Partnership Account -: Retirement of a Partner

Retirement of a Partner -:

According to Section 32(1) of the Indian Partnership Act, a partner may retire:

(a)    with the consent of all the partners;

(b)   in accordance with an express agreement by the partners;

(c)    where the partnership is at will, by giving notice in writing to all the other partners of his intention to retire.

A partner may retire from the partnership firm because of old age, illness, etc. But the partnership firm may not come to an end by one of the partner’s retire, other partners may continue to run the business of the firm. Readjustment take place in case of retirement of a partner likewise the case of admission of a partner.

Gaining Ratio -:

On retirement of a partner, the continuing partners will gain in terms of profit sharing ratio.Example -: Vivek, Karan and Virat were sharing profit & lo0sses in the ratio of 5:4:6 and virat retires, than vivek & karan have to decide at which ratio they will share profit and losses in future at the ratio of 3:2.

                  Vivek gains -:  3/5 –  5/15  =  4/15

                  Karan gains -: 2/5  -  4/15 =  2/15

            So gaining ratio between Vivek & Karan is 4:2.

If vivek & Karan decide to continue at the ratio of 5:4 this indicates that they are dividing the gained share in the previous profit sharing ratio.

Revalue Assets & Liabilities on Retirement of a Partner -:

When a  partner retire, it is require to revalue assets and liabilities as it is at admission of partner. If there is profit then such profit should be distributed amongst the existing partner including the retiring partner at the exiting profit sharing ratio. If there is loss then such loss should be distributed amongst the existing partner including the retiring partner at the exiting profit sharing ratio.

                                                       Profit or loss on revaluation of assets & liabilities, a Revaluation A/c or Profit and Loss Adjustment  A/c is open and this A/c  is closed automatically by transfer of profit and loss  balance to the partner’s capital a/c.

            When decided that revalued amounts of assets & liabilities will not appear in the balance sheet of the continuing partners then a journal entry should be passed with the amount payable or chargeable to the retiring partners which the continuing partners will share at the ratio of gain.

1.       For Profit on Revaluation –:

                 Revaluation  a/c Dr

                    To Partners capital A/c

2.       For loss on Revaluation-:

                     Partner’s Capital A/c Dr.

                       To Revaluation A/c

Reserve -:

1.       On the retirement of a partner, any undistributed profit or reserve standing at the balance sheet is to be credited to the partners capital A/c  in the exiting profit sharing ratio.

               Reserve a/c Dr

                  To Partners capital A/c

2.       Alternatively, only the retiring partner share may be transferred to his capital a/c if the others continue at the same profit sharing ratio.

               Reserve a/c Dr

                  To Retiring Partner capital A/c

3.   Alternative, if the continuing partners want to show reserve in the balance sheet.

               Continue partner’s capital a/c Dr

                  To Retiring Partner capital A/c

Final Payment to a Retiring Partner -:

1.       Transfer of reserve 
2.       Transfer of goodwill 
3.       Transfer of profit and loss on revaluation

After adjustment of the above mentioned item, the capital A/c balance standing to the credit of the retiring partner represents amount to be paid to him.

• When continuing partners my discharge the whole claim at the time of retirement.

         Retiring Partners Capital A/c  Dr. 
                 To Bank A/c

• When retiring partner agree to retain some portion of his claim in the partnership as loan

            Retiring Partners Capital A/c  Dr
                To Retiring Partner Loan A/c                             

To Bank A/c

Paying a Partner’s Loan in Installment -:

In this the loan amount should be divide into equal parts. The interest for the period should be calculated and the payment should consist of the installment on account of the loan +interest for the period.

Payment of Retiring Partners Interest -:

The amount due to the retiring partner can be paid as per the terms of the partnership agreement. In case the terms of the agreement are silent, the payment may be made as mutually agreed. The payment can be made by any of the following methods:

(i)     Lump Sum Payment Method: If the firm has adequate funds, the amount due to the retired partner may be paid forthwith. His Capital Account will be debited and Bank will be credited.

(j)     Installment Payment Method: In order to avoid financial difficulties, a part or full payment due to the retired partner, may be deferred, In this case, the balance of his Capital Account will be transferred to his Loan Account which will be credited periodically with interest at the agreed rate on the outstanding balance and debited with payment on account until the balance is extinguished. The arrangement of installments may take the following two forms.

a.       Decreasing Payment Method: In this method, the total amount due is divided in a number of equal installments and the installment amount plus interest on the outstanding balance is paid out.

b.      Equal Payment Method: In this method, the total amount to be paid is divided in a number of equal installments in such a way that the amount after including interest on the outstanding balance is always equal.

