FUNDAMENTALS OF ACCOUNTING - CHAPTER 8

2. Calculation of sacrificing ratio Partners New share Old share Sacrifice Gain 3 3 3 A - 6 5 30 2 2 2 B - 6 5 30 1 1 C 6 6 3 Therefore, A will get = Rs. 45,000x = Rs. 4,500; 30 2 B will get = Rs. 45,000x = Rs. 3,000; and 30 1 C will be debited on account of goodwill = Rs. 45,000x = Rs. 7,500 6 3. RESERVES IN THE BALANCE SHEET Whenever a new partner is admitted, any reserve etc. lying in the Balance Sheet should be transferred to the Capital Accounts of the old partners in the old profit sharing ratio. (In examination problems it should be done even if there are no instructions on this point). Illustration 4 Dalal, Banerji and Mallick are partners in a firm sharing profits and losses in the ratio 2:2:1. Their Balance Sheet as on 31st March, 2009 is as below : Liabilities Rs. Assets Rs. Sundry Creditors 12,850 Land and Buildings 25,000 Outstanding Liabilities 1,500 Furniture 6,500 General Reserve 6,500 Stock of goods 11,750 Capital Account : Sundry Debtors 5,500 Mr. Dalal 12,000 Cash in hand 140 Mr. Banerji 12,000 Cash at Bank 960 Mr. Mallick 5,000 29,000 49,850 49,850 FUNDAMENTALS OF ACCOUNTING 8.51 Copyright -The Institute of Chartered Accountants of India ADMISSION OF NEW PARTNER The partners have agreed to take Mr. Mistri as a parner with effect from 1st April, 2009 on the following terms : (1) Mr. Mistri shall bring Rs. 5,000 towards his capital. (2) The value of stock should be increased by Rs. 2,500 and Furniture should be depreciated by 10%. (3) Reserve for bad and doubtful debts should be provided at 10% of the debtors. (4) The value of land and buildings should be enhanced by 20% and the value of the goodwill be fixed at Rs. 15,000. (5) The value of the goodwill be fixed at Rs. 15,000. (6) General Reserve will be transferred to the Partners’ Capital Accounts. (7) The new profit sharing ratio shall be : Mr. Dalal 5/15, Mr. Banerji 5/15, Mr. Mallick 3/15 and Mr. Mistri 2/15. The outstanding liabilities include Rs. 1,000 due to Mr. Sen which has been paid by Mr. Dalal. Necessary entries were not made in the books. Prepare (i) Revaluation Account, and (ii) The Capital Accounts of the partners. Solution Revaluation Account 2009 Rs. 2009 Rs. April1 To Provision for bad and April 1 By Stock in trade 2,500 doubtful debts 550 By Land and Building 5,000 To Furniture and fittings 650 ToCapital A/cs: (Profit on revaluation transferred) Dalal 2,520 Banerji 2,520 Mallick 1,260 6,300 7,500 7,500 8.52 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Partners’ Capital Accounts Dr. Cr. Particulars Dalal Banerji Mallick Mistri Particulars Dalal Benerji Mallick Mistri Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs. To Dalal 1,000 By Balance b/d 12,000 12,000 5,000 – To Banerji 1,000 By General To Balance c/d 19,120 18,120 7,560 3,000 Reserve 2,600 2,600 1,300 By Cash – – – 5,000 By Mistri 1,000 1,000 – – By Outstanding Liabilities 1,000 – – – By Revaluation A/c 2,520 2,520 1,260 – 19,120 18,120 7,560 5,000 19,120 18,120 7,560 5,000 Working Note: Calculation of sacrificing ratio Partners New share Old share Sacrifice Gain 5 2 5 Dalal - 15 5 75 5 2 5 Banerji - 15 5 75 3 1 Mallick No gain No loss – 15 5 2 2 Mistri 15 15 5 Sacrifice by Mr. Dalal and Mr. Banerji = Rs.15,000x = Rs.1,000 each 75 Illustration 5 With the information given in illustration 4, after preparing revaluation account and partners’ capital accounts, prepare the Balance Sheet of the firm after admission of Mr. Mistri. FUNDAMENTALS OF ACCOUNTING 8.53 Copyright -The Institute of Chartered Accountants of India ADMISSION OF NEW PARTNER Solution Balance Sheet of M/s. Dalal, Banerji, Mallick and Mistri as on 1-4-2009 Liabilities Rs. Assets Rs. Sundry Creditors 12,850 Land and Buildings 30,000 Outstanding Liabilities 500 Furniture 5,850 Capital Accounts of Partners : Stock of goods 14,250 Mr. Dalal 19,120 Sundry Debtors 5,500 Mr. Banerji 18,120 Less : Provisions 550 4,950 Mr. Mallick 7,560 Cash in hand 140 Mr. Mistri 3,000 47,800 Cash at Bank 5,960 61,150 61,150 4. COMPUTATION OF NEW PROFIT SHARING RATIO When a new partner is admitted and there is no agreement to the contrary, it is supposed that old partners will continue to have inter se at the old profit sharing ratio. For example, A and B are in partnership sharing profits and losses at the ratio of 3:2. They admitted C as 1/5 partner. For computation of new profit sharing ratio. (i) Firstly, deduct the share offered to new partner from 1. 1 – 1/5 = 4/5 (ii) Divide the balance of share between A and B in the ratio of 3:2. A = 4/5 x 3/5 = 12/25 B = 4/5 × 2/5 = 8/25 (iii) New profit sharing ratio is A : B : C 12/25 : 8/25 : 1/5 or 12/25 : 8/25 : 5/25 i.e. 12 : 8 : 5 Illustration 6 A and B are in partnership sharing profits and losses at the ratio 3:2. They take C as a new partner. Calculate the new profit sharing ratio if - (i) C purchases 1/10 share from A (ii) A and B agree to sacrifice 1/10th share to C in the ratio of 2 : 3 8.54 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India (iii) Simply gets 1/10th share of profit. Solution (i) New profit sharing ratio : A = 3/5 – 1/10 = 5/10 B = 2/5 i.e. 4/10 C = 1/10 i.e. 5 : 4 : 1 (ii) A’s sacrifice 1/10× 2/5 = 2/50 B’s sacrifice 1/10 × 3/5 = 3/50 New profit sharing ratio A = 3/5 – 2/50 = 28/50 B = 2/5 – 3/50 = 17/50 C = 1/10 i.e. 5/50 i.e. 28 : 17 : 5 (iii) Balance of share to be divided between A and B : 1 – 1/10= 9/10 Distribution : A = 9/10 × 3/5 = 27/50 B = 9/10 × 2/5 = 18/50 C = 1/10. i.e. = 5/50 i.e. 27 : 18 : 5 Illustration 7 A and B are in the partnership sharing profits and losses in the proportion of three-fourth and one-fourth respectively. Their balance sheet as on 31st March, 2009 was as follows: Cash Rs. 1,000; sundry debtors Rs. 25,000; stock Rs. 22,000: plant and machinery Rs. 4,000; sundry creditors Rs. 12,000; bank overdraft Rs. 15,000; A’s capital Rs. 15,000; B’s capital Rs. 10,000. On 1st April, 2009, they admitted C into partnership on the following terms: (i) C to purchase one–third of the goodwill for Rs. 2,000 and provide Rs. 10,000 as capital. Goodwill not to appear in books. (ii) Further profits and losses are to be shared by A, B and C equally. (iii) Plant and machinery is to be reduced by 10% and Rs. 500 is to be provided for estimated bad debts. Stock is to be taken at a valuation of Rs. 24,940. FUNDAMENTALS OF ACCOUNTING 8.55 Copyright -The Institute of Chartered Accountants of India ADMISSION OF NEW PARTNER (iv) By bringing in or withdrawing cash and capitals of A and B are to be made proportionate to that of C on their profit-sharing basis. Set out entries to the above arrangement in the firm’s journal and give the partners’ capital accounts in tabular form. Solution Journal Entries as on 1st April, 2009 Dr. (Rs.) Cr. (Rs.) Revaluation Account Dr. 900 To Plant and machinery Account 400 To Provision for bad debts Account 500 (Plant & machinery reduced by 10% and Rs. 500 provided for bad debts) Stock Account Dr. 2,940 To Revaluation Account 2,940 (Value of stock increased by Rs. 2,940) Revaluation Account Dr. 2,040 To A’s capital Account 1,530 To B’s capital Account 510 (Profit on revaluation transferred) Cash Account Dr. 10,000 To C’s capital Account 10,000 (Cash brought in by C as his capital) Cash Account Dr. 2,000 B’s capital Account Dr. 500 To A’s capital Account 2,500 (Entry for goodwill purchased by B and C) A’s capital Account Dr. 9,030 B’s capital Account Dr. 10 To Cash Account 9,040 (Excess amount of capital withdrawn) 8.56 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Partners’ Capital Accounts Dr. Cr. A B C A B C Rs. Rs. Rs. Rs. Rs. Rs. To A’s capital A/c - 500 By Balance b/d 15,000 10,000 – To Cash 9,030 10 By Revaluation A/c 1,530 510 – To Balance c/d 10,000 10,000 10,000 By Cash 2,000 – 10,000 By B’s Capital A/c 500 19,030 10,510 10,000 19,030 10,510 10,000 Working Note: Calculation of goodwill C pays Rs. 2,000 on account of goodwill for 1/3rd share of profit/loss. Total goodwill is Rs. 2,000 x 3 = Rs. 6,000. Gaining ratio: B: 1/3-1/4 = 1/12 C: 1/3 Goodwill to be paid to A: By B Rs. 6,000 x 1/12 = Rs. 500 By C Rs. 6,000 x 1/3 = Rs. 2,000 Total Rs. 2,500 Illustration 8 A and B are partners of X & Co. sharing profits and losses in 3:2 ratio between themselves. On 31st March, 2009, the balance sheet of the firm was as follows: Balance Sheet of X & Co. as at 31.3.2009 Liabilities Rs. Rs. Assets Rs. Capital accounts: Plant and machinery 20,000 A 37,000 Furniture and fittings 5,000 B 28,000 65,000 Stock 15,000 Sundry creditors 5,000 Sundry debtors 20,000 Cash in hand 10,000 70,000 70,000 FUNDAMENTALS OF ACCOUNTING 8.57 Copyright -The Institute of Chartered Accountants of India ADMISSION OF NEW PARTNER X agrees to join the business on the following conditions as and from 1.4.2009: (a) He will introduce Rs. 25,000 as his capital and pay Rs. 15,000 to the partners as premium for goodwill for 1/3rd share of the future profits of the firm. (b) A revaluation of assets of the firm will be made by reducing the value of plant and machinery to Rs. 15,000, stock by 10%, furniture and fitting by Rs. 1,000 and by making a provision of bad and doubtful debts at Rs. 750 on sundry debtors. Prepare profit and loss adjustment account, capital accounts of partners including the incoming partner X assuming that the relative ratios of the old partners will be in equal proportion after admission. Solution Profit and Loss Adjustment Account Dr. Cr. 2009 Rs. 2009 Rs. April 1 April 1 To Plant and machinery A/c 5,000 By Partners’ capital accounts To Stock A/c 1,500 - Loss on revaluation To Furniture and fitting A/c 1,000 A (3/5) 4,950 To Provision for bad and doubtful debts 750 B (2/5) 3,300 8,250 8,250 8,250 Partners’ Capital Accounts Dr. Cr. A B X A B X Rs. Rs. Rs. Rs. Rs. Rs. To Profit & loss adjustment A/c 4,950 3,300 – By Balance b/d 37,000 28,000 – By Cash A/c – – 40,000 To A’s & B’s capital By X’s capital A/cs – – 15,000 A/c 12,000 3,000 – To Balance c/d 44,050 27,700 25,000 [W. N.