Lesson
Learn what happens in accounts when a partner leaves the firm or passes away.
Understand new profit sharing ratio, gaining ratio, goodwill, revaluation, old reserves, and final settlement of the outgoing partner.
Concept explanation
Retirement of a Partner means one partner leaves the partnership firm, while the remaining partners continue the business.
If a partner does not want to continue in the business, that partner may retire.
Example: Riya, Amit, and Neha run a stationery shop. Amit decides to leave the firm. Riya and Neha continue the business.
Simple line: Retirement means one partner leaves and the business continues.
If a partner dies, that partner's relationship with the firm ends.
The remaining partners may continue the business.
The deceased partner's share of capital, profit, goodwill, and other dues is calculated.
The amount due is transferred to the deceased partner's executor or legal representative.
Example: Riya, Amit, and Neha are partners. Amit passes away. Amit's share is calculated and transferred to Amit's Executor A/c.
Simple line: In case of death, the amount due is paid to the deceased partner's executor or legal representative.
Riya, Amit, and Neha run a mobile accessories shop.
Their profit sharing ratio is Riya : Amit : Neha = 2 : 2 : 1.
Amit wants to retire because he wants to start another business.
Before Amit leaves, the firm must calculate Amit's capital balance, goodwill share, revaluation share, old reserve share, and profit up to the retirement date.
After Amit leaves, Riya and Neha continue the business.
Now Riya and Neha need a new profit sharing ratio.
This is why retirement accounting is needed.
Old profit sharing ratio changes.
Remaining partners get a larger share of future profit.
Gaining ratio is calculated.
Goodwill is adjusted.
Assets and liabilities may be revalued.
Old reserves, profits, and losses are distributed.
Amount due to the outgoing partner is calculated.
The outgoing partner may be paid immediately or later.
In case of death, the amount is transferred to executor.
Simple line: Retirement or death accounting makes sure the outgoing partner gets the correct amount.
After one partner leaves, the remaining partners share future profits in a new ratio.
Example: Riya, Amit, and Neha share profit in 2:2:1.
Amit retires.
Riya and Neha agree to share future profit equally.
New ratio is Riya : Neha = 1:1.
Simple line: New ratio is used for future profit after the partner leaves.
Rule: Gain = New Share - Old Share
When one partner leaves, the remaining partners usually gain that partner's share.
Gaining Ratio shows how much extra share each remaining partner gets.
Old ratio is Riya : Amit : Neha = 2:2:1.
So Riya = 2/5, Amit = 2/5, and Neha = 1/5.
Amit retires and the new ratio between Riya and Neha is 1:1.
So Riya = 1/2 and Neha = 1/2.
Riya's gain = 1/2 - 2/5 = 1/10.
Neha's gain = 1/2 - 1/5 = 3/10.
Gaining ratio is Riya : Neha = 1 : 3.
Simple line: Gaining ratio shows who gains how much after a partner leaves.
When a partner retires or dies, that partner should get compensation for their share in the firm's goodwill.
Why? Because the firm's reputation was built while that partner was also part of the business.
Example: goodwill of firm is Rs.50,000 and Amit's old share is 2/5.
Amit's share of goodwill = Rs.50,000 x 2/5 = Rs.20,000.
This amount is compensated by the gaining partners in their gaining ratio.
Simple line: Outgoing partner gets their share of goodwill.
Before the partner leaves, the firm may update the value of assets and liabilities.
Example: furniture is recorded at Rs.20,000, but actual value is Rs.25,000.
Increase in value is Rs.5,000.
This profit belongs to all old partners, including the retiring partner.
Another example: a liability increases by Rs.3,000. This loss also belongs to old partners.
Revaluation profit or loss is shared by old partners in the old profit sharing ratio.
Simple line: Revaluation profit or loss belongs to old partners.
The firm may have old profits or losses not yet distributed.
Examples are General Reserve, Profit and Loss balance, Advertisement Suspense, and accumulated loss.