Partnership Account -: Death of a Partner

All the problems which arise on the retirement of a partner also arise in case of the death of a partner. But there are some additional Point in death of a Partner -:

1.      If the balance of deceased partner’s capital account is not immediately paid in cash, the amount should be transferred to the deceased partner’s Executors Account and not to any Loan Account.

2.      Partnership deed may provide that in case of death of a partner during the accounting year, the deceased partner’s capital account will be credited with his share of profits for the period for which he remained alive during the year on the basis of profits of the year preceding the year in which death takes place.

Joint Life Policy -:

Partners often take out a joint life policy to provide funds for settling the claim of the deceased partner. Annual premium is paid by the firm and on the death of a Partner, the amount of the policy is received by the firm from the insurance company. It is possible to treat a joint life policy in anyone of the following three ways in the books of account.

1. When premium paid is treated as an expense -:

Under this method, the annual premium is treated as an expense and debited to the Profit and Loss Account. On the death of a partner, the amount of the policy received by the firm is credited to all the partners’ capital accounts in the profit sharing ratio.                             

            (i) For payment of premium of the joint life policy -:

                   

            (a) Joint Life Insurance Premium A/c Dr.

                      To Bank A/c

                  

            (b) Profit and Loss A/c Dr.

                   To Joint Life Insurance Premium A/c.

         (The amount of premium charged to Profit and Loss A/c)

          (ii) For Receipt of the Policy Money -:

               Bank A/c Dr.

                  To All Partners’ Capital Accounts

   (The policy money distributed among all partners in the profit sharing ratio)

2. When premium paid is treated as an asset and surrender value is taken into account -:

                    Under this method, Joint Life Policy Account is debited with the amount of premium as and when paid. At the end of the year, the amount in excess of surrender value is treated as loss and transferred to Profit and Loss Account. The balance in Joint Life Policy Account is shown as an asset in the balance sheet. The amount received on maturity of policy in excess of surrender value will be net gain and divided among all the partners in their profit sharing ratio.

                               

           (i) Joint Life Policy A/c Dr.

                   To Bank

           (The premium paid on policy)

         (ii) Profit and Loss A/c Dr.

               To Joint Life Policy A/c

(The adjustment of book value with the surrender value i.e. excess of joint life policy over the surrender value)

                    

          (iii) Bank Dr.

                To Joint Life Policy A/c

     (Amount received on maturity of policy)

                 

         (iv) Joint Life Policy A/c Dr.

               To All Partners’ Capital Accounts

(The amount received minus the surrender value on that date distributed among the partners.)

3. When premium paid is treated as an asset and life policy reserve account is maintained-:

                         Under this method, whenever premium is paid, the amount of the premium is debited to Joint Life Policy Account. At the end of the year, Profit and Loss account is debited and Joint Life Policy Reserve Account is credited with the amount of the premium paid for the year. Then, in order to reduce the balances of Joint Life Policy Account and Joint Life Policy Reserve Account to the figure of surrender value of the policy, Joint Life Policy Reserve Account is debited and Joint Life Policy Account is credited with the difference between balance of Joint Life Policy Account and surrender value of the policy. The entries are repeated every year. On maturity of the policy, the amount received from the insurance company is credited to Joint Life Policy Account, Joint Life Policy Reserve Account is transferred to Joint Life Policy Account and the balance in Joint Life Policy Account is transferred to all the partners’ capital accounts in their profit sharing ratio. The amount standing to the credit of Joint Life Policy Reserve Account may alternatively be transferred directly to partners’ capital accounts in their profit sharing ratio.

                 (i) For payment of premium of the Joint Life Policy -:

               Joint Life Policy A/c Dr.

                   To Bank

      (The amount of premium paid on Joint Life Policy)

                (ii) For appropriation of amount equal to annual premium -:

                          Profit and Loss A/c Dr.

                              To Joint Life Policy Reserve A/c

                        (The amount transferred to Joint Life Policy Reserve Account)

(iii) For adjusting the difference between the premium paid and the increase in the surrender value -:

                         Joint Life Policy Reserve A/c Dr.

                               To Joint Life Policy A/c

                           (Excess of premium over surrender value adjusted)

               (iv) For receipt of the policy money -:

                            (a) Bank Dr.

                                     To Joint Life Policy A/c

                               (The amount received of joint life policy on maturity)

                           

                            (b) Joint Life Policy Reserve A/c Dr.