(ii)] 49,000 31,000 40,000 49,000 31,000 40,000 8.58 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Working Notes: (i) New profit sharing ratio : On admission of X who will be entitled to 1/3rd share of the future profits of the firm. A and B would share the remaining 2/3rd share in equal proportion i.e. 1:1. A: 2/3 x 1/2 = 1/3 B: 2/3 x 1/2 = 1/3 X:1/3 A, B and X would share profits and losses in equal ratio. (ii) Adjustment of goodwill : X pays Rs. 15,000 as premium for goodwill for 1/3rd share of the future profits. Thus, total value of goodwill is Rs. 15,000 x 3 i.e. Rs. 45,000 Sacrificing ratio: A: 3/5 - 1/3 = 4/15 A: 2/5 - 1/3 = 1/15 Hence, sacrificing ratio is 4:1 Adjustment of X’s share of goodwill through existing partners’ capital accounts in the profit sacrificing ratio: Rs. A: 15,000 x 4/5 = 12,000 B: 15,000 x 1/5 = 3,000 15,000 5. HIDDEN GOODWILL When the value of the goodwill of the firm is not specifically given, the value of goodwill has to be inferred as follows: Rs. Incoming partner’s capital x Reciprocal of share of incoming partner xxx Less: Total capital after taking into consideration the capital brought in by incoming partner xxx Value of Goodwill xxx Illustration 9 A and B are partners with capitals of Rs. 7,000 each. They admit C as a partner with 1/4th share in the profits of the firm. C brings Rs. 8,000 as his share of capital. Give the necessary journal entry to record goodwill. FUNDAMENTALS OF ACCOUNTING 8.59 Copyright -The Institute of Chartered Accountants of India ADMISSION OF NEW PARTNER Solution: Journal Entry Particulars Dr. (Rs.) Cr. (Rs.) C’s Capital A/c [Rs. 10,000 x 1/4] Dr. 2,500 To A’s Capital A/c 1,250 To B’s Capital A/c 1,250 (Being the share of C in the hidden goodwill adjusted through capital accounts by crediting sacrificing partners in their sacrificing ratio) ⎛ 4⎞ Note: Hidden Goodwill = ⎜8,000x ⎟−(Rs.7,000+Rs.7,000+8,000)=Rs.10,000 ⎝ 1⎠ Illustration 10 A and B are in partnership sharing profits and losses equally. The Balance Sheet M/s. A and B as on 31.12.2009, was as follows : Liabilities Rs. Assets Rs. Capital A/cs Sundry Fixed Assets 60,000 A 45,000 Stock 30,000 B 45,000 Bank 20,000 Sundry Creditors 20,000 1,10,000 1,10,000 On 1.1.2010 they agreed to take C as 1/3rd partner to increase the capital base to Rs. 1,35,000. C agrees to pay Rs. 60,000. Show the necessary journal entries and partners’ capital accounts. Solution In the Books of M/s. A, B and C Journal Entries Rs. Rs. Bank A/c Dr. 60,000 To C’s Capital A/c 60,000 (Cash brought in by C for 1/3rd share) C’s capital A/c Dr. 15,000 To A’s Capital A/c 7,500 To B’s Capital A/c 7,500 A’s Capital A/c Dr. 7,500 B’s Capital A/c Dr. 7,500 To Bank A/c 15,000 (Amount of goodwill due to A and B withdrawn) 8.60 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Workings : (1) Old Profit Sharing Ratio : 1 : 1 (2) New Profit Sharing Ratio : 1:1:1 (3) C’s share of capital Rs. 1,35,000 × 1/3 = Rs. 45,000 (4) Goodwill Rs. 60,000 – Rs. 45,000 = Rs. 15,000 for 1/3rd share. Total Goodwill : Rs. 15,000 × 3 = Rs. 45,000 Partners’ Capital A/cs Dr. Cr. Particulars A B C Particulars A B C Rs. Rs. Rs. Rs. Rs. Rs. To A 7,500 By Balance b/d 45,000 45,000 – To B 7,500 By Bank – – 60,000 To Bank 7,500 7,500 – By C 7,500 7,500 – To Balance c/d 45,000 45,000 45,000 52,500 52,500 60,000 52,500 52,500 60,000 SELF EXAMINATION QUESTIONS Pick up the correct answer from the given choices : 1. A and B are partners sharing profits and losses in the ratio 5:3. They admitted C and agreed to give him 3/10th of the profit. What is the new ratio after C’s admission? (a) 35:42:17. (b) 35:21:24. (c) 49:22:29. (d) 34:20:12. 2. A and B are partners sharing profits in the ratio 5:3, they admitted C giving him 3/10th share of profit. If C acquires 1/5 from A and 1/10 from B, new profit sharing ratio will be: (a) 5:6:3. (b) 2:4:6. (c) 18:24:38. (d) 17:11:12 3. C was admitted in a firm with 1/4th share of the profits of the firm. C contributes Rs. 15,000 as his capital, A and B are other partners with the profit sharing ratio as 3:2. Find the required capital of A and B, if capital should be in profit sharing ratio taking C’s as base capital: (a) Rs. 27,000 and Rs. 16,000 for A and B respectively. (b) Rs. 27,000 and Rs. 18,000 for A and B respectively. (c) Rs. 32,000 and Rs. 21,000 for A and B respectively. (d) Rs. 31,000 and Rs. 26,000 for A and B respectively. 4. A, B and C are partners sharing profits and losses in the ratio 6:3:3, they agreed to take D into partnership for 1/8th share of profits. Find the new profit sharing ratio. (a) 12:27:36:42. (b) 14:7:7:4. (c) 1:2:3:4. (d) 7:5:3:1. FUNDAMENTALS OF ACCOUNTING 8.61 Copyright -The Institute of Chartered Accountants of India ADMISSION OF NEW PARTNER 5. X and Y are partners sharing profits in the ratio 5:3. They admitted Z for 1/5th share of profits, for which he paid Rs. 1,20,000 against capital and Rs. 60,000 against goodwill. Find the capital balances for each partner taking Z’s capital as base capital. (a) Rs. 3,00,000; Rs. 1,20,000 and Rs.1,20,000. (b) Rs.3,00,000; Rs.1,20,000 and Rs.1,80,000. (c) Rs. 3,00,000; Rs. 1,80,000 and Rs.1,20,000. (d) Rs.3,00,000; Rs.1,80,000 and Rs.1,80,000. 6. A and B are partners sharing profits and losses in the ratio of 3:2 (A’s Capital is Rs. 30,000 and B’s Capital is Rs. 15,000). They admitted C and agreed to give 1/5th share of profits to him. How much C should bring in towards his capital? (a) Rs. 9,000. (b) Rs. 12,000. (c) Rs. 14,500. (d) Rs. 11,250. 7. A and B are partners sharing the profit in the ratio of 3:2. They take C as the new partner, who brings in Rs. 25,000 against capital and Rs. 10,000 against goodwill. New profit sharing ratio is 1:1:1. In what ratio will this amount will be shared among the old partners A & B. (a) Rs. 8,000: Rs. 2,000. (b) Rs. 5,000: Rs. 5,000. (c) Old partners will not get any share in the goodwill brought in by C. (d) Rs. 6,000: Rs. 4,000. 8. A and B are partners sharing the profit in the ratio of 3:2. They take C as the new partner, who is supposed to bring Rs. 25,000 against capital and Rs. 10,000 against goodwill. New profit sharing ratio is 1:1:1. C is able to bring Rs. 30,000 only. How this will be treated in the books of the firm. (a) A and B will share goodwill brought by C as Rs. 4,000: Rs. 1,000. (b) Goodwill not brought, will be adjusted to the extent of Rs. 15,000 in old profit sharing ratio. (c) Both. (d)None. 9. A and B are partners sharing the profit in the ratio of 3:2. They take C as the new partner, who is supposed to bring Rs. 25,000 against capital and Rs. 10,000 against goodwill. New profit sharing ratio is 1:1:1. C is able to bring only his share of Capital. How this will be treated in the books of the firm. (a) A and B will share goodwill bought by C as 4,000:1,000. (b) Goodwill not brought, will be adjusted to the extent of Rs. 30,000 in old profit sharing ratio. (c) Both. (d) None. 10. A and B are partners sharing the profit in the ratio of 3:2. They take C as the new partner, who is supposed to bring Rs. 25,000 against capital and Rs. 10,000 against goodwill. New profit sharing ratio is 1:1:1. C brought cash for his share of Capital and agreed to compensate to A and B outside the firm. How this will be treated in the books of the firm. (a) Cash brought in by C will only be credited to his capital account. (b) Goodwill will be raised to full value in old ratio. (c) Goodwill will be raised to full value in new ratio. 8.62 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India (d) Cash brought by C will be credited to his account and debited with his share of goodwill, which will be debited to A and B’s account in sacrificing ratio. 11. Profit or loss on revaluation is shared among the partners in ……… ratio. (a) Old Profit Sharing. (b) New Profit Sharing. (c) Capital. (d) Equal. 12. Amit and Anil are partners of a partnership firm sharing profits in the ratio of 5:3 respectively. Atul was admitted on the following terms: Atul would pay Rs. 50,000 as capital and Rs. 16,000 as Goodwill, for 1/5th share of profit. Machinery would be appreciated by 10% (book value Rs. 80,000) and building would be depreciated by 20% (Rs. 2,00,000). Unrecorded debtors of Rs. 1,250 would be brought into books now and a creditors amounting to Rs. 2,750 died and need not to pay anything to its estate. Find the distribution of profit/loss on revaluation between Amit, Anil and Atul. (a) Loss – Rs. 17,500: Rs. 10,500:0. (b) Loss – Rs. 14,000: Rs. 8,400: Rs. 5,600. (c) Profits – Rs. 17,500: Rs. 10,500:0. (d) Profits – Rs. 14,000: Rs. 8,400: Rs. 5,600. 13. Amit and Anil are partners of a partnership firm sharing profits in the ratio of 5:3 with capital of Rs. 2,50,000 & Rs. 2,00,000 respectively. Atul was admitted on the following terms: Atul would pay Rs. 50,000 as capital and Rs. 16,000 as Goodwill, for 1/5th share of profit. Find the balance of capital accounts after admission of Atul. (a) Rs. 2,60,000: Rs. 2,06,000: Rs. 50,000. (b) Rs. 2,20,000: Rs. 1,82,000: Rs. 66,000. (c) Rs. 2,92,500: Rs. 2,25,500: Rs. 50,000. (d) Rs. 2,82,500: Rs. 2,19,500: Rs. 66,000. 