Key Points

The retirement or death of a partner leads to the reconstitution of the partnership firm. The existing partnership agreement ends, and a new one is formed among the remaining partners to continue the business.

The New Profit Sharing Ratio is the ratio in which continuing partners share future profits. The Gaining Ratio is the proportion in which they acquire the outgoing partner's share, calculated as New Share minus Old Share.

If the agreement is silent, it is assumed that the continuing partners acquire the retiring partner's share in their old profit sharing ratio. In this case, their old ratio also becomes their gaining ratio.

The retiring or deceased partner is compensated for their share of goodwill. This is done by debiting the gaining partners' capital accounts in their gaining ratio and crediting the outgoing partner's capital account.

If goodwill already appears in the firm's balance sheet at the time of retirement, it must be written off. This is done by debiting all partners' capital accounts, including the outgoing partner, in their old profit sharing ratio.

Assets and liabilities are revalued to their current values. The net profit or loss from this revaluation is transferred to the capital accounts of all partners, including the retiring partner, in their old profit sharing ratio.

Undistributed profits, such as General Reserve, and accumulated losses are distributed among all partners in their old profit sharing ratio at the time of retirement or death.

The total amount payable includes the credit balance of the capital account, share of goodwill, reserves, and revaluation profit, less any drawings, share of losses, and interest on drawings.

The outgoing partner's share of profit for the period from the last balance sheet to the date of retirement/death is calculated on a time or turnover basis. This amount is typically debited to a 'Profit and Loss Suspense Account'.

The amount due to the retiring partner can be paid immediately in full, or the whole amount can be transferred to a loan account. It can also be settled through a combination of part payment in cash and the balance as a loan.

If the amount due is not paid immediately, it is transferred to the Retiring Partner's Loan Account. The firm then pays this loan in installments along with interest, as per the agreed terms.

In case of a partner's death, the final amount due is transferred to their legal representative's account, known as the Deceased Partner's Executor's Account, and settled in a similar manner to a retiring partner.

If the firm agrees to pay a retiring partner a lump sum amount which is more than their adjusted capital balance, the excess amount is treated as their share of goodwill, known as hidden goodwill.

The remaining partners may decide to adjust their capitals to be proportionate to their new profit sharing ratio. This adjustment is made by either bringing in additional cash or withdrawing the excess amount.