Reconstitution of Partnership: Admission, Retirement and Death of a Partner
Scope
Admission, retirement and death all change the profit-sharing arrangement, so the exam tests one skill repeatedly: adjusting the books so the old partners' claims are settled before the new arrangement begins.
Admission: four adjustments
- New ratio and sacrificing ratio. Sacrificing ratio = old share − new share; only sacrificing partners share the premium for goodwill.
- Goodwill. Premium brought in cash is credited to the sacrificing partners' capital accounts. If goodwill already stands in the books, it is written off among the old partners in the old ratio before admission.
- Revaluation of assets and liabilities; the profit or loss belongs to the old partners alone.
- Capital adjustment, by bringing in or withdrawing cash, or through current accounts.
Retirement and death
Gaining ratio = new share − old share. The outgoing partner's share of goodwill is compensated by the gaining partners, usually by debiting their capital accounts and crediting the outgoing partner. Revaluation profit, accumulated reserves and the share of profit up to the date of death are credited in the old ratio. On death, profit for the part-year is estimated from last year's sales or profit, and the balance due is transferred to the executor's account.
Worked example
X and Y share profits 3:2. Z is admitted for 1/5, which X and Y sacrifice in the old ratio: X 3/25, Y 2/25. New ratio 12:8:5. If Z brings ₹60,000 as premium, X receives ₹36,000 and Y ₹24,000. Had Z acquired the whole 1/5 from X alone, the entire ₹60,000 would go to X.
Traps
Sharing revaluation profit in the new ratio; crediting goodwill premium to all partners; forgetting to write off an existing goodwill balance; and debiting instead of crediting the retiring partner for his share of goodwill.