14. A and B shares profit and losses equally. They admit C as an equal partner and assets were revalued as follow: Goodwill at Rs. 30,000 (book value NIL). Stock at Rs. 20,000 (book value Rs. 12,000); Machinery at Rs. 60,000 (book value Rs. 55,000). C is to bring in Rs. 20,000 as his capital and the necessary cash towards his share of Goodwill. Goodwill Account will not be shown in the books. Find the profit/loss on revaluation to be shared among A, B and C. (a) Rs. 21,500: Rs. 21,500:0. (b) Rs. 6,500: Rs. 6,500:0. (c) Rs. 14,333: Rs. 14,333: Rs. 14,333. (d) Rs. 4,333: Rs. 4,333: Rs. 4,333. 15. A and B shares profit and losses equally. They admit C as an equal partner and goodwill was valued as Rs. 30,000 (book value NIL). C is to bring in Rs. 20,000 as his capital and the necessary cash towards his share of Goodwill. Goodwill Account will not remain in the books. What will be the final effect of goodwill in the partner’s capital account? (a) A & B’s account credited with Rs. 5,000 each. (b) All partners’ account credited with Rs. 10,000 each. (c) Only C’s account credited with Rs. 10,000 as cash bought in for goodwill. (d) Final effect will be nil in each partner. FUNDAMENTALS OF ACCOUNTING 8.63 Copyright -The Institute of Chartered Accountants of India ADMISSION OF NEW PARTNER 16. A and B having share capital of Rs. 10,000 each, share profits and losses equally. They admit C as an equal partner and goodwill was valued as Rs. 30,000 (book value NIL). C is to bring in Rs. 20,000 as his capital and the necessary cash towards his share of Goodwill. Goodwill Account will not be shown in the books. If profit on revaluation is Rs. 13,000, find the closing balance of the capital account. (a) Rs. 31,500: Rs. 31,500: Rs. 20,000. (b) Rs. 31,500: Rs. 31,500: Rs. 30,000. (c) Rs. 26,500: Rs. 26,500: Rs. 30,000. (d) Rs. 20,000: Rs. 20,000: Rs. 20,000. 17. Balance sheet prepared after the new partnership agreement, assets and liabilities are recorded at: (a) Original Value. (b) Revalued Figure. (c) At realisable value. (d) At current cost. 18. P and Q are partners sharing Profits in the ratio of 2:1. R is admitted to the partnership with effect from 1st April on the term that he will bring Rs. 20,000 as his capital for 1/4th share and pays Rs. 9,000 for goodwill, half of which is to be withdrawn by P and Q. How much cash can P & Q withdraw from the firm (if any). (a) Rs. 3,000: Rs. 1,500. (b) Rs. 6,000: Rs. 3,000. (c) NIL. (d) None of the above. 19. P and Q are partners sharing Profits in the ratio of 2:1. R is admitted to the partnership with effect from 1st April on the term that he will bring Rs. 20,000 as his capital for 1/4th share and pays Rs. 9,000 for goodwill, half of which is to be withdrawn by P and Q. If profit on revaluation is Rs. 6,000 and opening capital of P is Rs. 40,000 and of Q is Rs. 30,000, find the closing balance of each capital. (a) Rs. 47,000: Rs. 33,500: Rs. 20,000. (b) Rs. 50,000: Rs. 35,000: Rs. 20,000. (c) Rs. 40,000: Rs. 30,000: Rs. 20,000. (d) Rs. 41,000: Rs. 30,500: Rs. 29,000. 20. Adam, Brain and Chris were equal partners of a firm with goodwill Rs. 1,20,000 shown in the balance sheet and they agreed to take Daniel as an equal partner on the term that he should bring Rs. 1,60,000 as his capital and goodwill, his share of goodwill was evaluated at Rs. 60,000 and the goodwill account is to be written off before admission. What will be the treatment for goodwill? (a) Write off the goodwill of Rs. 1,20,000 in old ratio. (b) Cash brought in by Daniel for goodwill will be distributed among old partners in sacrificing ratio. (c) Both (a) & (b) (d) None of the above 8.64 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 21. Which of the following asset is compulsory to revalue at the time of admission of a new partner: (a) Stock. (b) Fixed Assets. (c) Investment. (d) Goodwill. 22. X and Y are partners sharing profits in the ratio of 3 : 1. They admit Z as a partner who pays Rs. 4,000 as Goodwill the new profit sharing ratio being 2 : 1 : 1 among X, Y and Z respectively. The amount of goodwill will be credited to : (a) X and Y as Rs. 3,000 and Rs. 1,000 respectively. (b) X only (c) Y only. (d) None of the above. ANSWERS 1. (b) 2. (d) 3. (b) 4. (b) 5. (c) 6. (d) 7. (a) 8. (c) 9. (b) 10. (a) 11. (a) 12. (a) 13. (a) 14. (b) 15. (a) 16. (a) 17. (b) 18. (a) 19. (a) 20. (c) 21. (d) 22. (b) FUNDAMENTALS OF ACCOUNTING 8.65 Copyright -The Institute of Chartered Accountants of India CHAPTER ----- 8 PARTNERSHIP ACCOUNTS Unit 4 Retirement of a Partner Copyright -The Institute of Chartered Accountants of India Learning Objectives After studying this unit, you will be able to : (cid:2) Learn how to compute the gaining ratio and observe the use of such gaining ratio, (cid:2) Be familiar with the accounting treatment in relation to revaluation of assets and liabilities, (cid:2) Learn the accounting entries to be passed for transfer of reserves standing in the balance sheet to partners’ capital accounts in a manner already discussed for admission of a partner in unit 3 of the chapter, (cid:2) Learn the technique of keeping records if the balance due to the retiring partner is transferred to loan account. (cid:2) Familiarize with the term Joint Life Policy. (cid:2) Learn how to keep records for payment of premium in relation to Joint Life Policy. Also observe the accounting treatment in relation to such Joint Life Policy in case of retirement of a partner. 1. INTRODUCTION A partner may retire from the partnership firm because of old age, illness, etc. Generally, the business of the partnership firm may not come to an end when one of the partners retires. Other partners may continue to run the business of the firm. Readjustment takes place in case of retirement of a partner likewise the case of admission of a partner. Whenever a partner retires, the continuing partners make gain in terms of profit sharing ratio. Therefore, the remaining arrange for the amount to be paid to discharge the claims of the retiring partners. Assets and liabilities are revalued, value of goodwill is raised and surrender value of joint life policy, if any, is taken into account. Revaluation profit and reserves are transferred to capital and current accounts of partners. Lastly, final amount due to the retiring partner is determined and discharged. 2. CALCULATION OF GAINING RATIO On retirement of a partner, the continuing partners will gain in terms of profit sharing ratio. For example, if A, B and C were sharing profits and losses in the ratio of 5 : 3 : 2 and B retires, then A and C have to decide at which ratio they will share profits and losses in future. If it is decided that the continuing partners will share profits and losses in future at the ratio of 3:2, then A gains 1/10th [(3/5)-(5/10)] and C gains 2/10 [(2/5)-(2/10)]. So the gaining ratio between A and C is 1:2. If A and C decide to continue at the ratio 5:2, this indicates that they are dividing the gained share in the previous profit sharing ratio. Example: Amir, Jamir and Samir are in partnership sharing profits and losses at the ratio of 3:2:1. Now Amir wants to retire and Jamir and Samir want to continue at the ratio of 3:2. In this case, Jamir gains 8/30th of share of partnership (3/5 less 2/6) whereas Samir gains 7/30th (2/5 less 1/6) share of the partnership. So gaining ratio between Jamir and Samir is 8:7. On the other hand, if Jamir and Samir would decide to continue sharing profits and losses at the ratio of 2:1, then Jamir would gain 2/6th share of partnership i.e. [(2/3)–(2/6)], and Samir would gain 1/6th share of partnership i.e. [(1/3)–(1/6)]. So it appears that in such a case gaining ratio of Jamir and Samir would be 2:1. i.e., the existing profit sharing ratio between them. FUNDAMENTALS OF ACCOUNTING 8.67 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER 3. REVALUATION OF ASSETS AND LIABILITIES ON RETIREMENT OF A PARTNER On retirement of a partner, it is required to revalue assets and liabilities just as in the case of admission of a partner. If there is revaluation profit, then such profit should be distributed amongst the existing partners including the retiring partner at the existing profit sharing ratio. On the other hand, if there is loss on revaluation that is also to be distributed to all the partners including the retiring partner at the existing profit sharing ratio. To arrive at, profit or loss on revaluation of assets and liabilities, a Revaluation Account or Profit and Loss Adjustment Account is opened. Revaluation Account or Profit and Loss Adjustment Account is closed automatically by transfer of profit or loss balance to the Partners’ Capital Accounts. If it is decided that revalued figures of assets and liabilities will not appear in the balance sheet of the continuing partners, then a journal entry should be passed with the amount payable or chargeable to the retiring partner which the continuing partners will share at the ratio of gain. In the first instance, the journal entry for distribution of profit or loss on revaluation which will appear in the balance sheet also is as follows : Revaluation A/c Dr. To Partners’ Capital A/cs (For profit on revaluation) Or Partners’ Capital A/cs Dr. To Revaluation A/c (For loss on revaluation) Now see how to deal with a situation where revalued figures will not appear in the Balance Sheet. If A, B & C share profits and losses equally and there is a revaluation profit of Rs. 30,000 calculated on A’s retirement, then Rs. 10,000 becomes due to A which is to be borne by B and C equally. So the journal entry will be as follows : Rs. Rs. B’s Capital A/c Dr. 5,000 C’s Capital A/c Dr. 5,000 To A’s Capital A/c 10,000 Alternatively it is possible to account for the increase in the value of assets or decrease in the value of liabilities by debiting the appropriate asset account or liability account and crediting partners’ capital account at the existing profit sharing ratio. Simultaneously the partners capital 8.68 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India accounts are to be debited for such gain at the new profit sharing ratio and the respective assets and liabilities account is to be credited again. So the following journal entries are necessary for Rs. 10,000 increase in sundry fixed assets and Rs. 2,000/- decrease in sundry creditors: 1) Sundry Fixed Assets A/c Dr. 10,000 Sundry Creditors A/c Dr. 2,000 To A’s Capital A/c 4,000 To B’s Capital A/c 4,000 To C’s Capital A/c 4,000 (Distribution of Revaluation Profit amongst the existing partners at the old profit sharing ratio) 2) B’s Capital A/c Dr. 6,000 C’s Capital A/c Dr. 6,000 To Sundry Fixed Assets A/c 10,000 To Sundry Creditors A/c 2,000 (Being revalued assets and liabilities are not required to be shown in the Balance Sheet) In this case it is not necessary to open a separate Revaluation Account. 