Retirement & Death of a Partner: Accounting, Adjustments, Goodwill, New Ratio

TAKEAWAYS:

• A retiring/deceased partner’s capital account is settled using book value (not market value) of assets/liabilities, and any goodwill due.
• Goodwill is calculated based on average profit (usually last 3–5 years) and agreed valuation (purchased or retained).
• The new profit-sharing ratio is determined by the remaining partners’ agreement (or equally if not specified).
• Legal heirs (for death) or the retiring partner receive payments in cash, assets, or installments (if agreed).
• Revaluation account adjusts assets/liabilities to fair market value before settlement.
• NEB exams test: journal entries, ledger adjustments, and ratio calculations—always show workings!

1. Why Retirement/Death Matters in Partnerships

Partnerships are based on trust, agreement, and shared profits. When a partner retires or dies:

• The firm continues (unless dissolved).
• The remaining partners must adjust their capital and profit-sharing.
• The outgoing partner (or their heirs) must be fairly compensated.

Key Idea:

"A partnership is like a team. If one player leaves, the team must rebalance—new roles, new shares, and fair payoffs."

2. Steps When a Partner Retires/Dies

The process is similar for both cases, but legal heirs replace the deceased partner in death scenarios. Here’s the step-by-step flow:

flowchart TD
    A["Partner Retires/Dies"] --> B["Step 1: Revalue Assets/Liabilities"]
    B --> C["Step 2: Calculate Goodwill"]
    C --> D["Step 3: Adjust Capital Accounts"]
    D --> E["Step 4: Prepare New Profit-Sharing Ratio"]
    E --> F["Step 5: Settle the Outgoing Partner’s Account"]
    F --> G["Step 6: Pass Journal Entries"]

3. Step 1: Revaluation of Assets & Liabilities

Why? Assets/liabilities may have changed in value since the last balance sheet. How?

• Compare book value (old value) with market value (current value).
• If assets increase → credit revaluation account.
• If liabilities increase → debit revaluation account.

Example: Suppose a firm has:

• Furniture (book value) = Rs. 50,000
• Market value = Rs. 60,000 → Profit on revaluation = Rs. 10,000 (credit revaluation A/c).

Journal Entry:

Revaluation A/c       Dr. 10,000
    To Furniture A/c       10,000

4. Step 2: Calculating Goodwill

Goodwill is the premium paid for the reputation, customer base, or future earnings of the firm.

Methods to Calculate Goodwill:

Example (Average Profit Method):

• Last 3 years’ profits: Rs. 50,000, Rs. 60,000, Rs. 70,000
• Average Profit = (50,000 + 60,000 + 70,000) / 3 = Rs. 60,000
• Years’ Purchase = 3 (given)
• Goodwill = 60,000 × 3 = Rs. 180,000

Journal Entry (if goodwill is retained):

All Partners’ Capital A/cs Dr. 180,000
    To Goodwill A/c       180,000

5. Step 3: Adjusting Capital Accounts

After revaluation and goodwill, the remaining partners’ capitals are adjusted to reflect:

1. Their new profit-sharing ratio.
2. Any goodwill share they must pay.

Formula:

New Capital = Old Capital + (Goodwill Share × Old Capital)

Example:

• Old capitals: A = Rs. 100,000, B = Rs. 80,000 (ratio 3:2)
• Goodwill = Rs. 180,000 (to be shared 3:2)
• A’s goodwill share = (3/5) × 180,000 = Rs. 108,000
• B’s goodwill share = (2/5) × 180,000 = Rs. 72,000
• New capitals:
  • A = 100,000 + 108,000 = Rs. 208,000
  • B = 80,000 + 72,000 = Rs. 152,000

Journal Entry:

A’s Capital A/c Dr. 108,000
B’s Capital A/c Dr. 72,000
    To Goodwill A/c       180,000

6. Step 4: New Profit-Sharing Ratio

The remaining partners decide a new ratio. If not specified:

• They share equally.
• Or continue the old ratio (if agreed).

Example:

• Old ratio: A:B:C = 3:2:1
• C retires.
• New ratio (if A and B agree 2:3):
  • A = 2/5, B = 3/5

Mermaid Diagram (Ratio Adjustment):

pie
    title Old Ratio (3:2:1)
    "A (3)" : 30
    "B (2)" : 20
    "C (1)" : 10

pie
    title New Ratio (2:3)
    "A (2)" : 40
    "B (3)" : 60

7. Step 5: Settling the Outgoing Partner’s Account

The retiring/deceased partner (or heirs) is paid:

1. Their capital balance (from books).
2. Their share of goodwill (if any).
3. Their share of reserves/profits (if agreed).

