Retirement and Death of a Partner

When a partner retires (or dies), the continuing partners take over his share of profits, so they gain. The reverse of admission applies. The gaining ratio = New Ratio − Old Ratio — the ratio in which the remaining partners acquire the outgoing partner's share, and the ratio in which they bear the goodwill compensation.

• If the remaining partners continue in their old mutual ratio, the gaining ratio = their old ratio.
• If a new ratio is specified, deduct old from new for each.

Worked example. A, B and C share 3:2:1. B retires; A and C continue equally (1:1). A's gain = 1/2 − 3/6 = 0; C's gain = 1/2 − 1/6 = 2/6. Hmm — better to take a clean case: A, B, C share 4:3:2 and B retires, A and C continuing in 4:2 (= 2:1). Old A 4/9, new A 2/3 = 6/9 → gain 2/9; old C 2/9, new C 1/3 = 3/9 → gain 1/9. Gaining ratio 2:1.

Goodwill on retirement. The retiring partner is entitled to his share of the firm's goodwill, which the gaining partners pay. Following AS-26, no goodwill account is raised; instead an adjustment entry is passed:

Gaining Partners' Capital A/cs  Dr (in gaining ratio)
   To Retiring Partner's Capital A/c

The amount = firm's goodwill × the retiring partner's share. For example, if goodwill is Rs 90,000 and the retiring partner's share was 1/3, his share of goodwill = Rs 30,000, debited to the gaining partners in their gaining ratio and credited to him. So retirement mirrors admission: there the newcomer pays; here the gainers pay the leaver.

As with any reconstitution, on retirement the firm revalues assets and liabilities and distributes accumulated reserves — but now all partners (including the retiring one) share, because these belong to the old ratio that included him.

• Revaluation Account — net profit/loss transferred to all partners (including the retiring partner) in the old ratio.
• Reserves & accumulated profits/losses — distributed to all partners in the old ratio.

After these, the retiring partner's total dues are settled. His capital account is credited with: his capital balance, his share of goodwill (from the gainers), his share of the revaluation profit and reserves, his share of any current profit up to the date of retirement, and salary/interest due; and debited with drawings, interest on drawings and his share of any losses. The resulting balance is the amount payable to him.

This amount may be settled in three ways: (i) paid in full in cash; (ii) transferred to his loan account to be paid in instalments with interest (often 6% p.a. under the Act if not agreed); or (iii) partly cash, partly loan. If paid by loan, his Loan Account carries the balance, and interest is added each year until repaid. For example, if his dues are Rs 1,20,000 and Rs 40,000 is paid in cash, the remaining Rs 80,000 is transferred to his loan account. With the dues computed and the mode of payment decided, the retirement is complete and the continuing partners carry on with adjusted capitals.

The death of a partner is treated almost exactly like retirement — the main difference is timing (death can occur on any date during the year, not just at year-end) and that the amount due is paid to the deceased partner's executor (legal representative) rather than to the partner himself.

The deceased partner's capital account is credited with the same items as a retiring partner — capital balance, share of goodwill (paid by gainers), share of revaluation profit and reserves — plus two items computed up to the date of death:

• Share of profit up to the date of death — since accounts are not closed mid-year, his profit share is estimated either on a time basis (last year's profit × months elapsed ÷ 12 × his share) or on a sales basis (profit estimated from sales to date).
• Interest on capital and any salary due up to the date of death.

The total is transferred to the Executor's Account, which replaces the partner. The executor is then paid — in full or by instalments with interest (6% p.a. if not agreed), exactly like a retiring partner's loan.

For example, if a partner dies three months into the year, his estimated profit share on a time basis = last year's profit × 3/12 × his share. Suppose last year's profit was Rs 1,20,000 and his share 1/4: estimated profit = 1,20,000 × 3/12 × 1/4 = Rs 7,500, credited to his account and ultimately to the executor. With the executor settled, the firm continues with the surviving partners — completing the reconstitution events before the bigger step of dissolution.