Imagine the sudden silence in a partnership meeting when news arrives—a partner has passed away. What happens next? How do the books settle, and who gets what share?
Partnership accounting on the death of a partner is about fairness, legal clarity, and honoring commitments. Let’s navigate the process with clear steps and practical explanations.
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Accounting Treatment on Death of a Partner
The death of a partner results in the dissolution of the existing partnership agreement. However, the partnership business may continue with the remaining partners if they choose to reconstitute the firm. The key accounting objective at this stage is the fair and accurate settlement of claims due to the deceased partner’s legal heirs. This process ensures the deceased’s contribution and entitlements are neither overstated nor understated.
Purpose of Settlement
Why do we bother with this detailed settlement? Simple—partnerships operate on trust and clear agreements. On a partner’s death, it’s crucial to:
- Transfer the correct share of profits, capital, and goodwill to legal heirs.
- Adjust for revaluation of assets and liabilities.
- Distribute insurance proceeds, if applicable.
- Maintain transparency and protect the interests of all parties involved.
Step-by-Step Settlement Process
a. Calculation of Share of Profits up to the Date of Death
The deceased partner deserves their share of profits earned until the death date. Since most firms close books annually, profits are calculated on a pro-rata basis—either by time or by sales achieved up to that point. This can be crucial in fast-growing businesses where sales fluctuate wildly.
| Basis | Method | When Used |
|---|---|---|
| Time Basis | Profit for last year × (No. of months till death / 12) | When profits accrue uniformly over time |
| Sales Basis | Profit for last year × (Sales till death / Total sales last year) | When profits correspond closely to sales volumes |
Isn’t it fair that a partner’s family receives a share of what the partner helped earn, even if only for part of the year?
b. Goodwill Share
Goodwill is an intangible asset representing a firm’s reputation and earning potential. On death, the outgoing partner’s share of goodwill is credited to their account—usually calculated as per the agreed method in the partnership deed or based on past profits. The continuing partners bear this adjustment in their gaining ratio.
c. Revaluation of Assets & Liabilities
Assets and liabilities may have changed in value since the last balance sheet. A Revaluation Account is created to determine any profit or loss due to such changes. This result is distributed among all partners, including the deceased, in their old profit-sharing ratio. Why? Because the outgoing partner contributed to these changes during their tenure.
d. Accumulated Reserves and Profits
Any accumulated profits, reserves, or losses (like General Reserve, Profit & Loss Account balances) on the date of death are shared among all partners in the old profit-sharing ratio and transferred to their capital accounts. This ensures all previously earned profits (or losses) are distributed equitably.
e. Joint Life Policy (JLP) or Individual Life Policy Accounting
Many partnerships take out a Joint Life Policy (JLP) or individual policies on partners’ lives to provide funds for settlement upon death. On the death of a partner:
- If the policy amount received exceeds the policy’s book value, the surplus (profit) is shared among all partners as per the agreement or in the old profit-sharing ratio.
- The deceased partner’s share in the policy amount is credited to their capital account.
| Type of Policy | Who Receives Amount? | Accounting Treatment |
|---|---|---|
| Joint Life Policy | Firm receives policy amount | Amount credited to all partners’ capital accounts in agreed ratio |
| Individual Policy | Policy proceeds go to firm/legal heirs | Share of deceased’s policy credited to their account |
Not all partnerships hold such policies, but when they do, they can make settlements much smoother—no need to scramble for cash.
f. Settlement with Legal Heirs
Once all calculations are complete, the balance due to the deceased partner is transferred to the Executor’s Account (legal heirs). The payment may be made in full or in agreed installments, depending on the partnership deed and the firm’s liquidity.
g. Updating the Partnership Agreement
After the settlement, the remaining partners should update and sign a fresh partnership agreement reflecting the new terms and ratios. This ensures clarity for future operations.
Illustration: Calculating Profit up to Date of Death
Suppose a partner, Mr. X, died on September 30. The firm’s profit for the preceding year was Rs. 1,20,000. If profits accrue evenly, Mr. X’s share up to September 30 (9 months) would be:
Profit till death = Rs. 1,20,000 × (9/12) = Rs. 90,000 If Mr. X’s share = 1/3, then: Rs. 90,000 × (1/3) = Rs. 30,000
If the partnership prefers sales basis and sales till death were 60% of the entire previous year’s sales, then:
Profit till death = Rs. 1,20,000 × 60% = Rs. 72,000 Mr. X’s share = Rs. 72,000 × (1/3) = Rs. 24,000
Journal Entries for Settlement
The following are typical journal entries to settle the deceased partner’s claims:
1. For share of profit till date of death:
Profit and Loss Suspense A/c Dr. [Deceased partner’s share]
To Deceased Partner’s Capital A/c
2. For share of goodwill:
Continuing Partners’ Capital A/c Dr. (in gaining ratio)
To Deceased Partner’s Capital A/c
3. For profit/loss on revaluation:
Revaluation A/c Dr./Cr.
To All Partners’ Capital A/c (including deceased, in old ratio)
4. For share of reserves/accumulated profits:
General Reserve A/c Dr.
To All Partners’ Capital A/c (old ratio)
5. For policy amount received (if any):
Bank A/c Dr.
To Joint Life Policy A/c
Joint Life Policy A/c Dr.
To All Partners’ Capital A/c (old ratio)
6. Transferring balance to Executor (legal heir):
Deceased Partner’s Capital A/c Dr.
To Executor’s (Legal Heirs) A/c
- Interest on Capital/Drawings: If provided by the partnership deed, interest up to date of death must be calculated and adjusted.
- Outstanding Salary/Commission: Similar adjustments for any unpaid salary/commission due to the deceased partner.
The death of a partner is a moment of reckoning. With the right accounting treatment, everyone walks away with a sense of fairness and closure.