Full Text Transcript
14
ISSUES IN PARTNERSHIP ACCOUNTS
Learning Objectives
After studying this unit, you will be able to:
♦ Understand the features of a partnership firm and the need for a Partnership Deed.
♦ Understand the points to be covered in a Partnership Deed regarding accounts.
♦ Learn the technique of maintaining Profit and Loss Appropriation Account.
♦ Familiarise with the two methods of maintaining Partners' Capital Accounts, namely
Fixed Capital Method and Fluctuating Capital Method.
♦ Learn where to show interest on capital and drawings, salaries/commissions to
partners etc. Also learn that drawings by partners will not appear in the Appropriation
Account.
♦ Learn the accounting of goodwill and see when valuation of goodwill becomes
essential in partnership accounts.
♦ Deal with change in profit sharing ratio without any change in the constitution of
partnership.
♦ Understand the reasons for which revaluation of assets and recomputation of liabilities
is required in case of admission of a new partner. Also understand the logic of
revaluation of assets and recomputation of liabilities at the time of admission,
retirement of a partner and death of a partner.
♦ Learn the treatment of reserve balance on admission, retirement or death of a partner.
♦ Know how to arrive at new profit-sharing ratio after admission, retirement or death of a partner.
♦ Learn how to keep records if the balance due to the retiring partner is transferred to
loan account.
♦ Understand the accounting implications if death of a partner takes place at any date
during the accounting period.
♦ Learn to record the above mentioned transaction and how to record payment of profit
to the Executor of the deceased partner for part of the accounting year.
© The Institute of Chartered Accountants of India
Accounting
1. Definition and Features of Partnership Accounts
The Indian Partnership Act defines partnership as the relationship between persons who have
agreed to share the profit or loss of a business carried on by all or any of them acting for all.
Such persons are individually known as partners and they do business in the name of their
firm. Generally, partners agree among themselves as regards terms and conditions on which
the business of the firm will be carried on. But often they carry on business on the basis of a
verbal agreement.
The essential features of partnership are:
(i) Association of two or more persons;
(ii) An agreement entered by all persons concerned;
(iii) Expenses of a business;
(iv) The carrying on of business by all or any of them acting for all;
(v) Sharing of profits and losses of the business at an agreed ratio.
So a partnership is run by a mutual written agreement called partnership deed which may be
either registered or unregistered but for the sake of settlement of future disputes among the
partners, it is better to have a registered partnership deed.
The partnership deed generally details out the following clauses:
(i) Name of the firm and nature of the partnership business;
(ii) Commencement and tenure of the business;
(iii) Amount of capital to be contributed by each partner;
(iv) The ratio for sharing profit and loss of the partnership business among the partners;
(v) Arrangement of drawings by partners, making limit thereon and interest if any, to be
charged on drawings;
(vi) Salary to be given to the partners;
(vii) Interest, if any, to be allowed on capital contributed by the partners;
(viii) Rent to be paid to the partners whose premises are used for the purpose of business;
(ix) Process of appropriation in case of any dispute among the partners;
(x) Procedure for maintenance of accounts and audit thereof;
(xi) Valuation of goodwill in case of admission of new partners, retirement of existing partners
and death of a partner;
(xii) Procedure for settlement of partners’ claims in case of retirement or death.
(xiii) Procedure for dissolution of partnership, etc.
If any situation or circumstances is not either covered in the partnership deed or adequately
14.2
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
explained, such situation or circumstance should be settled by applying the provisions of the
Partnership Act, 1932.
The partners are supposed to have the power to act in certain matters and not to have such
powers in others. Students are advised to go through Unit 1, Chapter 8 of CPT Study Material
to understand the powers in details.
2. Partners’ Capital and Current Accounts
From the point of view of accounting, maintenance of the partners’ capital accounts and
current accounts are very important. The relevant accounting transactions and events are:
• Initial contribution by partners towards capital of the firm.
• Fresh capital contributed by partners.
• Interest entitlements (if agreed in the partnership deed) on capital so contributed;
• Amount withdrawn by the partners from time to time;
• Interest liability of partners on such drawings (if agreed in the partnership deed);
• Salary to partners for services rendered to run the partnership business;
• Rent of premises let out to partnership by the partners;
• Share of profit or loss of the partnership business.
How to account for all such transactions and events in the partnership accounts should be
understood properly.