4. RESERVE On the retirement of a partner any undistributed profit or reserve standing at the Balance Sheet is to be credited to the Partners’ Capital Accounts in the old profit sharing ratio. Alternatively, only the retiring partner’s share may be transferred to his Capital Account if the others continue at the same profit sharing ratio. For example, A, B and C were in partnership sharing profits and losses at the ratio 5 : 3 : 2. A retired and B and C agreed to share profits and losses at the ratio of 3:2. Reserve balance was Rs. 10,000. In this case either of the following journal entries can be passed : Rs. Rs. (1) Reserve A/c Dr. 10,000 To A’s Capital A/c 5,000 To B’s Capital A/c 3,000 To C’s Capital A/c 2,000 (Transfer of reserve to Partners’ Capital A/cs in 5 : 3 : 2 on A’s retirement) or (2) Reserve A/c Dr. 5,000 To A’s Capital A/c 5,000 (Transfer of A’s share of Reserve to the Capital Account on his retirement) FUNDAMENTALS OF ACCOUNTING 8.69 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Note that alternative (2) has the same implications because B and C continued at the same ratio 3 : 2 as they did before A’s retirement. Take another example : X, Y and Z were equal partners. Z decided to retire. X and Y decided to continue at the ratio of 3 : 2. Reserve standing at the date of retirement of Z was Rs. 9,000. In this case adjustment of Z’s share was not sufficient since the relationship between X and Y was also changed. 3 1 9-5 4 X’s gain : - = = 5 3 15 15 2 1 6-5 1 Y’s gain : - = = 5 3 15 15 Gaining Ratio : X : Y 4 : 1 This is different from 1 : 1. So alternative (1) is to be followed in this case. Rs. Rs. Reserve A/c Dr. 9,000 To X’s Capital A/c 3,000 To Y’s Capital A/c 3,000 To Z’s Capital A/c 3,000 (Transfer of Reserve on Z’s retirement) If the continuing partners want to show reserve in the Balance Sheet, the journal entry will be: Rs. Rs. X’s Capital A/c Dr. 2,400 Y’s Capital A/c Dr. 600 To Z’s Capital A/c 3,000 (Adjustment entry for Z’s share in reserve) 5. FINAL PAYMENT TO A RETIRING PARTNER The following adjustments are necessary in the Capital A/c : (i) Transfer of reserve, (ii) Transfer of goodwill, (iii) Transfer of profit/loss on revaluation. After adjustment of the above mentioned items, the Capital Account balance standing to the credit of the retiring partner represents amount to be paid to him. 8.70 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India The continuing partners may discharge the whole claim at the time of retirement. Then the journal entry will appear as follows : Retiring Partner’s Capital A/c Dr. To Bank A/c Sometimes the retiring partner agrees to retain some portion of his claim in the partnership as loan. The journal entry will be as follows : Retiring partner’s Capital A/c Dr. To Retiring Partner’s Loan A/c To Bank A/c Illustration 1 A and B partners in a business sharing profit and losses as A-3/5ths and B-2/5ths. Their balance sheet as on 1st January, 2009 is given below : Liabilities Rs. Assets Rs. Capital Accounts Plant and Machinery 20,000 A 20,000 Stock 16,000 B 15,000 35,000 Debtors 15,000 Reserve Account 15,000 Balance at Bank 6,000 Sundry Creditors 7,500 Cash in hand 500 57,500 57,500 B retires from the business owing to illness and A takes it over. The following revaluation was made: (1) The goodwill of the firm is valued at Rs. 25,000. (2) Depreciate Plant & Machinery by 7.5% and stock by 15%. (3) Doubtful debts provision is raised against debtors at 5% and a discount reserve against creditors at 2%. You are asked to journalise the above transactions in the books of the firm and close the Partners’ Accounts as on 1st January 2009. Give also the opening Balance Sheet of A. Solution Journal 2009 Dr. Cr Rs. Rs. Jan 1. A’s Capital Account Dr. 10,000 To B’s Capital Account 10,000 (The amount of share of goodwill adjusted on B’s retirement) FUNDAMENTALS OF ACCOUNTING 8.71 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Reserve Account Dr. 15,000 To A’s Capital Account 9,000 To B’s Capital Account 6,000 (Transfer of reserve to A’s Capital Account and B’s Capital Account in the profit sharing ratio) Profit and Loss Adjustment Account Dr. 4,650 To Plant and Machinery Account 1,500 To Stock Account 2,400 To Provision for Doubtful Debts Account 750 (Reduction in the values, assets and creation of provision for doubtful debts as per agreement with B) Reserve for Discount on Creditors A/c Dr. 150 To Profit and Loss Adjustment Account 150 (Creation of reserve for discount on creditors at 2%) A’s Capital Account Dr. 2,700 B’s Capital Account Dr. 1,800 To Profit and Loss Adjustment Account 4,500 (Transfer of loss on revaluation of assets and liabilities to Capital Accounts of A and B in the profit sharing ratio) B’s Capital Account Dr. 29,200 To B’s Loan Account 29,200 (Transfer of B’s Capital Account to his Loan A/c) Balance Sheet of A as on 1st January, 2009 Liabilities Rs. Rs. Assets Rs. A’s Capital Account 16,300 Plant and Machinery 18,500 B’s Loan Account 29,200 Stock 13,600 Sundry Creditors 7,500 Debtors 15,000 Less : Reserve for Discount 150 7,350 Less : Prov for Bad Debts 750 14,250 Balance at Bank 6,000 Cash 500 52,850 52,850 8.72 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Illustration 2 F, G and K were partners sharing profits and losses at the 2 : 2 : 1. K wants to retire on 31.12.2009. Given below is the Balance Sheet of the partnership as well as other information : Balance Sheet as on 31.12.2009 Liabilities Rs. Assets Rs. Capital A/cs Sundry Fixed Assets 1,50,000 F 1,20,000 Stock 50,000 G 80,000 Debtors 50,000 K 60,000 Bills Receivable 20,000 Reserve 10,000 Bank 50,000 Sundry Creditors 50,000 3,20,000 3,20,000 F and G agree to share profits and losses at the ratio of 3 : 2 in future. Value of Goodwill is taken to be Rs. 50,000. Sundry Fixed Assets are revalued upward by Rs. 30,000 and stock by Rs. 10,000. Bills Receivable dishonoured Rs. 5,000 on 31.12.2009 but not recorded in the books. Dishonour of bill was due to insolvency of the customer. F and G agree to bring sufficient cash to discharge claim of K and to make their capital proportionate. Also they wanted to maintain Rs. 75,000 bank balance for working capital. Pass necessary journal entries and draft the Balance Sheet of Ms/ F & G. Solution Journal Entries Rs. Rs. (1) F’s Capital A/c Dr. 10,000 To K’s Capital A/c 10,000 (Being the adjustment for goodwill on K’s retirement) - Refer W.N. (2) Reserve A/c Dr. 10,000 To F’s Capital A/c 4,000 To G’s Capital A/c 4,000 To K’s Capital A/c 2,000 (Transfer of Reserve to Partners’ Capital A/cs on K’s retirement) (3) Sundry Fixed Assets A/c Dr. 30,000 Stock A/c Dr. 10,000 To Profit and Loss Adjustment A/c 40,000 (Increase in the value of Sundry Fixed Assets and Stock recorded) FUNDAMENTALS OF ACCOUNTING 8.73 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER (4) Profit and Loss Adjustment A/c Dr. 5,000 To Bills Receivable A/c 5,000 (Loss arising out of dishonoured bill recorded) (5) Profit and Loss Adjustment A/c Dr. 35,000 To F’s Capital A/c 14,000 To G’s Capital A/c 14,000 To K’s Capital A/c 7,000 (Profit on revaluation transferred to Partners’ Capital A/cs on K’s retirement) (6) Bank A/c Dr. 1,04,000 To F’s Capital A/c 70,000 To G’s Capital A/c 34,000 (Cash brought in by F and G as per agreement) (7) K’s Capital A/c Dr. 79,000 To Bank A/c 79,000 (Payment made to K on retirement) Working Note: Adjusting entry for goodwill Partner Old Share New Share Gain Sacrifice 2 3 1 F – 5 5 5 2 2 G – – 5 5 1 1 K – – 5 5 Adjusting entry: F’s Capital A/c (50,000 X 1/5) Dr. Rs. 10,000 To K’s Capital A/c Rs. 10,000 8.74 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Illustration 3 With the illustration 2, prepare capital accounts of partners and draft the Balance Sheet of Ms/ F & G after K’s retirement. Solution Balance Sheet (after K’s retirement) Liabilities Rs. Assets Rs. Capital A/cs Sundry Fixed Assets 1,80,000 F 1,98,000 Stock 60,000 G 1,32,000 Debtors 50,000 Sundry Creditors 50,000 Bills Receivable 15,000 Bank 75,000 3,80,000 3,80,000 Partners’ Capital Accounts F G K F G K Rs. Rs. Rs. Rs. Rs. Rs. To K’s Capital A/c 10,000 – – By Balance b/d 1,20,000 80,000 60,000 To Balance c/d 1,28,000 98,000 79,000 By F’s Capital A/c 10,000 By P & L Adj. A/c 14,000 14,000 7,000 By Reserve 4,000 4,000 2,000 1,38,000 98,000 79,000 1,38,000 98,000 79,000 To Bank – – 79,000 By