2. Interest at 12% is respectively ₹7,200, ₹5,400, ₹3,600 and ₹1,800. Add each interest amount to ₹15,000 to obtain payments of ₹22,200, ₹20,400, ₹18,600 and ₹16,800.
3. Initially debit Mahinder’s Capital and credit Mahinder’s Loan ₹60,000. Each year debit Interest and credit Mahinder’s Loan for that year’s interest.
4. Debit Mahinder’s Loan and credit Bank for each payment. Closing balances are ₹45,000, ₹30,000, ₹15,000 and nil. The loan therefore closes after the fourth payment, and interest falls as the unpaid principal falls.

Q6. Anil, Bhanu and Chandu share profits 5:3:2. Anil dies on 1 October 2017. At 31 March his capital is ₹30,000 and firm reserve ₹6,000. Goodwill is 2½ times average annual profits of ₹13,000, ₹12,000, ₹20,000 and ₹15,000. Patents fall from ₹11,000 to ₹8,000, machinery from ₹30,000 to ₹28,000, and buildings rise from ₹20,000 to ₹25,000. Estimate intervening profit at the last annual profit of ₹15,000 and allow capital interest at 10% per annum. Calculate his claim and the executor’s unpaid balance if half is paid immediately. [6 marks]

1. Average profit is (₹13,000 + ₹12,000 + ₹20,000 + ₹15,000) ÷ 4 = ₹15,000. Goodwill is ₹15,000 × 2½ = ₹37,500, of which Anil receives 5/10, or ₹18,750.
2. Revaluation produces no net profit: buildings gain ₹5,000, offset by patents loss ₹3,000 and machinery loss ₹2,000. Anil’s reserve share is ₹6,000 × 5/10 = ₹3,000.
3. For six months, profit share is ₹15,000 × 6/12 × 5/10 = ₹3,750. Interest is ₹30,000 × 10/100 × 6/12 = ₹1,500.
4. Total claim is ₹30,000 + ₹18,750 + ₹3,000 + ₹3,750 + ₹1,500 = ₹57,000. Debit Anil’s Capital and credit his Executor’s Account ₹57,000. Pay ₹28,500 by debiting the Executor’s Account and crediting Bank; ₹28,500 remains payable.

Q7. Asha, Deepa and Lata share profits 3:2:1. Deepa retires with no change in the continuing partners’ relative profit shares. After all adjustments, Asha’s capital is ₹1,60,000 and Lata’s ₹80,000. Use their combined capital as total capital and adjust it to the new ratio. Give the cash entries. [4 marks]

1. The new ratio is 3:1. Combined adjusted capital is ₹1,60,000 + ₹80,000 = ₹2,40,000.
2. Asha requires ₹2,40,000 × 3/4 = ₹1,80,000; Lata requires ₹2,40,000 × 1/4 = ₹60,000.
3. Asha therefore brings in ₹20,000: debit Bank A/c and credit Asha’s Capital A/c ₹20,000. Lata withdraws ₹20,000: debit Lata’s Capital A/c and credit Bank A/c ₹20,000. The final capitals are proportional to their future profit shares.

Key takeaways

• Calculate the outgoing partner’s final entitlement after goodwill, reserves, revaluation, intervening profit and all other applicable adjustments.
• Use the new ratio for future profit sharing and the gaining ratio for compensation between partners.
• Write off existing goodwill against all old partners before adjusting the outgoing partner’s current goodwill entitlement.
• Allocate revaluation profit or loss and accumulated balances to all old partners in their old profit sharing ratio.
• Estimate intervening profit using the agreed time or sales basis and keep each alternative calculation separate.
• Read whether loan instalments include interest or require interest in addition to the principal repayment.
• Adjust continuing partners’ capitals after other retirement adjustments, using the agreed total capital and new profit sharing ratio.
• Transfer a deceased partner’s final capital claim to the Executor’s Account and record actual payment separately.

Test yourself

What ratio is assumed if no acquisition arrangement is specified?

The continuing partners acquire the outgoing share in their old relative profit sharing ratio.

What does a negative result for new share minus old share mean?

It means the continuing partner sacrifices part of the old profit share and may require goodwill compensation.

Which partners bear the write-off of existing goodwill?

All old partners, including the retiring or deceased partner, bear it in the old profit sharing ratio.

How is an unrecorded liability brought into the books?

Debit Revaluation Account and credit the relevant Liability Account for the amount recognised.

Why does the retiring partner receive a share of general reserve?

The reserve represents accumulated profits belonging to the old partners, so it is distributed in their old ratio.

Where is an unpaid retirement loan shown?

It remains on the liabilities side of the balance sheet until the outstanding amount is settled.

What is credited when estimated intervening profit is recognised for a deceased partner?

The deceased partner’s Capital Account is credited, with the corresponding debit to Profit and Loss Suspense.

Does transferring the deceased partner’s capital to the executor reduce bank?

No. Bank is reduced when payment is recorded by debiting the Executor’s Account and crediting Bank.