Reconstitution of Partnership (Death of Partner)
Class-12-Commerce-Book Keeping and Accountancy-Chapter-5-Maharashtra Board
Notes
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Topics to be Learn :
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Meaning
- A partner stops being a partner immediately on his/her death.
- Death is treated as compulsory retirement because the partner does not choose to leave the firm.
- The partnership with the deceased partner automatically comes to an end. If the Partnership Deed allows, the surviving partners can continue the business. The amount due to the deceased partner is paid to his/her legal representative (executor, nominee, or administrator).
- The legal representative can choose to receive interest at 6% per annum on the amount due. This interest is calculated from the date of death until the date of final payment.
| Key Point
Death = Compulsory Retirement. The settlement procedure closely follows the accounting treatment used for retirement of a partner. |
New Profit Sharing Ratio
- When a partner dies, the profit sharing ratio of the remaining (surviving) partners changes.
- The share of the deceased partner is distributed among the surviving partners, so their New Ratio is higher than their Old Ratio.
- Unless the deed specifies otherwise, the deceased partner's share is usually distributed among surviving partners in their existing (old) profit-sharing ratio.
Example 1: Calculation of New Profit Sharing Ratio
Scenario: X, Y, and Z are partners sharing profits and losses in the ratio of \(\frac{1}{2} : \frac{3}{10} : \frac{1}{5}\) respectively. Z dies, and the surviving partners, X and Y, take over Z's share in the proportion of 2 : 1. Find the new profit-sharing ratio of X and Y.
Solution:
Step 1: Write the old profit-sharing ratio with a common denominator.
- X = \(\frac{1}{2} = \frac{5}{10}\)
- Y = \(\frac{3}{10}\)
- Z = \(\frac{1}{5} = \frac{2}{10}\)
Old Ratio = \(\frac{5}{10} : \frac{3}{10} : \frac{2}{10}\)
Step 2: Calculate Z's share taken by X and Y.
Z's share = \frac{2}{10}\)
- X receives = \frac{2}{10}\) × \frac{2}{3}\) = \frac{4}{30}\)
- Y receives = \frac{2}{10}\) × \frac{1}{3}\) = \frac{2}{30}\)
Step 3: Calculate the new share of X.
X's new share = \frac{5}{10}\) + \frac{4}{30}\)
= \frac{15}{30}\) + \frac{4}{30}\)
= \frac{19}{30}\)
Step 4: Calculate the new share of Y.
Y's new share = \frac{3}{10}\) + \frac{2}{30}\)
= \frac{9}{30}\) + \frac{2}{30}\)
= \frac{11}{30}\)
Answer:
The new profit-sharing ratio of X and Y = 19 : 11.
Gain Ratio (Benefit Ratio)
Gain Ratio (also called Benefit Ratio) is the ratio in which the surviving partners benefit because of a partner's death.
- The additional share each surviving partner receives, over and above their old share, is called their 'Gain'.
- This ratio is mainly used to write off (extinguish) the goodwill raised in the books to the extent of the deceased partner's share.
| Gain Ratio = New Ratio − Old Ratio |
Example 2: Calculation of Gain (Benefit) Ratio
Scenario: A, B, and C are partners sharing profits in the ratio of 4:3:2. Partner A dies. If no new ratio is specified, what is the Gain Ratio of B and C?
Solution:
- According to the sources, if the new ratio of continuing partners is not specifically given, the gain ratio of continuing partners will remain the same as their old ratio.
- Old Ratio (B and C): 3:2.
- Answer: The Gain Ratio of B and C is 3:2.
Example 3: Share of Accrued Profit (Profit and Loss Suspense A/c)
Scenario: Naman, a partner in a firm, died on 1st July 2023. The firm's accounting year ends on 31st March. His share in the profits was 1/5. The profit for the preceding year (2022–23) was ₹16,000. Calculate Naman's share of profit up to the date of his death based on last year's profit.