                                        To Joint Life Policy A/c

             (The credit balance of joint life policy reserve account transferred to Joint Life Policy A/c)

                     

                           (c) Joint Life Policy A/c Dr.

                                    To All Partners’ Capital Accounts

                                 (Balance joint life policy transferred to capital a/c)

4. Individual policies on the life of each partner -:

If instead of one joint life policy, a number of individual policies are taken, on the death of a partner, the amount of the policy of the life of the deceased partner will be received in cash. The other policies will be shown at their respective surrender values while ascertaining the amount due to the executors of the deceased partner.

Repayment of the Amount due to Deceased Partner -:

On death of a partner, the amount due to his legal representatives will have to be paid. It may not be possible to pay the whole amount in a lump sum. As a rule, the payment is made according to the terms of partnership agreement. The various courses available are –

• Repayment in installments over a period of time and interest being paid on outstanding balances.
• The amount due may be treated as a loan to the firm. The firm may pay interest at an agreed rate or a share of profit of the firm.
• An annuity may be paid to the heirs of deceased partner.

Dissolution of Partnership -:

Dissolution of a firm means that the business of the firm is put to an end, assets are disposed of, liabilities are paid off, and the accounts of all the partners are also settled. Dissolution of a firm differs from dissolution of a partnership. A partnership is dissolved on the expiry of the term or on the completion of the specified venture, death, retirement or insolvency of a partner.

   In case of dissolution of firm -:

• The firm ceases to continue its business i.e. the business comes to an end. But in the case of dissolution of partnership, the business of the firm is continued.
• In dissolution of firm, the partnership among all the partners no longer exists while in case of dissolution of partnership, the partnership among all the partners does not come to an end.
• Dissolution of partnership does not necessarily mean dissolution of firm whereas dissolution of firm necessarily implies dissolution of partnership.

   A firm is dissolved when:

• The partners of the firm decide to dissolve it,
• All the partners or all the partners except one become insolvent,
• The business of the firm is declared illegal,
• In case partnership at will, a partner gives notice of dissolution,
• The Court may order dissolution of the firm which may happen in the following circumstances-:

       (a) where a partner has become of unsound mind.

       (b) where a partner suffers from permanent incapacity.

       (c) where a partner is guilty of misconduct affecting the business.

       (d) where there is persistent disregard of partnership agreement by a partner.

       (e) where a partner transfers his interest or share to a third person.

       (f) where a business cannot be carried on except at a loss.

       (g) where a dissolution appears to the Court to be just and equitable on any other ground.

Accounting Treatment on Dissolution of Partnership -:

1. “Realisation Account” is opened and transfer to it all the assets except cash in hand and at bank.Sundry Debtors will be transferred at gross amount.
2. Realisation Account is created will all liabilities to outsiders and provisions against assets like Provision for Bad Debts. However, accounts denoting accumulated losses or profits will not be transferred to Realisation Account.
3. Now, Realisation Account will be credited with the actual amount realised by sale of assets. If a partner takes over an asset, the capital account of that partner is debited and Realisation Account is credited with the value agreed upon.
4. Actual amount paid to the creditors of the firm is debited to Realisation Account. If a partner takes over a liability, his capital account is credited and Realisation Account is debited with the amount agreed upon.
5. Expenses during the course of dissolution are debited to Realisation Account and credited to cash.
6. Profit or loss revealed by Realisation Account is transferred to all the partners’ capital accounts in their profit sharing ratio. Realisation Account is thus closed.
7. Loans advanced by partners to the firm are repaid.
8. Any reserve or accumulated profit or loss lying in the books of accounts is transferred to capital accounts in the profit sharing ratio.
9. Partners whose capital accounts may be showing a debit balance bring cash to clear their accounts.
10. Payment is made to the partners whose capital accounts are showing credit balances. This will close the books of accounts.

Return of Premium on Dissolution-:

If a partner on his admission pays to the other partner an amount for goodwill (also known as premium) and it is agreed that the partnership would be for a fixed term, then, if the firm is dissolved before the expiry of such a term, the partner will be entitled to a refund of a rat able amount of the premium so paid. Suppose, K and S admit T as a new partner on the condition that T pays 10,000 for goodwill and it is agreed that the partnership would be for 10 years. But if the firm is dissolved after 4 years, T will be entitled to a refund of 6,000 depending upon the circumstances.

However, such a refund cannot be claimed under the following conditions:

(i) When the firm is dissolved due to the death of a partner.

(ii) When the dissolution takes place mainly due to the misconduct of the partner  making the claim, or

(iii) Where the dissolution is in pursuance of an agreement that no such refund will be made.