There are two methods of accounting –
i) fixed capital method and
ii) fluctuating capital method.
In fixed capital method, generally initial capital contributions by the partners are credited to
partners’ capital accounts and all subsequent transactions and events are dealt with through
current accounts, Unless a decision is taken to change it, initial capital account balance is not
changed.
In fluctuating capital method, no current account is maintained. All such transactions and
events are passed through capital accounts. Naturally, capital account balance of the
partners fluctuates every time. So in fixed capital method a fixed capital balance is maintained
over a period of time while in fluctuating capital method capital account balances fluctuate all
the time.
Illustration 1
A and B start business on 1st January, 2010, with capitals of ` 30,000 and ` 20,000.
According to the Partnership Deed, B is entitled to a salary of ` 500 per month and interest is
to be allowed on capitals at 6% per annum. The remaining profits are to be distributed
14.3
© The Institute of Chartered Accountants of India
Accounting
amongst the partners in the ratio of 5:3. During 2010 the firm earned a profit, before charging
salary to B and interest on capital amounting to ` 25,000. During the year A withdrew `
8,000 and B withdrew ` 10,000 for domestic purposes. Show the capital accounts of the
partners following fluctuating capital method.
Solution
A’s Capital Account
Dr. Cr.
2010 ` 2010 `
Dec. 31 To Cash (Drawings) 8,000 Jan. 1 By Cash 30,000
To Balance c/d 33,800 Dec. 31 By Profit and Loss A/c
(Interest) 1,800
By Profit and Loss A/c
(5/8 Profit) 10,000
41,800 41,800
2011
Jan. 1 By Balance b/d 33,800
B’s Capital Account
2010 ` 2010 `
To Cash (Drawings) 10,000 Jan. 1 By Cash 20,000
To Balance c/d 23,200 Dec. 31 By Profit and Loss A/c
Salary 6,000
Interest 1,200
By Profit and Loss A/c 6,000
(3/8 Profit)
33,200 33,200
2011
Jan. 1 By Balance b/d 23,200
Illustration 2
Ram and Rahim started business with capital of ` 50,000 and ` 30,000 on 1st January,
2010. Rahim is entitled to a salary of ` 400 per month. Interest is allowed on capitals and is
charged on drawings at 6% per annum. Profits are to be distributed equally after the above
noted adjustments. During the year Ram withdrew ` 8,000 and Rahim withdrew ` 10,000.
The profit for the year before allowing for the terms of the Partnership Deed came to `
30,000. Assuming the capitals to be fixed, prepare the Capital and Current Accounts of the
partners.
14.4
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Solution
Ram’s Capital Account
2010 ` 2010 `
Dec.31 To Balance c/d 50,000 Jan. 1 By Cash 50,000
2011
Jan. 1 By Balance b/d 50,000
Rahim’s Capital Account
2010 ` 2010 `
Dec. 31. To Balance c/d 30,000 Jan. 1 By Cash 30,000
2011
Jan. 1 By Balance b/d 30,000
Ram’s Current Account
2010 ` 2010 `
To Cash (Drawings) 8,000 Dec. 31 By Profit and Loss A/c
Dec. 31 To Profit and Loss A/c Interest 3,000
Interest on Drawings 240 By Profit and Loss A/c
To Balance c/d 5,230 1/2 Profit 10,470
13,470 13,470
2011
Jan. 1 By Balance b/d 5,230
Rahim’s Current Account
2010 ` 2010 `
? To Cash (Drawings) 10,000 Dec. 31 By Profit and Loss A/c
Dec. 31 To Profit and Loss A/c Salary 4,800
Interest on drawings 300 Interest 1,800
To Balance c/d 6,770 By Profit and Loss A/c
Profit 10,470
17,070 17,070
2011
Jan. 1 By Balance b/d 6,770
3. Profit and Loss Appropriation Account
• Profit and Loss Appropriation Account is prepared by a partnership firm to distribute
the net profit among the partners in accordance with the partnership deed.
• Any interest on drawing is added to the net profit and thereafter out of such total
14.5
© The Institute of Chartered Accountants of India
Accounting
profit, interest on partners’ capital, salaries, commission, rent etc. are distributed as
per agreement.
• The balance of profit is distributed among the partners at the profit sharing ratio.