Solution:
Step 1: Calculate the period up to the date of death.
- Last Balance Sheet Date = 31st March 2023
- Date of Death = 1st July 2023
- Period = 1st April to 1st July = 3 months
Step 2: Apply the formula.
Share of Profit = Last Year's Profit × Proportionate Period × Partner's Share
= ₹16,000 × \frac{3}{12}\) × \frac{1}{5}\)
Step 3: Calculate the amount.
- ₹16,000 × \frac{3}{12}\) = ₹4,000
- ₹4,000 × \frac{1}{5}\) = ₹800
Answer:
Naman's share of accrued profit up to the date of his death is ₹800.
This amount is credited to Naman's Capital Account and debited to the Profit and Loss Suspense Account.
Note: The journal entry is:
Profit and Loss Suspense A/c …..Dr. ₹800
To Naman's Capital A/c ₹800
Example 4: Share of Goodwill Calculation
Scenario: Rahul, Rohit, and Ramesh share profits in the ratio 3 : 2 : 1. Ramesh dies. The Partnership Deed provides that goodwill is to be valued at two times the average profit of the last five years. The total profit for the last five years was ₹9,00,000. Calculate Ramesh's share of goodwill.
Solution:
Step 1: Calculate the average profit.
Average Profit = Total Profit of Last 5 Years ÷ 5
= ₹9,00,000 ÷ 5
= ₹1,80,000
Step 2: Calculate the total goodwill of the firm.
Goodwill = Average Profit × Number of Years' Purchase
= ₹1,80,000 × 2
= ₹3,60,000
Step 3: Calculate Ramesh's share of goodwill.
Ramesh's share = ₹3,60,000 × \frac{1}{6}\) = ₹60,000
Answer:
Ramesh's share of goodwill is ₹60,000.
Revaluation of Assets and Liabilities
On the death of a partner, the assets and liabilities of the firm are revalued so that the deceased partner's representative receives the benefit (or bears the burden) of any change in value up to the date of death.
- The effect of revaluation is recorded in a Revaluation Account (also called Profit and Loss Adjustment Account) — exactly as is done at the time of a partner's retirement.
- The resulting profit or loss on revaluation is transferred to all partners' capital accounts (including the deceased partner's) in the old profit-sharing ratio; the deceased partner receives/bears only his or her share.
Example 5: Revaluation of Assets and Liabilities
Scenario: Upon the death of a partner, the firm revalues its assets. Land and Building (book value ₹4,00,000) is appreciated by 10%, and Furniture (book value ₹3,00,000) is adjusted to its market price of ₹3,40,000. Provide the net profit or loss on revaluation for these two items.
Solution:
Land and Building Appreciation: 10% of ₹4,00,000 = ₹40,000 (Profit/Credit).
Furniture Appreciation: ₹3,40,000 - ₹3,00,000 = ₹40,000 (Profit/Credit).
Total Profit on Revaluation: ₹40,000 + ₹40,000 = ₹80,000.
Answer:
There is a total profit of ₹80,000 on these adjustments, which would be credited to the Partners' Capital Accounts in their old profit-sharing ratio.
Amount Due to Deceased Partner's Executor
The amount payable to the deceased partner's Executor / Nominee / Administrator is built up from the balance in the deceased partner's Capital Account, computed using:
- Opening capital balance (as per the last Balance Sheet)
- Share of profit or loss on revaluation of assets and liabilities
- Share of General Reserve / accumulated (undistributed) profit or loss
- Share of Goodwill of the firm
- Partner's Salary / Commission (if allowed under the deed)
- Interest on Capital (if allowed under the deed)
- Less: Interest on Drawings (if chargeable) and Drawings up to the date of death
- Share of Profit up to the date of death (via Profit & Loss Suspense Account)
Settlement of Amount Due
The final balance in the deceased partner's Capital Account is transferred to a new account called the 'Executor's / Nominee's / Administrator's Loan Account'.