Balance b/d 1,28,000 98,000 79,000 To Balance c/d 1,98,000 1,32,000 – By Bank 70,000 34,000 – 1,98,000 1,32,000 79,000 1,98,000 1,32,000 79,000 Working Notes : 1. Total Capital Rs. Sundry Fixed Assets (Rs. 1,50,000 + 30,000) 1,80,000 Stock (Rs. 50,000 + Rs. 10,000) 60,000 Debtors 50,000 Bills Receivable (Rs. 20,000 – Rs. 5,000) 15,000 Bank 75,000 3,80,000 Less: Sundry Ceditors 50,000 3,30,000 F’s share (3,30,000 × 3/5) 1,98,000 G’s share (3,30,000 × 2/5) 1,32,000 FUNDAMENTALS OF ACCOUNTING 8.75 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER 2. Bank Account Rs. Rs. To Balance b/d 50,000 By K’s Capital A/c 79,000 To F’s Capital A/c 70,000 By Balance c/d 75,000 To G’s Capital A/c 34,000 1,54,000 1,54,000 Illustration 4 A, B & C were in partnership sharing profits in the proportions of 5:4:3. The balance sheet of the firm as on 31st March, 2009 was as under : Liabilities Rs. Assets Rs. Capital accounts: Goodwill 40,000 A 1,35,930 Fixtures 8,200 B 95,120 Stock 1,57,300 C 61,170 Sundry Debtors 93,500 Sundry creditors 41,690 Cash 34,910 3,33,910 3,33,910 A had been suffering from ill-health and gave notice that he wished to retire. An agreement was, therefore, entered into as on 31st March, 2009, the terms of which were as follows: (i) The profit and loss account for the year ended 31st March, 2009 which showed a net profit of Rs. 48,000 was to be re-opened. B was to be credited with Rs. 4,000 as bonus, in consideration of the extra work which had devolved upon him during the year. The profit sharing was to be revised as from 1st April, 2008, to 3:4:4. (ii) Goodwill was to be valued at two years’ purchase of the average profits of the preceding five years. The fixtures were to be valued by an independent valuer. A provision of 2% was to be made for doubtful debts and the remaining assets were to be taken at their book values. The valuations arising out of the above agreement were goodwill Rs. 56,800 and fixtures Rs. 10,980. B and C agreed, as between themselves, to continue the business, sharing profits in the ratio of 3:2 and decided to eliminate goodwill from the balance sheet, to retain the fixtures on the books at the revised value, and to increase the provision for doubtful debts to 6%. You are required to submit the journal entries necessary to give effect to the above arrangements and to draw up the capital account of the partners after carrying out all adjusting entries as stated above. 8.76 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Solution Journal Entries Particulars Dr. Cr. Rs. Rs. A’s Capital Account Dr. 20,000 B’s Capital Account Dr. 16,000 C’s Capital Account Dr. 12,000 To Profit and Loss Adjustment Account 48,000 (Profit written back for making adjustments) Profit and Loss Adjustment Account Dr. 4,000 To B’s Capital account 4,000 (Bonus Credited to B’s Capital Account) Profit and Loss Adjustment Account Dr. 44,000 To A’s Capital Account 12,000 To B’s Capital Account 16,000 To C’s Capital Account 16,000 (Distribution of profits in the new ratio) Fixtures Account Dr. 2,780 To Provision for Doubtful debts Account @ 2% 1,870 To A’s Capital Account 248 To B’s Capital Account 331 To C’s Capital Account 331 (Revaluation of assets on A’s retirement) A’s Capital Account Dr. 10,909 B’s Capital Account Dr. 14,545 C’s Capital Account Dr. 14,546 To Goodwill 40,000 (Old goodwill shown in the balance sheet has been written off) A’s Capital Account Dr. 1,32,760 To A’s Loan Account 1,32,760 (Transfer of A’s Capital Account to his Loan Account) B’s Capital Account Dr. 2,244 C’s Capital Account Dr. 1,496 To Provision for Doubtful Debts Account 3,740 (Raising provision for bad debts) FUNDAMENTALS OF ACCOUNTING 8.77 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER B’s Capital Account Dr. 13,425 C’s Capital Account Dr. 2,066 To A’s Capital Account 15,491 (Adjusting entry of goodwill passed through partners’ capital accounts in gaining/sacrificing ratio) Partners’ Capital Accounts Dr. Cr. A B C A B C Rs. Rs. Rs. Rs. Rs. Rs. To Profit and Loss Adjustment A/c 20,000 16,000 12,000 By Balance b/d 1,35,930 95,120 61,170 By Profit and Loss To Goodwill 10,909 14,545 14,546 Adjustment A/c – 4,000 – To A’s Loan A/c 1,32,760 – – To Provision for By Profit and loss Doubtful Adjustment A/c 12,000 16,000 16,000 Debts A/c – 2,244 1,496 By Fixtures Less To A – 13,425 2,066 provision for To Balance c/d – 69,237 47,393 DD A/c 248 331 331 By B 13,425 By C 2,066 1,63,669 1,15,451 77,501 1,63,669 1,15,451 77,501 Note : The balance of A’s Capital Account has been transferred to A’s Loan Account. Working Note: Calculation for adjustment of Amount of Goodwill Partner Old Share New Share Gain Sacrifice 3 3 A – – 11 11 4 3 13 B – 11 5 55 4 2 2 C – 11 5 55 Illustration 5 K, L & M are partners sharing profits and losses in the ratio 5:3:2. Due to illness, L wanted to retire from the firm on 31.3.2009 and admit his son N in his place. 8.78 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Balance Sheet of K, L and M as on 31.3.2009 Liabilities Rs. Rs. Assets Rs. Capital: Goodwill 30,000 K 40,000 Furniture 20,000 L 60,000 Sundry Debtors 50,000 M 30,000 1,30,000 Stock in Trade 50,000 Reserve 50,000 Cash and Bank balances 50,000 Sundry Creditors 20,000 2,00,000 2,00,000 On retirement of L assets were revalued : Goodwill Rs. 50,000, furniture Rs. 10,000 and Stock in trade Rs. 30,000. 50% of the amount due to L was paid off in cash and the balance was retained in the firm as capital of N. On admission of the new partner, goodwill has been written off. M is paid off his extra balance to make capital proportionate. Pass necessary journal entries. Prepare balance sheet of M/s K, M and N as on 1.4.2009. Show necessary workings. Solution Journal Entries Date Particulars Dr. Cr. Rs. Rs. 31.3.09 K’s Capital A/c Dr. 15,000 L’s Capital A/c Dr. 9,000 M’s Capital A/c Dr. 6,000 To Goodwill A/c 30,000 (Being old goodwill of balance sheet written off) Profit and Loss Adjustment A/c Dr. 30,000 To Furniture A/c 10,000 To Stock in Trade A/c 20,000 (Being revaluation of furniture and stock in trade recorded) K’s Capital A/c Dr. 15,000 L’s Capital A/c Dr. 9,000 M’s Capital A/c Dr. 6,000 To Profit and Loss Adjustment A/c 30,000 (Being net revaluation loss debited to capital accounts of K, L and M in the ratio 5:3:2) FUNDAMENTALS OF ACCOUNTING 8.79 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Reserve A/c Dr. 50,000 To K’s Capital A/c 25,000 To L’s Capital A/c 15,000 To M’s Capital A/c 10,000 (Being reserve transferred to capital accounts, K, L and M) L’s Capital A/c Dr. 72,000 To Cash A/c 36,000 To N’s Capital A/c 36,000 (Being 50% of the amount due to L was paid off in cash and balance was retained in the firm as capital of N) N’s Capital A/c Dr. 15,000 To L’s Capital A/c 15,000 (Being adjusting entry for goodwill passed in gaining/sacrificing ratio) M’s Capital A/c Dr. 14,000 To Bank A/c 14,000 (Being amount paid to M to make his capital proportionate) Working Note: 1. Calculation for adjustment of Amount of Goodwill Partner Old Share New Share Gain Sacrifice 5 5 K – – 10 10 3 3 L – – 10 10 2 2 M – – 10 10 3 3 N – – 10 10 2. Calculation of excess capital paid off to M to make capital proportionate. Partner Capital Balance Capital Ratio P/L Ratio Excess Capital (After all Paid Off Adjustments) K 35,000 5 5 – N 21,000 3 3 – 28,000 M 28,000 4 2 x 2 = 14,000 4 8.80 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Illustration 6 With the information given in illustration 5, prepare capital accounts of partners and prepare balance sheet of M/s K, M and N as on 1.4.2009. Show necessary workings. Solution Partners’ Capital Accounts Dr. Cr. K L M N K L M N Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs. To Goodwill 15,000 9,000 6,000 - By Balance b/d 40,000 60,000 30,000 - To Profit and By Reserve 25,000 15,000 10,000 - Loss adjustment By L’s Capital A/c - - - 36,000 A/c 15,000 9,000 6,000 - By N’s Capital A/c - 15,000 - - To Cash A/c - 36,000 - - To N’s capital A/c - 36,000 - - To L’s Capital A/c - - - 15,000 To Bank A/c (Balancing figure) - - 14,000 - To Balance c/d 35,000 - 14,000 21,000 65,000 90,000 40,000 36,000 65,000 90,000 40,000 36,000 By Balance b/d 35,000 – 14,000 21,000 Balance Sheet of M/s K, M & N as on 1st April, 2009 Liabilities Rs. Rs. Assets Rs. Capital Accounts: Furniture 10,000 K 35,000 Sundry Debtors 50,000 M 14,000 Stock in Trade 30,000 N 21,000 70,000 Sundry Creditors 20,000 90,000 90,000 FUNDAMENTALS OF ACCOUNTING 8.81 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Illustration 7 Dowell & Co. is a partnership firm with partners Mr. A, Mr. B and Mr., C, sharing profits and losses in the ratio of 10:6:4. The balance sheet of the firm as at 31st March, 2009 is as under: Rs. Rs. Capital : Land 10,000 Mr. A 80,000 Buildings 2,00,000 Mr. B 20,000 Plant and machinery 1,30,000 Mr. C 30,000 1,30,000 Furniture 43,000 Reserves Investments 12,000 (unappropriated profit) 20,000 Stock 1,30,000 Long Term Debt 3,00,000 Debtors 1,39,000 Bank Overdraft 44,000 Trade Creditors 1,70,000 6,64,000 6,64,000 It was mutually agreed that Mr. B will retire from partnership and in his place Mr. D will be admitted as a partner with effect from 1st April, 2009. For this purpose, the following adjustments are to be made: (a) Goodwill is to be valued at Rs. 1 lakh but the same will not appear as an asset in the books of the reconstituted firm. (b) Buildings and plant and machinery are to be depreciated by 5% and 20% respectively. Investments are to be taken over by the retiring partner at Rs. 15,000. Provision of 20% is to be made on debtors to cover doubtful debts. (c) In the reconstituted firm, the total capital will be Rs. 2 lakhs which will be contributed by Mr. A, Mr. C and Mr. D in their new profit sharing ratio, which is 2:2:1. (a) The surplus funds, if any, will be used for repaying bank overdraft. (b) The amount due to retiring partner shall be transferred to his loan account. Prepare (a) Revaluation account; (b) Partners’ capital accounts; (c) Bank account; and (d) Balance sheet of the reconstituted firm as on 1st April, 2009. 