Class 12 Accountancy Chapter 3: Reconstitution of a Partnership Firm – Retirement/Death of a Partner

When a partner retires or dies, the existing partnership arrangement changes, requiring adjustments to the partners’ capital accounts and the firm’s financial records. Questions from this chapter often involve the gaining ratio, goodwill, revaluation profit or loss, reserves and the calculation of the outgoing partner’s final dues. Incorrect ratios or journal entries can affect the entire solution.

For focused revision, Physics Wallah’s Class 12 Accountancy notes on Retirement or Death of a Partner help you revisit the accounting principles, formulas and journal entries involved. Study each adjustment separately and practise combining them to calculate the final amount payable to the retiring partner or the deceased partner’s legal representative.

Reconstitution of a Partnership Firm

Reconstitution of a partnership firm occurs when a change in the relationship among partners alters the existing partnership agreement. A partner's retirement or death changes the firm's constitution, while the continuing partners may carry on the business under a new agreement.

The main accounting adjustments include:

• Calculation of the new profit-sharing ratio and gaining ratio.

• Adjustment of goodwill.

• Revaluation of assets and liabilities.

• Distribution of accumulated profits, reserves and losses.

• Calculation and settlement of the outgoing partner’s dues.

• Calculation of profit up to the date of death, where applicable.

New Profit-Sharing Ratio and Gaining Ratio

New Profit-Sharing Ratio

The new profit-sharing ratio determines how the continuing partners share future profits after a partner's retirement or death.

When a partner leaves the firm, the continuing partners may acquire the outgoing partner’s share in an agreed proportion.

New Share = Old Share + Share Gained

This relationship applies when the continuing partners acquire additional shares without sacrificing any part of their existing shares.

Example:

A and B share profits in the ratio of 3:2. B retires, and A becomes entitled to the entire profit share.

A’s old share = 3/5

B’s share acquired by A = 2/5

A’s new share = 3/5 + 2/5 = 1

Therefore, A receives the entire share of profits after B’s retirement.

Gaining Ratio

The gaining ratio is the ratio in which continuing partners acquire the outgoing partner’s share of profits.

Gaining Ratio = New Share − Old Share

Calculate the gain for each continuing partner and express the positive gains as a ratio.

Example:

A and B share profits equally. They decide that after C retires, A and B will share future profits in the ratio of 3:2.

A’s gain = 3/5 − 1/2 = 1/10

B’s gain = 2/5 − 1/2 = −1/10

Here, A gains 1/10 while B sacrifices 1/10. Since B is not a continuing partner who gains a share in this example, the arrangement would need to be interpreted according to the actual partners involved. For a standard gaining-ratio calculation, calculate only the gains made by the continuing partners acquiring the outgoing partner’s share.

Revision point: Always identify the old and new shares before calculating the gaining ratio. Do not confuse the gaining ratio with the sacrificing ratio used in the admission of a partner.

Goodwill Treatment on Retirement or Death

Goodwill represents the reputation and other advantages that help a firm earn profits. When a partner retires or dies, the outgoing partner is entitled to their share of goodwill, subject to the partnership agreement and the applicable accounting treatment.

The continuing partners compensate the outgoing partner in their gaining ratio.

Outgoing Partner’s Share of Goodwill = Total Goodwill × Outgoing Partner’s Old Share

Goodwill Adjustment Through Capital Accounts

When goodwill is not already recorded in the books, the adjustment is generally made through the partners’ capital accounts.

Journal Entry:

Continuing Partners’ Capital A/c Dr.

    To Retiring or Deceased Partner’s Capital A/c

(Being the outgoing partner’s share of goodwill adjusted in the gaining ratio.)

The continuing partners’ capital accounts are debited in the gaining ratio, while the retiring or deceased partner’s capital account is credited with the appropriate share.

Important: If goodwill already appears in the books, its existing balance must be considered before adjusting. Follow the treatment specified in the question.

Revaluation of Assets and Liabilities

At the time of retirement or death, the firm reassesses the values of its assets and liabilities. A Revaluation Account records the changes and determines the resulting profit or loss.

Treatment of Revaluation Adjustments

• Increase in the value of an asset: Credit the Revaluation Account.

• Decrease in the value of an asset: Debit the Revaluation Account.

• Increase in a liability: Debit the Revaluation Account.

• Decrease in a liability: Credit the Revaluation Account.

• Unrecorded assets and liabilities: Record them using the appropriate accounting treatment.

Transfer of Revaluation Profit or Loss

The profit or loss on revaluation is transferred to all partners’ capital accounts in their old profit-sharing ratio, including the retiring or deceased partner.

Journal Entry for Revaluation Profit:

Revaluation A/c Dr.

    To Partners’ Capital A/cs

Journal Entry for Revaluation Loss:

Partners’ Capital A/cs Dr.

    To Revaluation A/c

The partners’ capital accounts are affected according to their respective shares in the old profit-sharing ratio.

Revision point: The old ratio applies because revaluation adjustments relate to the partnership arrangement that existed before retirement or death.