- This is shown as a liability in the Balance Sheet of the reconstituted (continuing) firm.
- It is paid off to the executor after completing all legal formalities — either in a lump sum, or in instalments together with interest, as agreed between the firm and the executor.
Accounting Treatment
The accounting treatment for the death of a partner closely mirrors that for retirement of a partner. The key steps, in order, are:
- Step 1: Prepare the Revaluation Account (Profit & Loss Adjustment A/c) for changes in asset/liability values; transfer the resulting profit/loss to all partners' capital accounts in the old ratio.
- Step 2: Distribute General Reserve / accumulated profits and losses among all partners in the old ratio.
- Step 3: Calculate and record the deceased partner's share of Goodwill (credited to the deceased partner's capital account; debited to surviving partners' capital accounts in Gain Ratio).
- Step 4: Calculate the deceased partner's share of profit up to the date of death and record it via the Profit & Loss Suspense Account.
- Step 5: Record Interest on Capital, Salary/Commission (if any) due to the deceased partner, and deduct Drawings plus Interest on Drawings up to the date of death.
- Step 6: Transfer the final balance of the deceased partner's Capital Account to the Executor's Loan Account.
- Step 7: Prepare the Balance Sheet of the continuing firm, showing the Executor's Loan Account as a liability and Profit & Loss Suspense Account as an asset (representing the unexpired part of the accounting year).
Key Formulas — Quick Reference :
| Item | Formula |
| Gain Ratio | New Ratio − Old Ratio |
| Goodwill of Firm | Average Profit × Number of Years' Purchase |
| Average Profit | Total Profit of given years ÷ Number of Years |
| Deceased Partner's Share of Goodwill | Goodwill of Firm × Deceased Partner's Share |
| Profit up to Date of Death (basis: average profit) | Average Profit × (Period from start of year to death ÷ 12) × Deceased Partner's Share |
| Profit up to Date of Death (basis: last year's / estimated profit) | Last Year's or Estimated Profit × (Period ÷ 12) × Deceased Partner's Share |
| Interest on Capital | Capital Balance × Rate % × Period ÷ 12 |
| Interest on Amount Due to Executor (if unpaid) | Amount Due × 6% p.a. × Period, till date of payment |
Illustrative Examples :
Illustration 1 — Rekha, Menaka and Mukta (Ratio 2:1:1)
Mukta died on 1st July 2019. Balance Sheet as on 31-03-2019 showed: Capitals — Rekha ₹60,000, Menaka ₹70,000, Mukta ₹34,000; Creditors ₹18,000; Bills Payable ₹2,000; General Reserve ₹16,000 (Total ₹2,00,000) against Plant & Machinery ₹60,000, Debtors ₹50,000, Furniture ₹30,000, Bank ₹60,000.
Adjustments: (1) Plant & Machinery revalued to ₹70,000; R.D.D. to be created ₹2,000. (2) Mukta's drawings to date of death ₹10,000; interest on drawings ₹1,000. (3) Goodwill valued at 3 years' purchase of average profit of last 4 years (₹1,50,000, ₹1,30,000, ₹70,000, ₹50,000). (4) Share of profit to date of death based on average profit of last 2 years.
Working Note 1 — Profit up to Date of Death :
Average profit of last 2 years = (70,000 + 50,000) ÷ 2 = ₹60,000.
Proportionate profit (1 Apr – 1 Jul 2019, i.e. 3 months) = 60,000 × 3/12 = ₹15,000.
Mukta's share (1/4) = 15,000 × 1/4 = ₹3,750.
Working Note 2 — Valuation of Goodwill :
Average profit of 4 years = (1,50,000 + 1,30,000 + 70,000 + 50,000) ÷ 4 = ₹1,00,000.
Goodwill of firm = 1,00,000 × 3 = ₹3,00,000. Mukta's share (1/4) = ₹75,000.
