Retirement or Death of a partner

Retirement of a partner means retiring from the firm. i.e. ceasing to be partner of the firm. Retirement or death of a partner also leads to reconstitution of a partnership firm. On the retirement or death of a partner, the existing partnership deed comes to an end, and in its place, a new partnership deed needs to be framed.

Adjustment required on retirement of a partner

Change in profit sharing ratio. Determine new profit-sharing ratio and gaining ratio.
Accounting treatment of goodwill
Revaluation of assets and reassessment of liabilities
Reserves and accumulated profit or losses.
Computation of retiring partner’s interest and payment to the retiring partner
Adjustment of capitals if agreed by the partners

New profit-Sharing Ratio

It is the ratio in which the continuing or remaining partners decide to share future profits & losses. As a result of retirement of a partner, remaining partners gain a part of retiring partner’s share of profit.

New Share of a partner = Old Share + Acquired Share

Two Cases

Case 1 – New Profit-sharing ratio is not given. We presumed that the remaining partners will share profit and losses in their old ratio. This means PSR between continuing partners will remain same.
Case 2 – When the remaining partners acquire share of the retiring partner in specific ratio. The acquired share is added to their existing shares.

Case 1: When One Partner Retires and New Profit–Sharing Ratio among the Remaining Partners is Not Given

Illustration (New Profit-sharing Ratio of Remaining Partners)

A, B and C were partners, sharing profits in the ratio of 1/2, 2/5 and 1/10. Find the new ratio of the remaining partners if: (a) A retires, (b) B retires and (c) C retires.
X, Y and Z are partners sharing profits in the ratio of 5/10: 4/10: 1/10. Find out the new ratio of the remaining partners if: (a) X retires, (b) Y retires and (c) Z retires.

Solution

Step 1: Find out the ratio in simple figures by taking L.C.M. The ratio 1/2: 2/5: 1/10 can be restated as 5: 4: 1 (taking 10 as L.C.M.).

Step 2: Now calculate the new ratio of the remaining partners by striking out the share of the outgoing partner.

(a) If A retires, then ratio between B and C is 4: 1, i.e., 4/5: 1/5

(b) If B retires, then ratio between A and C is 5: 1, i.e., 5/6: 1/6

(ii) Profit-sharing ratio between X, Y and Z is 5: 4: 1

(a) If X retires, then ratio between Y and Z is 4: 1, i.e., 4/5: 1/5

(b) If Y retires, then ratio between X and Z is 5: 1, i.e., 5/6: 1/6

Note: Unless otherwise agreed, retiring partner’s share of profits is acquired by the remaining partners in their old profit-sharing ratio. It means that the profit-sharing ratio between the continuing partners will remain the same.

Case 2: When the Remaining Partners Acquire Share of the Retiring Partner in a Specified Ratio

Illustration (Remaining Partners take a Specific Share of the Retiring Partner)

A, B and C are sharing profits and losses in the ratio of 5: 3: 2. B retires. His share is taken by A and C in the ratio of 2: 1. Calculate the new profit-sharing ratio.

Solution: Calculation of New Profit-sharing Ratio. Since B was taking 3/10 share in the profits, on his retirement his share will be distributed between A and C in the ratio of 2: 1.

Thus: Share taken by A out of B’s share 3/10×2/3=2/10

A’s new share = Old share + Gain 5/10+2/10=7/10

Share taken by C out of B’s share 3/10×1/3=1/10

C’s new share = Old share + Gain 2/10+1/10=3/10

New Profit-Sharing Ratio 7/10:3/10=7:3

Illustration (Share of the Retiring Partner is Taken by Only One Partner)

A, B and C are partners sharing profits in the ratio of 2: 2: 1. B retires and his share is taken by C. Calculate the new profit-sharing ratio of A and C.

Solution: Calculation of New Profit-sharing Ratio

Share taken by C from B’s share

B’s share = 2/5

Since C alone takes B’s entire share: Share taken by C=2/5

C’s New Share = Old Share + Share Taken from B

Old share of C = 1/5

C’s New Share=1/5+2/5=3/5

A’s New Share

A’s share remains unchanged:

A’s New Share=2/5

New Ratio of A and C

2/5:3/5=2:3

Gaining Ratio

Ratio in which the continuing partners acquire the share from outgoing partners.

Formula

Gaining Ratio = New Ratio - Old Ratio
Admission of Partner – Sacrificing Ratio
Retirement/Death of Partner – Gaining Ratio

Why is Gaining Ratio important?

Gaining Ratio is necessary for adjusting the retiring partner’s share of goodwill. The remaining partners will compensate the outgoing partner by payment of goodwill in their Gaining Ratio.

Cases

Case 1 – When No Agreement Exists - It is assumed that the remaining partners, after the retirement of a partner, shall continue to share profits in the old ratio.
Case 2 – When New Profit-Sharing Ratio is Given - Gaining Ratio = New Ratio - Old Ratio

Illustration (New Profit-sharing Ratio and Gaining Ratio)

(i) A, B and C were partners sharing profits in the ratio of 3: 2: 1. Find out the gaining ratio when:

(a) A retires

(b) B retires

Solution

(i) Since the new profit-sharing ratio of the remaining partners is not given, the gain to the remaining partners must be in their old ratio.

(a) When A retires - Gain to B and C is in 2: 1 ratio.

(b) When B retires - Gain to A and C is in 3: 1 ratio.

(ii) X, Y and Z share profits in the ratio 1/2, 1/3 and 1/6, i.e., 3: 2: 1. Z dies. New profit-sharing ratio of X and Y is not given. Thus, gain will be in the ratio 3: 2. So, the new profit-sharing ratio of X and Y will be 3: 2.

Illustration (Gaining Ratio)

A, B and C are partners sharing profits and losses in the ratio of 1/2, 3/10 and 1/5. B retires from the firm, and A and C decide to share future profits and losses in the ratio of 3 : 2. Calculate the gaining ratio.

Solution

(i) Their New Shares

Partner New Share

A 3/5

C 2/5

(ii) Their Old Shares

Partner Old Share

A 1/2

C 1/5

(iii) Gain of a Partner (New Share – Old Share)

A’s Gain 3/5-1/2=1/10

C’s Gain 2/5-1/5=2/10

(iv) Gaining Ratio of A and C

1/10:2/10=1:2

Fintaxman

Retirement or Death of a partner