Journal Entry (Payment in Cash):

[Retiring Partner’s] Capital A/c Dr. [Amount]
    To Cash A/c       [Amount]

Example (Death Scenario):

• C’s capital = Rs. 50,000
• C’s goodwill share = Rs. 30,000
• Total payable to heirs = 50,000 + 30,000 = Rs. 80,000

Journal Entry:

C’s Capital A/c Dr. 50,000
Goodwill A/c Dr. 30,000
    To C’s Executor A/c       80,000

8. Key Differences: Retirement vs. Death

9. Solved Example (NEB-Style)

Problem: A, B, and C are partners sharing profits in 3:2:1. C retires on 31.12.2023. On that date:

• Capital balances: A = Rs. 150,000, B = Rs. 100,000, C = Rs. 50,000
• Goodwill is valued at Rs. 120,000 (to be shared 3:2).
• Revaluation shows:
  • Furniture (book Rs. 40,000, market Rs. 50,000)
  • Debtors (book Rs. 60,000, market Rs. 55,000)
• New profit-sharing ratio between A and B is 2:3.
• C is paid Rs. 70,000 in cash.

Solution:

Step 1: Revaluation Account

Revaluation A/c       Dr. 5,000 (50,000 - 40,000)
    To Furniture A/c       5,000
Debtors A/c       Dr. 5,000 (60,000 - 55,000)
    To Revaluation A/c       5,000

Step 2: Goodwill Calculation

• C’s goodwill share = (1/6) × 120,000 = Rs. 20,000
• A’s share = (3/6) × 120,000 = Rs. 60,000
• B’s share = (2/6) × 120,000 = Rs. 40,000

Step 3: Adjusting Capitals

• New capitals (A:B = 2:3):
  • A’s new capital = 150,000 + 60,000 = Rs. 210,000
  • B’s new capital = 100,000 + 40,000 = Rs. 140,000

Step 4: C’s Final Settlement

• C’s capital = Rs. 50,000
• Goodwill share = Rs. 20,000
• Total payable = 50,000 + 20,000 = Rs. 70,000 (matches given)

Journal Entries:

1. Revaluation:

   Revaluation A/c       Dr. 5,000
       To Furniture A/c       5,000
   Debtors A/c       Dr. 5,000
       To Revaluation A/c       5,000
   

2. Goodwill:

   A’s Capital A/c Dr. 60,000
   B’s Capital A/c Dr. 40,000
       To Goodwill A/c       100,000
   

3. C’s Payment:

   C’s Capital A/c Dr. 50,000
   Goodwill A/c Dr. 20,000
       To Cash A/c       70,000
   

10. Common Mistakes in NEB Exams

❌ Ignoring revaluation → Always adjust assets/liabilities first! ❌ Wrong goodwill share → Use the correct ratio (old or new? Check the question). ❌ Forgetting to pass entries for goodwill → Goodwill must be shared among remaining partners. ❌ Miscounting new capitals → Always add goodwill share to old capital. ❌ Not showing workings → NEB marks step-by-step calculations!

11. Exam Tip: How to Score Full Marks

1. Show all steps (revaluation → goodwill → new ratio → settlement).
2. Label every journal entry clearly.
3. Use T-accounts for capital adjustments (helps visualize debits/credits).
4. Mention assumptions if data is missing (e.g., "Goodwill is valued at Rs. X").
5. For death cases, always note "paid to executor/legal heirs".

NEB-Style Question (Practice): "X, Y, and Z are partners sharing profits in 5:3:2. Z retires on 31.12.2023. On that date:

• Capitals: X = Rs. 200,000, Y = Rs. 150,000, Z = Rs. 100,000
• Goodwill is Rs. 180,000 (shared 5:3:2).
• Revaluation shows: Land (book Rs. 300,000, market Rs. 350,000).
• New ratio between X and Y is 3:2.
• Z is paid Rs. 140,000 in cash. Pass necessary journal entries."

Answer Outline:

1. Revaluation of Land.
2. Goodwill calculation (Z’s share = 2/10 × 180,000 = Rs. 36,000).
3. Adjusting capitals (X = 200,000 + 90,000 = Rs. 290,000; Y = 150,000 + 60,000 = Rs. 210,000).
4. Z’s final payment (100,000 + 36,000 = Rs. 136,000 → But given Rs. 140,000? Check for errors!).

Final Note:

"Retirement/death is like closing a chapter—accounting ensures fairness. Always follow the steps, and NEB will reward you!" 📚✨