8.82 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Solution Revaluation Account Dr. Cr. Rs. Rs. To Buildings A/c 10,000 By Investments A/c 3,000 To Plant and Machinery A/c 26,000 By Loss to Partners: To Provision for Doubtful Debts A/c 27,800 A 30,400 B 18,240 C 12,160 60,800 63,800 63,800 A’s Capital Account Dr. Cr. Rs. Rs. To Revaluation A/c 30,400 By Balance b/d 80,000 To Balance c/d 80,000 By Reserves A/c 10,000 By C and D’s Capital A/c 10,000 By Bank A/c (balancing figure) 10,400 1,10,400 1,10,400 B’s Capital Account Dr. Cr. Rs. Rs. To Revaluation A/c 18,240 By Balance b/d 20,000 To Investments A/c 15,000 By Reserves A/c 6,000 To B’s Loan A/c 22,760 By C and D’s Capital A/c 30,000 56,000 56,000 C’s Capital Account Dr. Cr. Rs. Rs. To Revaluation A/c 12,160 By Balance b/d 30,000 To A and B’s Capital A/c 20,000 By Reserves A/c 4,000 To Balance c/d 80,000 By Bank A/c (balancing figure) 78,160 1,12,160 1,12,160 FUNDAMENTALS OF ACCOUNTING 8.83 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER D’s Capital Account Dr. Cr. Rs. Rs. To A and B’s Capital A/cs 20,000 By Bank A/c 60,000 To Balance c/d 40,000 60,000 60,000 Illustration 8 After preparing revaluation account and partners’ capital accounts, let us prepare Bank account and Balance Sheet of the reconstituted firm as on 1st April, 2009 from the information given in illustration 7. Solution Bank Account Dr. Cr. Rs. Rs. To A’s capital A/c 10,400 By Bank Overdraft A/c 44,000 To C’s capital A/c 78,160 By Balance c/d 1,04,560 To D’s capital A/c 60,000 1,48,560 1,48,560 Balance Sheet of Dowell Co. as at 1st April, 2009 Liabilities Rs. Assets Rs. Capital Accounts: Land 10,000 A 80,000 Buildings 1,90,000 B 80,000 Plant and Machinery 1,04,000 C 40,000 2,00,000 Furniture 43,000 Long Term Debts 3,00,000 Stock 1,30,000 Trade Creditors 1,70,000 Debtors 1,39,000 B’s Loan Account 22,760 Less: Provision for Doubtful Debts 27,800 1,11,200 Balance at Bank 1,04,560 6,92,760 6,92,760 8.84 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 6. PAYING A PARTNER’S LOAN IN INSTALMENT Strictly speaking, paying a partner’s loan is only a matter of arranging finance. However, sometimes it is stated that the loan is to be paid off in so many equal instalments and that the balance is to carry interest. In such case what should be done is that the loan should be divided into equal parts. The interest for the period should be calculated and the payment should consist of the instalment on account of the loan plus interest for the period. Suppose a partner’s loan stands at Rs. 30,000 and that it has to be paid in four annual equal instalments and that the loan is to carry interest at 6% per annum. The annual instalment on account of loan comes to Rs. 7,500. For the first year the first interest is Rs. 1,800 i.e. 6% on Rs. 30,000. In the first year the amount to be paid will be Rs. 9,300. Balance of Rs. 22,500 will now be left. Next year the interest will be Rs. 1,350. The amount to be paid therefore will be Rs. 7,500 plust interest viz., Rs. 8,850. The loan account will appear in the books as under. Retiring Partner’s loan Account Dr. Cr. Rs. Rs. I Year To Cash (7,500 + 1,800) 9,300 I year By Capital Account 30,000 To Balance c/d 22,500 By Interest Account 1,800 31,800 31,800 II Year To Cash (7,500 + 1,350) 8,850 II Year By Balance b/d 22,500 To Balance c/d 15,000 By Interest A/c 1,350 (6% on Rs. 22,500) 23,850 23,850 III Year To Cash 8,400 III Year By Balance b/d 15,000 To Balance c/d 7,500 By Interest Account 900 15,900 15,900 IV Year To Cash 7,950 IV Year By Balance b/d 7,500 450 7,950 7,950 FUNDAMENTALS OF ACCOUNTING 8.85 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Illustration 9 M/s X and Co. is a partnership firm with the partners A, B and C sharing profits and losses in the ratio of 3:2:5. The balance sheet of the firm as on 30th June 2009, was as under : Balance Sheet of X and Co. as on 30.06.2009 Liabilities Rs. Assets Rs. A’s Capital A/c 1,04,000 Land 1,00,000 B’s Capital A/c 76,000 Building 2,00,000 C’s Capital A/c 1,40,000 Plant and Machinery 3,80,000 Long Term Loan 4,00,000 Investments 22,000 Bank Overdraft 44,000 Stock 1,16,000 Trade Creditors 1,93,000 Sundry Debtors 1,39,000 9,57,000 9,57,000 It was mutually agreed that B will retire from partnership and in his place D will be admitted as a partner with effect from 1st July, 2009. For this purpose, the following adjustments are to be made: (a) Goodwill of the firm is to be valued at Rs. 2 lakhs due to the firm’s locational advantage but the same will not appear as an asset in the books of the reconstituted firm. (b) Buildings and plant and machinery are to be valued at 90% and 85% of the respective balance sheet values. Investments are to be taken over by the retiring partner at Rs. 25,000. Sundry debtors are considered good only upto 90% of balance sheet figure. Balance be considered bad. (c) In the reconstituted firm, the total capital will be Rs. 3 lakhs, which will be contributed by A, C and D in their new profit sharing ratio, which is 3:4:3. (d) The amount due to retiring partner shall be transferred to his loan account. You are required to prepare Revaluation Account and Partners’ Capital Accounts. 8.86 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Solution Revaluation Account Dr. Cr. 2009 Rs. 2009 Rs. July 1 To Building 20,000 July 1 By Investments 3,000 To Plant and Machinery 57,000 (25,000-22,000) To Bad Debts 13,900 By Partners’ Capital A/cs (loss on revaluation) A (3/10) 26,370 B (2/10) 17,580 C (5/10) 43,950 87,900 90,900 90,900 Partners’ Capital Accounts Dr. Cr. A B C D A B C D Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs. To Revaluation A/c 26,370 17,580 43,950 – By Balance b/d 1,04,000 76,000 1,40,000 – To B’s and C’s By D’s Capital A/c capital A/cs – – – 60,000 (W.N.1) – 40,000 20,000 – To Investments A/c – 25,000 – – By Bank A/c 12,370 – 3,9501,50,000 To B’s loan A/c – 73,420 – – To Balance c/d (W.N. 2) 90,000 - 1,20,000 90,000 1,16,370 1,16,000 1,63,950 1,50,000 1,16,370 1,16,000 1,63,9501,50,000 Working Notes : 1. Adjustment of goodwill Goodwill of the firm is valued at Rs. 2 lakhs Sacrificing ratio: A 3/10-3/10 = 0 B 2/10-0 = 2/10 C 5/10-4/10 = 1/10 Hence, sacrificing ratio of B and C is 2:1. A has not sacrificed any share in profits after retirement of B and admission of D in his place. FUNDAMENTALS OF ACCOUNTING 8.87 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Adjustment of D’s share of goodwill through existing partners’ capital accounts in the profit sacrificing ratio: Rs. B : Rs. 60,000 x 2/3 = 40,000 C : Rs 60,000 x 1/3 = 20,000 60,000 2. Capital of partners in the reconstituted firm : Rs. Total capital of the reconstituted firm (given) 3,00,000 A (3/10) 90,000 B (4/10) 1,20,000 C (3/10) 90,000 7. JOINT LIFE POLICY A partnership firm may decide to take a Joint Life Insurance Policy on the lives of all partners. The firm pays the premium and the amount of policy is payable to the firm on the death of any partner or on the maturity of policy whichever is earlier. The objective of taking such a policy is to minimise the financial hardships to the event of payment of a large sum to the legal representatives of a deceased partner or to the retiring partner. The accounting treatment for the premium paid and the Joint Life Policy may be on any of the following ways: 1. When premium paid is treated as an expense: When premium is treated as an expense then it is closed every year by transferring to profit and loss account. In this case complete amount received from the insurance company either on a surrender of policy or on the death of the partner becomes a gain. Accounting entries are: (a) On payment of premium Joint Life Policy Insurance Premium A/c Dr. To Bank A/c (b) On charging to Profit and Loss Account Profit and Loss Account Dr. To Joint Life Policy Insurance Premium A/c (c) On maturity of the Policy Insurance Company/ Bank Account Dr. To Partners’ Capital A/cs (individually) (Including the account of the representative of a deceased partner) 8.88 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 2. When premium paid is treated as an asset: In this case insurance premium paid is first debited to life policy account and credited to bank account. At the end of the year the amount in excess of surrender value is treated as a loss and is transferred to Profit and Loss Account. In this case the amount received from the insurance company in excess of the surrender value results in a gain at the time of receipt of such amount which is transferred to Capital Accounts of the partners in the profit sharing ratio. 