Key Takeaways
- Understand the reasons and process for retirement of a partner in a partnership firm.
- Master the accounting treatments including revaluation, goodwill adjustment, capital settlement, reserves, and profit-sharing changes.
- Learn through a practical numerical example and the essential legal provisions under the Partnership Act.
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Introduction to Retirement of a Partner
Retirement of a partner marks a significant event in the life of a partnership firm. It demands careful financial adjustments and legal compliance to ensure the interests of all parties — the retiring partner, continuing partners, and the firm — are safeguarded. Every UGC NET Commerce aspirant must be comfortable with both the conceptual framework and the practical accounting entries involved.
Retirement of a Partner: Definition and Modes
Definition
Retirement of a partner occurs when a partner leaves the partnership firm, relinquishing their rights and obligations. This process can happen in three ways:
- Voluntary Retirement: A partner may retire at will, if permitted by the partnership agreement.
- By Consent: If all partners agree, any partner can retire, regardless of the partnership deed.
- By Agreement: The partnership deed may specify certain conditions under which retirement is allowed.
Retirement is legally recognized under the Indian Partnership Act, 1932, typically requiring a public notice to bind third parties.
Accounting Treatments on Retirement of a Partner
a. Revaluation of Assets and Liabilities
Assets and liabilities must reflect their current fair value at the time of retirement. This ensures the outgoing partner receives a fair share based on the actual worth of the firm. The revaluation profit or loss is shared among all partners in the old profit-sharing ratio.
| Journal Entries for Revaluation | |
|---|---|
| For increase in asset value | Asset A/c Dr. To Revaluation A/c |
| For decrease in asset value | Revaluation A/c Dr. To Asset A/c |
| For increase in liability | Revaluation A/c Dr. To Liability A/c |
| For decrease in liability | Liability A/c Dr. To Revaluation A/c |
| For transfer of revaluation profit | Revaluation A/c Dr. To Partners’ Capital A/cs (old ratio) |
b. Goodwill Adjustment and Gaining Ratio
Goodwill is the firm’s reputation and earning potential. Upon retirement, the retiring partner is entitled to their share of goodwill. Continuing partners compensate the outgoing partner in proportion to their gain in profit share — called the gaining ratio (New Ratio – Old Ratio).
| Journal Entry for Goodwill Adjustment |
|---|
| Gaining Partner’s Capital A/c Dr. To Retiring Partner’s Capital A/c |
This ensures the partners who benefit from increased profit share bear the cost of goodwill.
c. Settlement of Retiring Partner’s Capital
The amount due to the retiring partner includes their capital balance, share of revaluation profit/loss, share in accumulated profits/reserves, and goodwill. This amount can be settled:
- By Cash Payment: The firm pays the retiring partner immediately.
- By Loan: The due amount is converted into a loan, to be paid over time with agreed interest.
d. Adjustment of Accumulated Profits and Reserves
Any undistributed profits, general reserves, or losses outstanding in the books are allocated among all partners in the old profit-sharing ratio before retirement.
| Journal Entry |
|---|
| General Reserve A/c Dr. To Partners’ Capital A/cs (old ratio) |
e. New Profit-Sharing Ratio
After retirement, the remaining partners agree on a new profit-sharing ratio. It’s calculated by deducting the retiring partner’s share from the old ratios, or as per a new agreement. The gaining ratio determines the distribution of goodwill cost.
Numerical Example: Retirement with Goodwill Raised in Books
Consider A, B, and C sharing profits in 3:2:1. B retires. The goodwill of the firm is valued at ₹60,000, and assets are revalued upward by ₹12,000. General Reserve stands at ₹18,000.
- Step 1: Revaluation Profit
Revaluation Profit = ₹12,000 (shared in 3:2:1) - Step 2: Goodwill Adjustment
B’s share = ₹60,000 × 2/6 = ₹20,000
New Ratio (A:C) = 3:1. Gaining Ratio:
- A: Old 3/6 → New 3/4; Gain = 3/4 – 3/6 = 1/12
- C: Old 1/6 → New 1/4; Gain = 1/4 – 1/6 = 1/12
Total gain = 2/12 = 1/6 (B’s old share), so both A and C compensate B equally.
Goodwill to be raised in books:
- A’s Capital A/c Dr. ₹10,000
- C’s Capital A/c Dr. ₹10,000
- To B’s Capital A/c ₹20,000 - Step 3: General Reserve
B’s share = ₹18,000 × 2/6 = ₹6,000 - Step 4: Settlement
B’s total due = Capital + Revaluation profit + Goodwill + General Reserve. This is either paid or transferred to B’s Loan A/c.
Legal Provisions: The Partnership Act
a. Rights and Liabilities on Retirement
The Indian Partnership Act, 1932, governs the process. Section 32 specifies:
- A partner may retire by agreement, consent, or with notice in a partnership at will.
- The retiring partner remains liable for acts of the firm done before retirement, unless released by agreement.
- Public notice is necessary to absolve liability to third parties post-retirement.
Exam questions often focus on these procedural safeguards.
Conclusion
Careful handling of a partner’s retirement is essential for the financial stability and legal standing of a partnership firm. Mastery of these concepts — especially the calculations and legal implications — will serve you well not only in UGC NET Commerce but also in professional practice.