These belong to old partners because they were created before retirement or death.
So they are distributed among old partners in the old ratio.
Simple line: Old profits and losses belong to old partners.
The outgoing partner's amount is calculated carefully before final settlement.
Add capital balance, share of goodwill, share of revaluation profit, share of old reserves or profits, share of profit till retirement or death date, and salary or interest due if applicable.
Less drawings, interest on drawings, share of revaluation loss, share of accumulated losses, and any amount owed by partner to firm.
Simple line: Amount due = what partner should receive minus what partner owes.
After calculating the amount due, the firm may pay the partner immediately.
If paid immediately, the entry idea is: Amit's Capital A/c Dr. Rs.80,000, To Bank A/c Rs.80,000.
If not paid immediately, the amount may be transferred to Amit's Loan A/c.
Example: Amit's Capital A/c Dr. Rs.80,000, To Amit's Loan A/c Rs.80,000.
Simple line: If the firm cannot pay now, the amount becomes loan payable to the retiring partner.
In case of death, amount due is not paid to the partner directly.
It is transferred to the deceased partner's executor or legal representative.
Example: amount due to Amit after death is Rs.90,000.
Entry idea: Amit's Capital A/c Dr. Rs.90,000, To Amit's Executor A/c Rs.90,000.
If paid later, the entry idea is: Amit's Executor A/c Dr., To Bank A/c.
Simple line: Executor's Account is used for amount payable after a partner's death.
A partner may retire or die during the year, before final profit is known.
The outgoing partner may still be entitled to profit up to the date of retirement or death.
This profit may be estimated using past profit or sales basis, depending on the question.
Simple line: The outgoing partner should get profit earned while they were still a partner.
Settlement guide
| Item | Simple meaning | Who is affected |
|---|---|---|
| New Ratio | Future profit sharing among remaining partners | Remaining partners |
| Gaining Ratio | Extra share gained by remaining partners | Remaining partners |
| Goodwill | Compensation for reputation built earlier | Outgoing partner and gaining partners |
| Revaluation | Update assets and liabilities before settlement | All old partners |
| Old Reserves | Past profits or losses | All old partners in old ratio |
| Final Amount | Amount payable to retiring partner or executor | Outgoing partner or legal representative |
The goal is fairness between the outgoing partner and the remaining partners.
Visual flow
Partner retires or dies
Calculate new profit sharing ratio
Calculate gaining ratio
Adjust goodwill
Revalue assets and liabilities
Distribute old profits or losses
Calculate outgoing partner's capital balance
Pay or transfer to loan or executor account
Remaining partners continue business
Solved examples
Example 1
New ratio: Riya : Neha = 1:1
Amit is no longer part of future profits.
Riya and Neha will share future profits equally.
Example 2
Riya's gain = 1/2 - 2/5 = 1/10 Neha's gain = 1/2 - 1/5 = 3/10 Gaining Ratio = 1:3
Gain means new share minus old share.
Neha gains more, so the gaining ratio is 1:3.
Example 3
Amit's share of goodwill = Rs.50,000 x 2/5 Amit's share of goodwill = Rs.20,000
Amit helped build the firm's reputation.
So Amit receives his share of goodwill.
Example 4
Amit's share = Rs.15,000 x 2/5 Amit's share = Rs.6,000
The gain happened before retirement.
So it belongs to all old partners in old ratio.
Example 5
Amit's share = Rs.25,000 x 2/5 Amit's share = Rs.10,000
General Reserve is an old profit.
Old profits are shared by old partners in old ratio.
Example 6
Bank paid immediately Rs.30,000 Balance transferred to Amit's Loan A/c Rs.50,000 Simple idea: loan payable to Amit Rs.50,000
The unpaid amount is still payable to Amit.
So it becomes a loan liability of the firm.
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After learning retirement or death of a partner, learn what happens when the partnership firm itself is closed.
Continue to Dissolution of Partnership Firm