Class 12 Reconstitution of a Partnership Firm Retirement/Death of a Partner

Class 12 Reconstitution of a Partnership Firm Retirement/Death of a Partner

Chapter 3: Retirement/Death of a Partner

Introduction

When a partner retires or dies, the existing partnership comes to an end and a new agreement is formed among the remaining partners. The firm’s accounts must be adjusted to ensure that the retiring or deceased partner receives their fair share.

1. Amount Payable to Retiring/Deceased Partner

The amount payable generally includes:

  • Capital balance
  • Current account balance
  • Share of goodwill
  • Share of reserves and accumulated profits
  • Share of revaluation profit
  • Share of profit earned till retirement/death
  • Interest on capital (if applicable)
  • Salary or commission due

Less:

  • Drawings
  • Interest on drawings
  • Share of accumulated losses
  • Revaluation loss
  • Other outstanding amounts

2. New Profit Sharing Ratio

The new profit-sharing ratio is the ratio in which the remaining partners divide future profits.

Formula

New Share = Old Share + Share Acquired from Retiring Partner

Important Points

  • If nothing is mentioned, the retiring partner’s share is assumed to be acquired in the old ratio.
  • If partners agree on another ratio, calculate accordingly.

3. Gaining Ratio

The gaining ratio shows how much additional share each continuing partner receives after retirement.

Formula

Gaining Ratio = New Share − Old Share

Importance

It is mainly used for goodwill adjustment.

4. Goodwill Treatment

The retiring partner deserves compensation for goodwill because it has been built through the efforts of all partners.

Case 1: Goodwill Not Appears in Books

Remaining partners compensate the retiring partner in the gaining ratio.

Journal Entry

Gaining Partners' Capital A/c Dr.
      To Retiring Partner's Capital A/c

Case 2: Goodwill Already Appears in Books

  • First write off the existing goodwill.
  • Then adjust goodwill according to the new valuation.

Hidden Goodwill

Sometimes goodwill is not given directly. If the amount paid to the retiring partner is more than the balance in the capital account after adjustments, the difference is treated as hidden goodwill.

5. Revaluation of Assets and Liabilities

Before retirement, assets and liabilities should be shown at their correct values.

Prepare a Revaluation Account to record:

  • Increase in assets
  • Decrease in assets
  • Increase in liabilities
  • Decrease in liabilities
  • Unrecorded assets
  • Unrecorded liabilities

The resulting profit or loss is transferred to all partners in their old profit-sharing ratio.

6. Distribution of Reserves and Accumulated Losses

Accumulated Profits

Examples:

  • General Reserve
  • Reserve Fund

Transferred to all partners in the old ratio.

Accumulated Losses

Examples:

  • Debit balance of Profit & Loss Account

Also shared in the old ratio.

7. Profit Till Date of Retirement

If a partner retires during the year, they are entitled to profit earned up to the retirement date.

Profit may be calculated on:

  • Previous year’s profit
  • Average profit
  • Sales basis
  • Any agreed method

8. Settlement of Retiring Partner’s Account

The amount due may be paid:

  • Fully in cash
  • Entirely as a loan
  • Partly in cash and partly as a loan

If converted into a loan, interest is charged according to the partnership agreement.

9. Adjustment of Continuing Partners’ Capitals

After retirement, continuing partners may decide to adjust their capitals according to the new profit-sharing ratio.

If:

  • Capital is excess → withdraw cash.
  • Capital is short → bring additional cash.

Important Formula Sheet

New Share

Old Share + Acquired Share

Gaining Share

New Share − Old Share

Retiring Partner’s Goodwill

Firm’s Goodwill × Retiring Partner’s Share

Share of Profit till Retirement

Estimated Profit × Time Period × Partner’s Share

Frequently Asked Examination Journal Entries

  1. Goodwill Adjustment
  2. Revaluation Entries
  3. Transfer of Revaluation Profit/Loss
  4. Distribution of General Reserve
  5. Settlement through Loan Account
  6. Cash Payment to Retiring Partner
  7. Capital Adjustment Entries

Examination Tips

  • Always calculate the new profit-sharing ratio before goodwill.
  • Goodwill is adjusted using the gaining ratio.
  • Revaluation profit or loss is shared in the old ratio.
  • Reserve and accumulated profits also follow the old ratio.
  • Capital adjustment is usually done after all other adjustments.
  • Read the question carefully to identify whether goodwill already appears in the books.