3. Creation of Joint Policy Reserve Account: Under this method, premium paid is debited to policy account and credited to bank account. At the end of the year, amount equal to premium is transferred from Profit and Loss Appropriation Account to Policy Reserve Account. After this, policy account is brought down to its surrender value by debiting the life policy reserve account with amount which exceeds the surrender value of the policy. Thus, in this method, policy account appears on the assets side and policy reserve account appears on the liabilities side of the Balance Sheet until it is realised. Both these accounts appear in the Balance Sheet at the surrender value of the policy. This method is different from the method discussed in (2) above only in respect of reserve account. On the death of a partner Joint Life Policy Reserve Account is transferred to Joint Life Policy Account and then the balance is transferred to Partners’ Capital Accounts. Illustration 10 Red, White and Black shared profits and losses in the ratio of 5:3:2. They took out a joint life Policy in 2005 for Rs. 50,000, a premium of Rs. 3,000 being paid annually on 10th June. The surrender value of the policy on 31st December of various years was as follows: 2005 nil; 2006 Rs. 900: 2007 Rs. 2,000; 2008 Rs. 3,600. Black retires on 15th April, 2009. Prepare ledger accounts assuming no Joint Life Policy Account is maintained. Solution Joint Life Policy Premium Account Rs. Rs. 10th June, 2005 To Bank Account 3,000 31st Dec., 2005 By Profit and Loss A/c 3,000 10th June, 2006 To Bank Account 3,000 31st Dec., 2006 By Profit and Loss A/c 3,000 10th June, 2007 To Bank Account 3,000 31st Dec., 2007 By Profit and Loss A/c 3,000 10th June, 2008 To Bank Account 3,000 31st Dec., 2008 By Profit and Loss A/c 3,000 FUNDAMENTALS OF ACCOUNTING 8.89 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Profit and Loss Account Rs. Rs. 31st Dec., 2005 To Joint Life Policy Premium Account 3,000 31st Dec., 2006 To Joint Life Policy Premium Account 3,000 31st Dec., 2007 To Joint Life Policy Premium Account 3,000 31st Dec., 2008 To Joint Life Policy Premium Account 3,000 Joint Life Policy Account Rs. Rs. 15th April, 2009 To Capital A/cs: 15th April, 2009 By Bank Account 3,600 (Transfer) Red 5/ 10 1,800 White 3/ 10 1,080 Black 2/10 720 3,600 3,600 Illustration 11 Red, White and Black shared profits and losses in the ratio of 5: 3: 2. They took out a Joint Life Policy in 2005 for Rs. 50,000, a premium of Rs. 3,000 being paid annually on 10th June. The surrender value of the policy on 31st December of various years was as follows: 2005 nil; 2006 Rs. 900: 2007 Rs. 2,000; 2008 Rs. 3,600. Black retires on 15th April, 2009. Prepare ledger accounts assuming Joint Life Policy Account is maintained on surrender value basis. 8.90 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Joint Life Policy Premium Account Rs. Rs. 10th June, 2005 To Bank Account 3,000 31st Dec., 2005 By Profit and Loss A/c 3,000 10th June, 2006 To Bank Account 3,000 31st Dec., 2006 By Profit and Loss A/c 2,100 By Balance c/d 900 3,000 3,000 1st January, 2007 To Balance b/d 900 31st Dec., 2007 By Profit and Loss A/c 1,900 10th June, 2007 To Bank Account 3,000 By Balance c/d 2,000 3,900 3,900 1st January, 2008 To Balance b/d 2,000 31st Dec., 2008 By Profit and Loss A/c 1,400 10th June, 2008 To Bank Account 3,000 By Balance c/d 3,600 5,000 5,000 1st January, 2009 To Balance b/d 3,600 15th April, 2009 By Bank 3,600 3,600 3,600 Profit and Loss Account Rs. Rs. 31st Dec., 2005 To Joint Life Policy Account 3,000 31st Dec., 2006 To Joint Life Policy Account 2,100 31st Dec., 2007 To Joint Life Policy Account 1,900 31st Dec., 2008 To Joint Life Policy Account 1,400 FUNDAMENTALS OF ACCOUNTING 8.91 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER Illustration 12 A, B and C are in partnership sharing profits and losses at the ratio of 5 : 3 : 2. The balance sheet of the firm on 31.12.2009 was as follows : Balance Sheet Liabilities Rs. Assets Rs. Capital A/cs Sundry Fixed Assets 80,000 A 50,000 Stock 50,000 B 40,000 Debtors 30,000 C 30,000 Joint Life Policy 20,000 Bank Loan 40,000 Bank 10,000 Sundry Creditors 30,000 1,90,000 1,90,000 On 1.1.2010, A wants to retire, B and C agreed to continue at 2:1. Joint Life Policy was taken on 1.1.2004 for Rs. 1,00,000 and its surrender value as on 31.12.2009 was Rs. 25,000. For the purpose of A’s retirement goodwill was raised for Rs. 1,00,000. Sundry Fixed Assets was revalued for Rs. 1,10,000. But B and C did not prefer to show such increase in assets in the Balance Sheet. Also they agreed to bring necessary cash to discharge 50% of the A’s claim, to make the bank balance Rs. 25,000 and to make their capital proportionate. Prepare necessary journal entries. Solution Journal Entries Rs. Rs. 1. B’s Capital A/c Dr. 49,500 C’s Capital A/c Dr. 18,000 To A’s Capital A/c 67,500 (Share of revaluation profit Rs. 67,500 including good will due to A borne by B and C at the gaining ratio 11 : 4) 2. A’s Capital A/c Dr. 1,17,500 To A’s Loan A/c 58,750 To Bank A/c 58,750 (Settlement of A’s claim on his retirement by payment of 50% in case and transferring the balance to his Loan A/c). 3. Bank A/c Dr. 73,750 To A’s Capital A/c 60,333 To A’s Capital A/c 13,417 (Cash brought in by the continuing partners). 8.92 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Working Notes : 1. Revaluation Profit Rs. Goodwill 1,00,000 Sundry Fixed Assets 30,000 Joint Life Policy 5,000 1,35,000 A’s Share Rs. 1,35,000 × 5/10 = Rs. 67,500. 2. Gaining Ratio B : 2/3 - 3/10 = 11/30 C : 1/3 - 2/10 = 4/30 Gaining Ratio : B : C 11 : 4 3. Total Capital Rs. Assets as per Balance Sheet 1,90,000 Additional Bank Balance 15,000 2,05,000 Less : Bank Loan 40,000 Sundry Crs. 30,000 A’s Loan 58,750 1,28,750 76,250 B’s Share 50,833 C’s Share 25,417 FUNDAMENTALS OF ACCOUNTING 8.93 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER SELF EXAMINATION QUESTIONS Pick up the correct answer from the given choices : 1. Retiring or outgoing partner: (a) Is liable for firm’s liabilities. (b) Not liable for any liabilities of the firm. (c) Is liable for obligations incurred before his retirement. (d) Is liable for obligations incurred before and after his retirement. 2. A, B and C are partners with profits sharing ratio 4:3:2. B retires. If A & C shares profits of B in 5:3, then find the new profit sharing ratio. (a) 47:25. (b) 17:11. (c) 31:11. (d) 14:21. 3. C, D and E are partners sharing profits and losses in the proportion of ½, 1/3 and 1/6. D retired and the new profit sharing ratio between C and E is 3:2 and the Reserve of Rs. 12,000 is divided among the partners in the ratio: (a) Rs. 2,000: Rs. 4,000: Rs. 6,000. (b) Rs. 5,000: Rs. 5,000: Rs. 2,000. (c) Rs. 4,000: Rs. 6,000: Rs. 2,000. (d) Rs. 6,000: Rs. 4,000: Rs. 2,000. 4. Outgoing partner is compensated for parting with firm’s future profits in favour of remaining partners. In what ratio do the remaining partners contribute to such compensation amount? (a) Gaining Ratio. (b) Capital Ratio. (c) Sacrificing Ratio. (d) Profit Sharing Ratio. 5. Joint Life Policy is taken by the firm on the life(s) of ……… (a) All the partners jointly. (b) All the partners severely. (c) On the life of all the partners and employees of the firm. (d) Both ‘a’ and ‘b’. 6. At the time of retirement of a partner, firm gets ……… from the insurance company against the Joint Life Policy taken jointly for all the partners. (a) Policy Amount. (b) Surrender Value. (c) Policy Value for the retiring partner and Surrender Value for the rest. (d) Surrender Value for all the partners. 7. A, B and C takes a Joint Life Policy, after five years B retires from the firm. Old profit sharing ratio is 2:2:1. After retirement A and C decides to share profits equally. They had taken a Joint Life Policy of Rs. 2,50,000 with the surrender value Rs. 50,000. What will be the treatment in the partner’s capital account on receiving the JLP amount if joint life policy premium is fully charged to revenue as and when paid? (a) Rs. 50,000 credited to all the partners in old ratio. (b) Rs. 2,50,000 credited to all the partners in old ratio. (c) Rs. 2,00,000 credited to all the partners in old ratio. (d) No treatment is required. 8.94 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 8. A, B and C takes a Joint Life Policy, after five years, B retires from the firm. Old profit sharing ratio is 2:2:1. After retirement A and C decides to share profits equally. They had taken a Joint Life Policy of Rs. 2,50,000 with the surrender value Rs. 50,000. What will be the treatment in the partner’s capital account on receiving the JLP amount if joint life policy is maintained at the surrender value? (a) Rs. 50,000 credited to all the partners in old ratio. (b) Rs. 2,50,000 credited to all the partners in old ratio. (c) Rs. 2,00,000 credited to all the partners in old ratio. (d) No treatment is required. 9. A, B and C takes a Joint Life Policy, after five years B retires from the firm. Old profit sharing ratio is 2:2:1. After retirement A and C decides to share profits equally. They had taken a Joint Life Policy of Rs. 2,50,000 with the surrender value Rs. 50,000. What will be the treatment in the partner’s capital account on receiving the JLP amount if joint life policy is maintained at surrender value along with the reserve? (a) Rs. 50,000 credited to all the partners in old ratio. (b) Rs. 2,50,000 credited to all the partners in old ratio. (c) Rs. 2,00,000 credited to all the partners in old ratio. (d) Distribute JLP Reserve Account in old profit sharing ratio. 10. A, B and C are partners sharing profits in the ratio 2:2:1. On retirement of B, goodwill was valued as Rs. 30,000. Find the contribution of A and C to compensate B. (a) Rs. 20,000 and Rs. 10,000. (b) Rs. 8,000 and Rs. 4,000. (c) They will not contribute any thing. (d) Information is insufficient for any comment. 11. Claim of the retiring partner is payable in the following form. (a) Fully in cash. (b) Fully transferred to loan account to be paid later with some interest on it. (c) Partly in cash and partly as loan repayable later with agreed interest. (d) Any of the above method. 