Reconstitution of a Partnership Firm – Retirement/Death of a Partner Explained

Understanding Reconstitution of a Partnership Firm

Reconstitution of a partnership firm means any change in the existing partnership agreement except the dissolution of the firm. In Class 12 NCERT Accountancy, this concept is crucial as it covers scenarios like retirement or death of a partner, admission of a new partner, or change in profit-sharing ratio.

When a partner retires or dies, the firm continues with the remaining partners. The partnership deed is modified accordingly, and accounting adjustments are made to reflect the changed structure. This ensures that the firm’s financial statements remain accurate and fair to all partners involved.

Key points:

• It does not mean the firm is closed or dissolved.
• Only the terms of partnership change.
• Remaining partners take over the share of the retiring or deceased partner.

This chapter focuses mainly on retirement and death, explaining how to handle goodwill, capital adjustments, and settlement of amounts due.

Accounting Treatment for Retirement of a Partner

When a partner retires, several accounting steps are necessary to reconstitute the firm:

1. Revaluation of Assets and Liabilities: Adjust the book values to reflect current market values. 2. Adjustment of Reserves and Accumulated Profits: These are shared among partners according to the old profit-sharing ratio. 3. Goodwill Adjustment: The retiring partner’s share of goodwill must be compensated by the continuing partners in their gaining ratio. 4. Settlement of Amount Due: The retiring partner’s capital, share of goodwill, and share of accumulated profits/losses are calculated and settled.

Gaining Ratio Calculation

The gaining ratio is the difference between the new share and old share of the continuing partners. For example, if a continuing partner’s old share was $\frac{1}{5}$ and new share is $\frac{3}{10}$, then:

$$\text{Gaining Ratio} = \frac{3}{10} - \frac{1}{5} = \frac{3}{10} - \frac{2}{10} = \frac{1}{10}$$

This ratio determines how much each continuing partner pays the retiring partner for goodwill.

Journal Entry for Goodwill Adjustment

`` Retiring Partner’s Capital A/c Dr. To Continuing Partners’ Capital A/c (in gaining ratio) (For goodwill adjustment) ``

This ensures the retiring partner is compensated fairly for their share of goodwill.

Settlement of Amount Due to Retiring Partner

After all adjustments for goodwill, revaluation, and reserves, the amount due to the retiring partner is calculated. This amount includes:

• Capital balance
• Share of goodwill
• Share of accumulated profits or losses
• Adjustments from revaluation

The firm can settle this amount in two ways:

• Immediate Payment in Cash: The firm pays the entire amount at once.
• Loan Account Creation: If immediate payment is not possible, the amount is recorded as a loan payable to the retiring partner.

If a loan account is created, interest is usually provided on the outstanding amount as per the partnership agreement. The payment can be made in installments.

Example of Settlement

Suppose the amount due to retiring partner Mohan is Rs. 67,200. The firm pays Rs. 22,200 immediately and creates a loan account for Rs. 45,000.

Journal Entry:

`` Mohan’s Capital A/c Dr. 67,200 To Bank A/c 22,200 To Mohan’s Loan A/c 45,000 ``

Over the years, the firm pays installments plus interest on the loan, adjusting the loan balance accordingly.

Accounting for Interest on Loan to Retiring Partner

When the firm cannot pay the retiring partner immediately, the outstanding amount is treated as a loan. Interest on this loan is charged annually as per the agreement.

Journal Entries

• To record interest:

`` Interest Expense A/c Dr. To Retiring Partner’s Loan A/c ``

• To record installment payment:

`` Retiring Partner’s Loan A/c Dr. To Bank A/c ``

Worked Example

If the loan amount is Rs. 45,000 and interest rate is 16% per annum, interest for one year is:

$$ 45,000 \times 0.16 = Rs. 7,200 $$

The journal entry to record interest:

`` Interest Expense A/c Dr. 7,200 To Retiring Partner’s Loan A/c 7,200 ``

When the firm pays Rs. 15,000 as installment:

`` Retiring Partner’s Loan A/c Dr. 15,000 To Bank A/c 15,000 ``

This process continues until the loan is fully paid.

Reconstitution Due to Death of a Partner

The death of a partner also leads to reconstitution of the partnership firm. The accounting treatment is similar to retirement but with some differences:

• The deceased partner’s executor or legal heir receives the amount due.
• The firm calculates the deceased partner’s share of capital, goodwill, accumulated profits, and revaluation adjustments.
• Settlement is made by paying the executor immediately or creating a loan account.

Key Points

• The deceased partner’s share of profit up to the date of death is calculated.
• Goodwill adjustment is made using the gaining ratio of continuing partners.
• The firm continues with the remaining partners unless dissolved.

This ensures the legal heirs receive fair dues and the firm’s books reflect the changed partnership.

Comparison: Retirement vs Death of a Partner

Understanding the differences and similarities between retirement and death of a partner helps clarify accounting treatment.

Both cases require revaluation of assets, adjustment of reserves, and proper settlement to maintain fairness and accuracy in accounts.