Illustration 3
X, Y & Z are in partnership. Y and Z are entitled to 15% commission on net profit to be shared
equally for the special service rendered by them to the partnership. However, all the partners
are entitled to 8% interest on fixed capital of ` 5,00,000 each. The business is run at the
premises of Mr. X who is further entitled to get a monthly rent of ` 2,000 to be adjusted
against his current account. They share profits and losses equally. Net profit during the year
2010 was ` 7,00,000.
During the year they were discussing to change the profit sharing ratio because X could not
attend to business work. Finally they decided to increase interest on capital to 12% p.a. with
effect from 1-10-2010 and to change the profit sharing ratio to 1:2:2 with effect from the same
date. With that Y and Z would not get any commission. Prepare Profit and Loss Appropriation
Account.
Solution
Profit and Loss Appropriation Account
` ` `
To Commission By Net Profit 7,00,000
Y 39,375
Z 39,375 78,750
To Interest
X 45,000
Y 45,000
Z 45,000 1,35,000
To Rent-X 24,000
To Current A/cs
X 1,37,550
Y 1,62,350
Z 1,62,350 4,62,250
7,00,000 7,00,000
14.6
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Working Notes :
(1) Interest Jan-Sept. 2010 Oct-Dec. 2010 Total
@ 8% @ 12%
` ` `
X 30,000 15,000 45,000
Y 30,000 15,000 45,000
Z 30,000 15,000 45,000
90,000 45,000 1,35,000
(2) Commission
¾ of (15% on ` 7,00,000) = ` 78,750
(3) Share of Profit Jan-Sept. Oct-Dec. Total
2010 2010
` ` `
Net Profit 5,25,000 1,75,000 7,00,000
Less : Commission 78,750 − 78,750
Less : Interest 90,000 45,000 1,35,000
Less : Rent 18,000 6,000 24,000
Profit available for distribution in the profit
sharing ratio 3,38,250 1,24,000 4,62,250
X 1,12,750 24,800 1,37,550
Y 1,12,750 49,600 1,62,350
Z 1,12,750 49,600 1,62,350
4. Treatment of Goodwill in Partnership Accounts
Goodwill is the value of reputation of a firm in respect of profits expected in future over and
above the normal rate of profits. The implication of the above is that there is always a certain
normal rate of profits earned by similar firms in the same locality. The excess profit earned by
a firm may be due to its locational advantage, better customer service, possession of a unique
patent right, personal reputation of the partners or for similar other reasons. The necessity for
valuation of goodwill in a firm arises in the following cases:
(a) When the profit sharing ratio amongst the partners is changed;
(b) When a new partner is admitted;
(c) When a partner retires or dies, and
(d) When the business is dissolved or sold.
14.7
© The Institute of Chartered Accountants of India
Accounting
There are four methods for valuation of goodwill:
(1) Average profit basis,
(2) Super profit basis,
(3) Annuity basis, and
(4) Capitalisation basis.
4.1 Methods for Goodwill Valuation
1. Average Profit Basis: In this case the profits of the past few years are averaged and
adjusted for any expected change in future. For averaging the past profit, either simple
average or weighted average may be employed depending upon the circumstances. If
there exists clear increasing or decreasing trend of profits, it is better to give more weight
to the profits of the recent years than those of earlier years. But, if there is no clear trend
of profit, it is better to go by simple average.
Let us suppose profits of a partnership firm for the last five years were ` 30,000,
` 40,000, ` 50,000, ` 60,000 and ` 70,000. In this case, a clear increasing trend is
noticed and therefore, average profit may be arrived at by assigning appropriate weight
as shown below:
Year Profit Weight Weighted Profit
` `
1 30,000 1 30,000
2 40,000 2 80,000
3 50,000 3 1,50,000
4 60,000 4 2,40,000
5 70,000 5 3,50,000
15 8,50,000
Rs.8,50,000
So Weighted Average Profit = = ` 56,667
15
If goodwill is valued at three years’ purchase of profit, then in this case the value of
goodwill is ` 56,667 × 3 = ` 1,70,000.
However, if any such trend is not visible from the figures of past profits, then one should
take simple average profit and calculate goodwill accordingly. Let us suppose, profits of a
partnership firm for five years were ` 30,000, ` 25,000, ` 20,000, ` 30,000 and `
28,000. In this case, there is no clear increasing or decreasing trend of profit. So average
profit comes to ` 26,600 (arrived at by taking simple average). If the goodwill is valued
by taking three years’ purchase of profit, value of goodwill becomes ` 79,800.