Result :
| Particulars | Amount (₹) |
| Profit on revaluation of Plant & Machinery (net of R.D.D.) | 8,000 |
| Goodwill credited to Mukta | 75,000 |
| Profit up to date of death (P&L Suspense A/c) | 3,750 |
| Mukta's Executor's Loan Account (balance transferred) | 1,07,750 |
Illustration 2 — Rakesh, Mahesh and Mukesh (Ratio 3:2:1)
Mukesh died on 30th June 2019. Assets were revalued: Plant & Machinery ₹44,000, Motor Truck ₹18,000, Investments ₹17,000; all debtors were considered good. Goodwill was valued at 2 times the average profit of the last 5 years (₹6,000, ₹11,000, ₹7,000, ₹12,000, ₹24,000), but no Goodwill account was to be raised in the firm's books — it was adjusted through partners' capital accounts instead.
Working Note 1 — Valuation of Goodwill
Average profit = (6,000+11,000+7,000+12,000+24,000) ÷ 5 = ₹12,000. Goodwill = 12,000 × 2 = ₹24,000.
Mukesh's share (1/6) = 24,000 × 1/6 = ₹4,000 — debited to Rakesh and Mahesh's capital accounts in their gaining ratio 3:2, i.e. Rakesh ₹2,400 and Mahesh ₹1,600.
Working Note 2 — Profit up to Date of Death
Average profit of last 2 years = (12,000 + 24,000) ÷ 2 = ₹18,000. Proportionate for 3 months = 18,000 × 3/12 = ₹4,500. Mukesh's share (1/6) = ₹750.
| Point to Note
When goodwill is not to appear in the books, it is adjusted by debiting the gaining partners' capital accounts and crediting the deceased (sacrificing) partner's capital account in the gain ratio — no separate Goodwill Account is opened. |
Format of Key Accounts :
Profit and Loss Adjustment A/c (Revaluation Account) :
| Debit Side (Particulars) | Credit Side (Particulars) |
| Decrease in value of assets | Increase in value of assets |
| Increase in value of liabilities | Decrease in value of liabilities |
| Unrecorded liabilities | Unrecorded assets |
| Profit on revaluation transferred to all Partners' Capital A/cs (old ratio) | Loss on revaluation transferred to all Partners' Capital A/cs (old ratio) |
Deceased Partner's Capital Account :
| Debit Side (Particulars) | Credit Side (Particulars) |
| Drawings | Balance b/d (opening capital) |
| Interest on Drawings | General Reserve (share) |
| Loss on Revaluation (if any) | Profit on Revaluation (if any) |
| Balance c/d → transferred to Executor's Loan A/c | Goodwill (share) |
| Interest on Capital / Salary (if allowed) | |
| Profit & Loss Suspense A/c (share of profit to date of death) |
Glossary of Key Terms :
| Term | Meaning |
| Executor / Nominee / Administrator | The legal representative of the deceased partner who receives the amount due on his/her behalf |
| Gain Ratio (Benefit Ratio) | Ratio in which surviving partners benefit due to the death of a partner (New Ratio − Old Ratio) |
| Profit & Loss Suspense Account | Account opened to record the deceased partner's share of profit for the part of the year before death, without disturbing the books until year-end; shown as an asset in the Balance Sheet |
| Executor's Loan Account | Liability account to which the final balance due to the deceased partner is transferred, pending payment |
| Revaluation Account | Account used to record changes in the value of assets and liabilities at the time of reconstitution |
| Compulsory Retirement | Term used for death of a partner, since the partnership with that person ends without choice |
Memory Aid — Steps on Death of a Partner :
| Remember: R-G-G-P-I-E
· R — Revalue assets & liabilities (Revaluation A/c) · G — General Reserve / accumulated profits distributed in old ratio · G — Goodwill: deceased partner's share credited (via gaining partners) · P — Profit up to date of death (via P&L Suspense A/c) · I — Interest on Capital / Salary added; Drawings & Interest on Drawings deducted · E — Executor's Loan Account: transfer final balance & settle as agreed |
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