New ratio and gaining ratio
When a partner retires or dies, the continuing partners take his share. Gain = New share − Old share; the ratio of gains is the gaining ratio.
- If the new ratio is not given, continuing partners share in their old ratio, so the gaining ratio = their old ratio.
- If the retiring share is taken in an agreed way, add it to each continuing partner's old share.
Treatment of goodwill
The outgoing partner is paid for his share of goodwill by the gaining partners (AS 26: no goodwill account raised):
Gaining Partners' Capital A/cs Dr, To Retiring/Deceased Partner's Capital A/c.
If goodwill already appears in the books, first write it off among all partners in the old ratio. Hidden goodwill: if the amount agreed to be paid is more than his capital balance after all adjustments, the extra is his share of goodwill.
Revaluation and reserves
Assets and liabilities are revalued; profit or loss goes to all partners (including the one leaving) in the old ratio. Reserves and accumulated profits or losses are also shared among all partners in the old ratio. Special reserves (Workmen Compensation, Investment Fluctuation) are treated as in admission.
Settling the retiring partner: loan account
Amount due = Capital + share of goodwill + revaluation gain + reserves + his current account balance − drawings − his share of losses.
- Paid in full: Retiring Partner's Capital A/c Dr, To Bank.
- Not paid at once: Retiring Partner's Capital A/c Dr, To Retiring Partner's Loan A/c. It is paid in instalments with interest (6% p.a. if nothing is agreed, or he can choose a share of profit instead of interest for the unpaid period).
New capitals of continuing partners may be adjusted in the new ratio by bringing in or taking out cash.
Death of a partner: share of profit till death
A partner may die during the year. His heirs get his share of profit from the last balance sheet date to the date of death, found by:
- Time basis: last year's (or average) profit × months ÷ 12 × his share.
- Turnover (sales) basis: profit as % of last year's sales × sales up to death × his share.
Entry: Profit and Loss Suspense A/c Dr, To Deceased Partner's Capital A/c (or the gaining partners' capital accounts are debited in the gaining ratio).
Executor's account
The amount due to a deceased partner is moved to his Executor's (or Legal Representative's) Account: Deceased Partner's Capital A/c Dr, To Executor's A/c. Payments to the family are debited to it until it is closed. Any unpaid balance is shown as a liability in the balance sheet.
Key formulas and definitions
- Gain = New share − Old share
- Goodwill to outgoing partner = Firm's goodwill × his share, paid in gaining ratio
- Profit till death (time) = Base profit × months/12 × his share
- Profit till death (sales) = (Last profit ÷ last sales) × sales till death × his share
- Amount due = Capital + goodwill share + revaluation gain + reserves ± current A/c − drawings − losses
- Unpaid amount → Loan A/c (retirement) or Executor's A/c (death)
Worked examples
1. A, B, C share 3:2:1. C retires; A and B will share 3:2. Gaining ratio?
A: 3/5 − 3/6 = 18/30 − 15/30 = 3/30. B: 2/5 − 2/6 = 12/30 − 10/30 = 2/30. Gaining ratio 3:2.
2. Same firm, goodwill ₹60,000. Entry.
C's share = 10,000. A's Capital Dr 6,000, B's Capital Dr 4,000, To C's Capital 10,000.
3. X, Y, Z share 2:2:1. Y retires; X and Z take Y's share equally. New ratio and gaining ratio.
Y's 2/5 split 1/5 each. X = 3/5, Z = 2/5 → 3:2. Gains: X 1/5, Z 1/5 → 1:1.
4. C's capital ₹50,000, goodwill share ₹10,000, revaluation gain share ₹2,000, reserve share ₹5,000, drawings ₹7,000. Firm pays ₹20,000 cash. Find loan.
Due = 50,000 + 10,000 + 2,000 + 5,000 − 7,000 = 60,000. Loan = 60,000 − 20,000 = ₹40,000.
5. D dies on 31 July. Last year's profit ₹1,20,000; his share 1/4; year starts 1 April. Profit till death (time basis).
4 months: 1,20,000 × 4/12 × 1/4 = ₹10,000.
6. Last year: sales ₹10,00,000, profit ₹1,50,000. Sales from 1 April to death ₹4,00,000. Deceased's share 1/3. Profit till death (sales basis).
Rate 15%. 4,00,000 × 15% = 60,000 × 1/3 = ₹20,000.
7. Retiring partner's loan ₹90,000 is paid in 3 equal yearly instalments plus 10% interest on the balance. First year payment?
Instalment 30,000 + interest 9,000 = ₹39,000.
Common mistakes
- Paying goodwill in the old ratio instead of the gaining ratio.
- Leaving the retiring partner out of the revaluation and reserve sharing; he shares in the old ratio.
- Taking the full year's profit for a partner who died mid-year.
- Showing the executor's balance as capital instead of a liability.