2. Super Profit Basis: In case of average profit basis, goodwill is calculated on the basis of
average profit multiplied by certain number of years. The implication is that such profit
14.8
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
will be maintained for so many numbers of years and the partner(s) who gains in terms of
profit sharing ratio should contribute for such gains in profit to the partners who make the
sacrifice. On the other hand, super profit means, excess profit that can be earned by a
firm over and above the normal profit usually earned by similar firms under similar
circumstances. Under this method, the partner who gains in terms of profit sharing ratio
has to contribute only for excess profit because he can earn normal profit by joining any
partnership. Under super profit method, what excess profit a partnership firm can earn is
to be determined first. The steps to be followed are given below:
(a) Identify the capital employed by the partnership firm;
(b) Identify the average profit earned by the partnership firm based on past few years’ figures;
(c) Determine normal rate of return prevailing in the locality for similar firms;
(d) Apply normal rate of return on capital employed to arrive at normal profit;
(e) Deduct normal profit from the average profit of the firm. If the average profit of the
firm is more than the normal profit, there exists super profit and goodwill.
Let us suppose total capital employed by a partnership firm was ` 1,00,000 and its
average profit was ` 25,000. Normal rate of return is 22% in case of similar firms working
under similar conditions. So normal profit is ` 22,000 and average profit is ` 25,000. The
partnership firm earns ` 3,000 super profit.
Goodwill is generally valued by multiplying the amount of super profit by certain number
of years depending upon the expectation about the maintenance of such super profit in
future. If it is expected that the super profit can be maintained for another five years in
future, then value of goodwill may be taken as ` 3,000 × 5 = ` 15,000.
3. Annuity Method: In the super profit method explained above, time value of money is not
considered. Although it was expected that super profit would be earned in five future years,
still no devaluation was done on the value of money for the time difference. In fact when
money will be received in different points of time, its values should be different depending
upon the rate of interest. If 15% rate of interest is considered appropriate, then discounted
value of super profit to be earned in different future years will be as follows:
Discounted
Year Super Profit Discount Factor @ 15% value of Super
Profit
` ` `
1 3,000 .8696 2,608.80
2 3,000 .7561 2,268.30
3 3,000 .6575 1,972.50
4 3,000 .5718 1,715.40
5 3,000 .4972 1,491.60
10,056.60
14.9
© The Institute of Chartered Accountants of India
Accounting
So under the annuity method, discounted value of super profit becomes ` 10,056.60 and
not ` 15,000 as was done under super profit method.
The word annuity is used to mean identical annual amount of super profit, so for
discounting it is possible to refer to annuity table. As per the annuity table, present value
of Re.1 to be received at the end of each year for 5 years @ 15% interest p.a. is 3.3522.
So value of goodwill under annuity method is ` 3000 × 3.3522 = ` 10,056.60.
4. Capitalisation Basis: Under this basis value of whole business is determined applying
normal rate of return. If such value (arrived at by applying normal rate of return) is higher
than the capital employed in the business, then the difference is goodwill. The steps to
be followed under this method are given below:
(a) Determine the normal rate of return,
(b) Find out the average profit of the partnership firm for which goodwill is to be determined,
(c) Determine the capital employed by the partnership firm for which goodwill is to be
determined,
(d) Find out normal value of the business by dividing average profit by normal rate of return.
(e) Deduct average capital employed from the normal value of the business to arrive at
goodwill.
Let us suppose capital employed by a partnership firm is ` 1,00,000, its average profit is
` 20,000, Normal rate of return is 15%.
20,000
Normal Value of business = x 100 = ` 1,33,333
15
Value of goodwill = ` 1,33,333 – ` 1,00,000 = ` 33,333
Illustration 4
Lee and Lawson are in equal partnership. They agreed to take Hicks as one-fourth partner.
For this it was decided to find out the value of goodwill. M/s Lee and Lawson earned profits
during 2007-2010 as follows:
Year Profit
`
2007 1,20,000
2008 1,25,000
2009 1,30,000
2010 1,50,000
On 31.12.2010 capital employed by M/s Lee and Lawson was ` 5,00,000. Rate of normal
profit is 20%.
Find out the value of goodwill following various methods.