Questions

🟢 SECTION A: MCQs (1 Mark Each)

1. Basic Concepts

  1. Retirement of a partner results in:
    • (A) Dissolution of firm
    • (B) Reconstitution of firm
    • (C) Closure of business
    • (D) Liquidation
      Ans: B
  2. On retirement, the retiring partner is entitled to:
    • (A) Only capital balance
    • (B) Only goodwill
    • (C) Net amount due from firm
    • (D) Only profits
      Ans: C
  3. New profit sharing ratio is:
    • (A) Old ratio
    • (B) Ratio among all partners
    • (C) Ratio of remaining partners
    • (D) Equal ratio
      Ans: C
  4. Gaining ratio is used for:
    • (A) Capital adjustment
    • (B) Goodwill distribution
    • (C) Revaluation
    • (D) Loan calculation
      Ans: B
  5. If nothing is specified, retiring partner’s share is taken by:
    • (A) Equal ratio
    • (B) Old profit ratio
    • (C) New ratio
    • (D) Capital ratio
      Ans: B

2. Goodwill

  1. Goodwill is shared at retirement based on:
    • (A) Old ratio
    • (B) Sacrificing ratio
    • (C) Gaining ratio
    • (D) Capital ratio
      Ans: C
  2. Hidden goodwill arises when:
    • (A) Goodwill is shown in books
    • (B) Excess payment is made to retiring partner
    • (C) Loss occurs
    • (D) Capital increases
      Ans: B
  3. If goodwill is not in books, it is:
    • (A) Ignored
    • (B) Written off
    • (C) Adjusted through capital accounts
    • (D) Transferred to bank
      Ans: C

3. Revaluation & Adjustments

  1. Revaluation account is prepared to find:
    • (A) Profit/loss on admission
    • (B) Profit/loss on retirement
    • (C) Firm capital
    • (D) Cash balance
      Ans: B
  2. Revaluation profit is shared among partners in:
  • (A) New ratio
  • (B) Gaining ratio
  • (C) Old ratio
  • (D) Equal ratio
    Ans: C
  1. Increase in liability is recorded by:
  • (A) Credit Revaluation A/c
  • (B) Debit Revaluation A/c
  • (C) Debit Capital A/c
  • (D) Credit Cash A/c
    Ans: B

4. Settlement of Retiring Partner

  1. If full amount is not paid, it is transferred to:
  • (A) Bank A/c
  • (B) Loan A/c
  • (C) Capital A/c
  • (D) Debtors A/c
    Ans: B
  1. Interest on retiring partner’s loan is:
  • (A) Compulsory 12%
  • (B) As per agreement
  • (C) 6% fixed
  • (D) Not allowed
    Ans: B

🟡 SECTION B: FILL IN THE BLANKS

  1. Retirement of a partner leads to __________ of firm.
    Ans: Reconstitution
  2. Gaining ratio = New share – __________.
    Ans: Old share
  3. Revaluation account is a __________ account.
    Ans: Nominal
  4. Goodwill is distributed among partners in __________ ratio.
    Ans: Gaining
  5. Accumulated profits are shared in __________ ratio.
    Ans: Old
  6. Retiring partner’s capital account is credited with his share of __________.
    Ans: Goodwill
  7. Hidden goodwill is also called __________ goodwill.
    Ans: Inferred
  8. Amount due to retiring partner may be transferred to __________ account.
    Ans: Loan
  9. Increase in assets is credited to __________ account.
    Ans: Revaluation
  10. Profit till date of retirement is called __________ profit.
    Ans: Intervening

🟠 SECTION C: VERY SHORT QUESTIONS (1–2 Marks)

  1. What is retirement of a partner?
  2. Define gaining ratio.
  3. What is new profit sharing ratio?
  4. Why is revaluation account prepared?
  5. What is hidden goodwill?
  6. State one method of settling retiring partner’s account.
  7. What is meant by reconstitution of firm?
  8. Who bears loss on revaluation?
  9. What happens to general reserve on retirement?
  10. Define goodwill in one line.

🔵 SECTION D: ASSERTION–REASON TYPE

  1. Assertion: Retirement of a partner leads to dissolution of firm.
    Reason: Remaining partners continue business.
    Ans: Assertion is false, Reason is true
  1. Assertion: Goodwill is shared in gaining ratio.
    Reason: Gaining partners benefit from retirement.
    Ans: Both true, Reason explains Assertion
  1. Assertion: Revaluation profit is transferred in old ratio.
    Reason: All partners are affected equally before retirement.
    Ans: Both true
  1. Assertion: Gaining ratio = New share – Old share
    Reason: It shows increase in profit share.
    Ans: Both true

🟣 SECTION E: CASE-BASED MCQs

Case 1

A, B, C share profits 3:2:1. C retires.

  1. New ratio of A and B will be:
    • (A) 3:2
    • (B) 2:1
    • (C) 1:1
    • (D) 5:1
      Ans: A
  2. Gaining ratio is:
    • (A) 3:2
    • (B) 2:1
    • (C) 1:1
    • (D) 5:1
      Ans: A

Case 2

Goodwill of firm = 60,000. A retires, B & C gain equally.

  1. B’s share of goodwill:
    • (A) 30,000
    • (B) 20,000
    • (C) 15,000
    • (D) 10,000
      Ans: B

🟤 SECTION F: MATCH THE FOLLOWING

Column AColumn B
1. Revaluation A/c(a) Profit/Loss on asset change
2. Gaining ratio(b) Goodwill distribution
3. New ratio(c) Future profit sharing
4. Loan A/c(d) Retiring partner settlement

Answers:
1–a
2–b
3–c
4–d

  • Always identify: Retirement → Reconstitution
  • Revaluation → Old ratio
  • Goodwill → Gaining ratio
  • Capital adjustment → Final step
  • Loan account → When payment is delayed