12. A, B and C were partners in a firm sharing profits and losses in the ratio of 2:2:1 respectively with the capital balance of Rs. 50,000 for A and B, for C Rs. 25,000. B declared to retire from the firm and balance in reserve on the date was Rs. 15,000. If goodwill of the firm was valued as Rs. 30,000 and profit on revaluation was Rs. 7,050 then what amount will be transferred to the loan account of B. (a) Rs. 70,820. (b) Rs. 50,820. (c) Rs. 25,820. (d) Rs. 58,820. FUNDAMENTALS OF ACCOUNTING 8.95 Copyright -The Institute of Chartered Accountants of India RETIREMENT OF A PARTNER 13. A, B and C are partners sharing profits and losses in the ratio of 3:2:1. C retires on a decided date and Goodwill of the firm is to be valued at Rs. 60,000. Find the amount payable to retiring partner on account of goodwill. (a) Rs. 30,000. (b) Rs. 20,000. (c) Rs. 10,000. (d) Rs. 60,000. 14. A, B and C were partners sharing profits and losses in the ratio of 3:2:1. A retired and Goodwill of the firm is to be valued at Rs. 24,000. What will be the treatment for goodwill? (a) Credited to Revaluation Account at Rs. 24,000. (b) Adjusted through partners’ capital accounts in gaining/sacrificing ratio. (c) Only A’s capital account credited with Rs. 12,000. (d) Only A’s capital account credited with Rs. 24,000. 15. A, B and C were partners sharing profits and losses in the ratio of 3:2:1. A retired and firm received the joint life policy as Rs. 7,500 appearing in the balance sheet at Rs. 10,000. JLP is credited and cash debited with Rs. 7,500, what will be the treatment for the balance in Joint Life Policy? (a) Credited to partner’s current account in profit sharing ratio. (b) Debited to revaluation account. (c) Debited to partner’s capital account in profit sharing ratio. (d) Either (b) or (c). 16. Balances of M/s. Ram, Rahul and Rohit sharing profits and losses in proportion to their capitals, stood as Ram - Rs. 3,00,000; Rahul - Rs. 2,00,000 and Rohit - Rs. 1,00,000. Ram desired to retire from the firm and the remaining partners decided to carry on, Joint life policy of the partners surrendered and cash obtained Rs. 60,000. What will be the treatment for Joint Life Policy Account? (a) Rs. 60,000 credited to Revaluation Account. (b) Rs. 60,000 credited to Joint Life Policy Account. c. Rs. 30,000 debited to Ram’s Capital Account. d. Either (a) or (b). 17. Balances of A, B and C sharing profits and losses in proportion to their capitals, stood as A - Rs. 2,00,000; B - Rs. 3,00,000 and C - Rs. 2,00,000; Joint Life Policy Reserve A/c Rs. 80,000 and Joint Life Policy A/c is shown in the Balance Sheet Rs. 80,000. A desired to retire from the firm and the remaining partners decided to carry on in equal ratio, Joint life policy of the partners surrendered and cash obtained Rs. 80,000. What will be the treatment for Joint Life Policy Reserve A/c? (a) Cash received credited to Revaluation Account. (b) JLP Reserve balance credited to Partner’s Capital Account in old profit sharing ratio. 8.96 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India (c) JLP Reserve balance credited to Partner’s Capital Account in new profit sharing ratio. (d) Cash received credited to Partners’ Capital Accounts in old profit sharing ratio. 18. Balances of A, B and C sharing profits and losses in proportionate to their capitals, stood as A - Rs. 2,00,000; B - Rs. 3,00,000 and C - Rs. 2,00,000. A desired to retire from the firm, B and C share the future profits equally, Goodwill of the entire firm be valued at Rs. 1,40,000 and no Goodwill account being raised. (a) Credit Partner’s Capital Account with old profit sharing ratio for Rs. 1,40,000. (b) Credit Partner’s Capital Account with new profit sharing ratio for Rs. 1,40,000. (c) Credit A’s Account with Rs. 40,000 and debit B’s Capital Account with Rs. 10,000 and C’s Capital Account with Rs. 30,000. (d) Credit Partner’s Capital Account with gaining ratio for Rs. 1,40,000. 19. Balances of Ram, Hari & Mohan sharing profits and losses in the ratio 2:3:2 stood as Ram - Rs. 10,00,000; Hari - Rs. 15,00,000; Mohan - Rs. 10,00,000; Joint Life Policy Rs. 3,50,000. Hari desired to retire from the firm and the remaining partners decided to carry on with the future profit sharing ratio of 3:2. Joint Life Policy of the partners surrendered and cash obtained Rs. 3,50,000. What would be the treatment for JLP A/c? (a) Rs. 3,50,000 credited to partner’s capital account in new ratio. (b) Rs. 3,50,000 credited to partner’s capital account in old ratio. (c) Rs. 3,50,000 credited to partner’s capital account in capital ratio. (d) Rs. 3,50,000 credited to JLP account. ANSWERS 1. (c) 2. (a) 3. (d) 4. (a) 5. (d) 6. (b) 7. (a) 8. (d) 9. (d) 10. (b) 11. (d) 12. (a) 13. (c) 14. (b) 15. (d) 16. (b) 17. (b) 18. (c) 19. (d) FUNDAMENTALS OF ACCOUNTING 8.97 Copyright -The Institute of Chartered Accountants of India CHAPTER - 8 PARTNERSHIP ACCOUNTS Unit 5 Death of a Partner Copyright -The Institute of Chartered Accountants of India Learning Objectives After studying this unit you will be able to: (cid:2) Understand the implication of the excess money received on death of a partner from a joint life policy from the insurance company in the accounts of the partnership. Learn the journal entries required to record this transaction. (cid:2) Understand the accounting implications if death of a partner takes place at any date during the accounting period. Learn to record this transaction and how to record payment of profit to the Executor of the deceased partner for part of the accounting year. (cid:2) Be familiar with other accounting treatments in case of death of partner which are similar to the explained in case of retirement of a partner. 1. INTRODUCTION Business of a partnership firm may not come to an end due to death of a partner. Other partners shall continue to run the business of the firm. The problems arising on the death of a partner are similar to those arising on retirement. Assets and liabilities have to be revalued and the resultant profit or loss has to be transferred to the capital accounts of all partners including the deceased partner. Goodwill is dealt with exactly in the way already discussed in the case of retirement in the earlier unit. Treatment of joint life policy will also be same as in the case of retirement. However, in case of death of a partner, the firm would get the joint policy value. The only additional point is that as death may occur on any day, the representatives of the deceased partner will be entitled to the partner's share of profit from the beginning of the year to the date of death. After ascertaining the amount due to the deceased partner, it should be credited to his Executor's Account. The amount due to the deceased partner carries interest at the mutually agreed upon rate. In the absence of agreement, the representatives of the deceased partner can receive, at their option, interest at the rate of 6% per annum or the share of profits earned for the amount due to the deceased partner. 2. SPECIAL TRANSACTIONS IN CASE OF DEATH: JOINT LIFE POLICY If Joint Life Policy appears in the Balance Sheet at surrender value, then the firm will gain on the death of a partner. For example, A, B and C are in partnership sharing profits and losses at the ratio of 5:3:2. They took a Joint Life Policy of Rs. 1,00,000 which is appearing in the Balance Sheet at the surrender value of Rs. 10,000,. Now, if A dies, the firm will receive Rs. 1,00,000 from the insurance company. FUNDAMENTALS OF ACCOUNTING 8.99 Copyright -The Institute of Chartered Accountants of India DEATH OF PARTNER The journal entries will appear as follows: Rs. Rs. (i) Bank A/c Dr. 1,00,000 To Joint Life Policy A/c 1,00,000 (Policy value received from the insurance company on A’s death) (ii) Joint Life Policy A/c Dr. 90,000 To A’s Capital A/c 45,000 To B’s Capital A/c 27,000 To C’s Capital A/c 18,000 However, if joint life policy does not appear in the Balance Sheet, then entry (ii) is to be passed for Rs. 1,00,000 and it would appear as follows : Joint Life Policy A/cs Dr. 1,00,000 To A’s Capital A/c 50,000 To B’s Capital A/c 30,000 To C’s Capital A/c 20,000 3. SPECIAL TRANSACTIONS IN CASE OF DEATH : PAYMENT OF DECEASED PARTNER'S SHARE The basic distinction between retirement and death of a partner relates to finalisation of amount payable to the Executor of the deceased partner. Although, revaluation of goodwill is done in the same way as it has been done in case of retirement, in addition, the executor of the deceased partner is entitled to share of profit upto the date of death. For example, A, B and C are in partnership sharing profits and losses at the ratio of 2:2:1. A died on 15th April, 2009. The firm closes its books of account as on 31st December every year. So the executor of A is entitled for 3½ months profit. If A's share is immediately paid off then profit for 2009 can be taken as base for calculating 3½ months profits in the year, 2009. If M/ s. A, B & C earned Rs. 96,000 in year 2008, then 3½ months profit is Rs. 28,000. A's share comes to Rs. 28,000 × 2/5 i.e. Rs. 11,200. Journal entry is : Profit and Loss Suspense A/c * Dr. Rs.11,200 To A's Capital A/c Rs. 11,200 (Share of A 3½ months profit in 2009 is transferred to his Capital Account on death) * At the end of the year 2009, the Profit & Loss Suspense A/c will be transferred to Profit and Loss A/c. 8.100 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India