14.10
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Solution
Average Profit:
Year Profit (` ) Weight Weighted Profit (` )
2007 1,20,000 1 1,20,000
2008 1,25,000 2 2,50,000
2009 1,30,000 3 3,90,000
2010 1,50,000 4 6,00,000
10 13,60,000
Weighted Average Profit = ` 1,36,000
Method (1): Average Profit Basis
Assumption: Goodwill is valued at 3 year's purchase
Value of Goodwill: ` 1,36,000 × 3 = ` 4,08,000
Method (2): Super Profit Basis
`
Average Profit 1,36,000
Normal Profit (20% on ` 5,00,000) 1,00,000
36,000
Assumption: Goodwill is valued at 3 years purchase.
Value of Goodwill: ` 36,000 × 3 = ` 1,08,000
Method (3): Annuity Basis
Assumptions:
(a) Interest rate is equivalent to normal profit rate i.e. 20% p.a.
(b) Goodwill is valued at 3 years' purchases
Valuation of Goodwill: ` 36,000 × 2.1065 = ` 75,834
Method (4): Capitalisation Basis
Normal Value of Capital employed:
1,36,000 x 100/ 20 = ` 6,80,000
Capital Employed in M/s Lee and Lawson = ` 5,00,000
Goodwill = ` 1,80,000
4.2 Accounting Treatment
Para 16 of AS-10 ‘Accounting for Fixed Assets’ states that goodwill can be recorded in the
14.11
© The Institute of Chartered Accountants of India
Accounting
books only when some consideration in money or money’s worth has been paid for it.
Para 35 of AS 26 ‘Intangible Assets’ also states that internally generated goodwill∗ should not
be recognized as an asset. Internally generated (self generated) goodwill is not recognized as
an asset because it is not an identifiable resource controlled by the enterprise that can be
measured reliably at cost.
Therefore, only purchased goodwill should be recorded in the books.
In case of admission/retirement/death of a partner or in case of change in profit sharing ratio
among partners, goodwill cannot be raised in the books of the firm because no consideration
in money or money’s worth’ is paid for it. If any partner brings any premium over and above
his capital contribution at the time of his admission, such premium should be distributed to
other existing partners.
Sometimes at the time of any change in the constitution of the firm (by way of admission/
retirement/death/change in profit sharing ratio) goodwill of the firm is evaluated. In that
situation the value of the goodwill should not be brought to books since it is inherent goodwill.
Rather the value of goodwill should be adjusted through partners’ capital accounts.
Accounting treatment of goodwill in case of admission of a partner
Example 1
A & B are equal partners. They wanted to take C as third partner and for this purpose goodwill
was valued at ` 1,20,000. The journal entry for adjustment of value of goodwill through part-
ners’ capital accounts will be:
C’s Capital A/c Dr. ` 40,000
To A’s Capital A/c ` 20,000
To B’s Capital A/c ` 20,000
(Adjustment for goodwill)
The net effect in partner’s capital accounts is shown on the basis of profit sacrificing ratio:
A 1 ` 20,000(Cr.)
= × ` 1,20,000 =
6
B 1 ` 20,000(Cr.)
= × ` 1,20,000 =
6
C 2 ` 40,000(Dr.)
= × ` 1,20,000=
6
∗ The enterprise while doing business develops goodwill over a period of time. Goodwill generated in the process
of doing business is called internally generated goodwill.
14.12
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Example 2
A & B are equal partners. They wanted to admit C as 1/6th partner who brought ` 60,000 as
goodwill. The new profit sharing ratio is 3:2:1. Profit sacrificing ratio is to be computed as follows:
Partners Old share – New share = Share sacrificed Share gained
A 1 – 1 = 0
2 2
B 1 – 2 = 1
2 6 6
C 1 1
6 6
So the entire goodwill should be credited to B’s Capital A/c.
Cash A/c Dr. ` 60,000
To B’s Capital A/c ` 60,000
(Goodwill brought in by C credited to B’s
Capital A/c in the profit sacrificing ratio)
Accounting treatment of goodwill in case of change in the profit sharing ratio
In case of change in profit sharing ratio, the value of goodwill should be determined and preferably
adjusted through capital accounts of the partners on the basis of profit sacrificing ratio.
Example 3
A, B & C are equal partners. They wanted to change the profit sharing ratio into 4:3:2. The
goodwill was valued as ` 90,000. Make the necessary journal entries.