Accumulated Profits, Reserves and Losses

Accumulated profits and reserves are distributed among the partners according to their old profit-sharing ratio. Accumulated losses are similarly adjusted before the outgoing partner’s account is settled.

Treatment of Accumulated Profits and Reserves

Examples include general reserves and undistributed profits.

Journal Entry:

Reserve A/c Dr.

    To Partners’ Capital A/cs

The partners’ capital accounts are credited in the old profit-sharing ratio.

Treatment of Accumulated Losses

Accumulated losses are transferred to the partners’ capital accounts in their old profit-sharing ratio.

Journal Entry:

Partners’ Capital A/cs Dr.

    To Accumulated Loss A/c

Revision point: Distribute accumulated profits and losses in the old ratio, not the new ratio.

Settlement of a Retiring Partner’s Account

The amount payable to a retiring partner is calculated after recording all applicable adjustments in their capital account.

The calculation may include:

• Opening capital balance.

• Share of goodwill.

• Share of revaluation profit or loss.

• Share of accumulated profits and reserves.

• Interest on capital, salary or commission, where applicable.

• Share of profit up to retirement, where applicable.

Deduct drawings, interest on drawings, the partner’s share of losses and other amounts payable to the firm.

The final balance may be paid immediately or transferred to the retiring partner’s loan account if the amount remains unpaid.

Journal Entry for Transfer to Loan Account:

Retiring Partner’s Capital A/c Dr.

    To Retiring Partner’s Loan A/c

(Being the unpaid balance due to the retiring partner transferred to their loan account.)

Settlement of a Deceased Partner’s Account

When a partner dies, their capital account is adjusted for all applicable items up to the date of death. The final amount due is transferred to the deceased partner’s executor’s account or the account of their legal representative.

The calculation may include:

• Capital balance.

• Share of goodwill.

• Share of revaluation profit or loss.

• Share of accumulated profits and reserves.

• Interest on capital, salary or commission, where applicable.

• Share of profit up to the date of death.

Drawings, interest on drawings and the deceased partner’s share of losses are deducted where applicable.

Transfer of the Amount Due

Journal Entry:

Deceased Partner’s Capital A/c Dr.

    To Deceased Partner’s Executor’s A/c

(Being the amount due to the deceased partner transferred to the executor’s account.)

The executor’s account is subsequently settled according to the payment arrangements.

Calculation of Profit up to the Date of Death

When a partner dies before the end of the accounting year, their share of profit for the period from the beginning of the financial year to the date of death may be calculated and credited to their capital account.

The estimate may be based on previous-year profit, average profit or sales, depending on the information given in the question.

Time Basis Method

When profit is assumed to accrue evenly throughout the year:

Estimated Profit for the Period = Annual Profit × Period Elapsed / 12 Months

The deceased partner’s share is then calculated using the applicable profit-sharing ratio.

Example:

A firm estimates its annual profit at ₹1,20,000. A partner with a 1/4 share dies three months into the financial year.

Estimated profit for three months:

= ₹1,20,000 × 3/12

= ₹30,000

Deceased partner’s share:

= ₹30,000 × 1/4

= ₹7,500

Therefore, ₹7,500 is credited to the deceased partner’s capital account, subject to the assumptions specified in the question.

Sales or Turnover Basis Method

When sales or turnover figures are provided, the estimated profit can be calculated using the applicable profit rate.

Estimated Profit = Estimated Sales × Applicable Profit Rate

The deceased partner’s share is then calculated by multiplying the estimated profit by their applicable profit-sharing fraction.

Use the profit rate and turnover figures specified in the question rather than assuming an unsupported rate.

Profit and Loss Suspense Account

When the deceased partner’s share of profit is estimated before the final profit is determined, the Profit and Loss Suspense Account may be used.

Journal Entry for Estimated Profit:

Profit and Loss Suspense A/c Dr.

    To Deceased Partner’s Capital A/c

(Being the deceased partner’s share of estimated profit credited up to the date of death.)

If the adjustment relates to a loss, the entry is reversed as appropriate.

Key Formulas and Accounting Rules

The following key formulas and accounting rules will help students understand the important adjustments involved in the retirement or death of a partner.

Important Points for Revision

• Identify the old and new profit-sharing ratios before calculating the gaining ratio.

• Adjust goodwill in favour of the retiring or deceased partner.

• Transfer revaluation profit or loss to all partners in the old ratio.

• Distribute accumulated profits, reserves and losses in the old ratio.

• Include profit up to the date of death when applicable.

• Deduct drawings and other amounts due from the outgoing partner.

• Transfer the final unpaid balance to the appropriate loan or executor account.

The Retirement or Death of a Partner Class 12 Accountancy Notes by PW cover essential concepts, including the gaining ratio, goodwill adjustment, revaluation of assets and liabilities, accumulated profits and reserves, and settlement of the outgoing partner’s dues. PW also offers Class 12 Accountancy batches to support your preparation. Revise the key formulas, journal entries and accounting treatments to strengthen your conceptual understanding and improve accuracy when solving numerical and application-based questions.

Revise the key formulas, journal entries and accounting treatments to strengthen your conceptual understanding and improve accuracy when solving Class 12 Accountancy numerical and application-based questions.