Solution
Journal Entries
` `
A’s Capital Dr. 10,000
To C’s Capital A/c 10,000
(Being adjusting entry passed for change in profit ratio)
In this case, due to change in profit sharing ratio
A's gain is = 4/9 less 1/3= 1/9
B's gain is = 1/3 less 1/3= 0
C's loss is = 1/3 less 2/9= 1/9
So, A should compensate C to the extent of 1/9th of goodwill i.e.
` 90,000 ×1/9 = ` 10,000
14.13
© The Institute of Chartered Accountants of India
Accounting
Example 4
A, B and C are in partnership sharing profits and losses in the ratio of 4:3:3. They decided to
change the profit sharing ratio to 7:7:6. Goodwill of the firm is valued at ` 20,000. Calculate
the sacrifice/gain by the partners and make the necessary journal entry.
Solution
Partners New share Old share Difference
Sacrifice Gain
A 7 − 4 1
20 10 20
B 7 − 3 1
20 10 20
C 6 − 3 - -
20 10
Thus, B gained 1/20th share while A sacrificed 1/20th share. For C there was no loss no gain.
Example 5
A, B, C and D are in partnership sharing profits and losses equally. They mutually agreed to
change the profit sharing ratio to 3:3:2:2.
3 1 1
A gains by − =
10 4 20
3 1 1
B gains by − =
10 4 20
1 2 1
C losses by − =
4 10 20
1 2 1
D losses by − =
4 10 20
So, if goodwill is valued at ` 20,000, A and B should pay @ ` 1,000 each as (i.e., ` 20,000 ×
1/20) compensation to C and D respectively for their sacrifice.
Journal Entry
` `
A’s Capital Account Dr. 1,000
B’s Capital Account Dr. 1,000
To C’s Capital Account 1,000
To D’s Capital Account 1,000
14.14
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
It is only when there is amalgamation, conversion or sale of partnership firms, the question of
recording goodwill will arise. If an existing partnership firm acquires another firm, and if the
purchase consideration exceeds the net assets acquired, the difference will be shown as
goodwill in the books of the transferee firm.
Accounting treatment of goodwill in case of retirement or death of a partner
In case of retirement of a partner, the continuing partners will gain in terms of profit sharing
ratio. Therefore they have to pay to retiring partner for his share of goodwill in the firm in the
gaining ratio.
Similarly, in case of death of the partner, the continuing partners should bear the share of
goodwill due to the heirs of the deceased partner. For this purpose, the goodwill is valued on
the date of the retirement of death and adjusted through the capital accounts of the partners.
Example 6
A, B & C are equal partners. C wanted to retire for which value of goodwill is considered as `
90,000. The necessary journal entry will be
A's Capital A/c Dr. ` 15,000
B's Capital A/c Dr. ` 15,000
To C's Capital A/c ` 30,000
(C's share of goodwill adjusted to existing
partners' capital accounts in profit gaining ratio)
Illustration 5
Wise, Clever and Dull were trading in partnership sharing profits and losses 4:3:3 respectively.
The accounts of the firm are made up to 31st December every year.
The partnership provided, inter alia, that:
On the death of a partner the goodwill was to be valued at three years' purchase of average
profits of the three years upto the date of the death after deducting interest @ 8 per cent on
capital employed and a fair remuneration of each partner. The profits are assumed to be
earned evenly throughout the year.
On 30th June, 2010, Wise died and it was agreed on his death to adjust goodwill in the capital
accounts without showing any amount of goodwill in the Balance Sheet.
It was agreed for the purpose of valuation of goodwill that the fair remuneration for work done
by each partner would be ` 15,000 per annum and that the capital employed would be `
1,56,000. Clever and Dull were to continue the partnership, sharing profits and losses equally
after the death of Wise.
14.15
© The Institute of Chartered Accountants of India
Accounting
The following were the amounts of profits of earlier years before charging interest on capital employed.
`
2007 67,200
2008 75,600
2009 72,000
2010 62,400
You are requested to compute the value of goodwill and show the adjustment thereof in the
books of the firm.
Solution
Computation of the value of goodwill:
(i) Average Profit for three years, ending 30th June; before
death:
Year ending 30th June, 2008 : ` `
1/2 of 2007 profits 33,600
1/2 of 2008 Profits 37,800 71,400
Year ending 30th June, 2009 :
1/2 of 2008 37,800
1/2 of 2009 Profits 36,000 73,800
Year ending 30th June, 2010 :
1/2 of 2009 36,000
1/2 of 2010 profits 31,200 67,200
Total 2,12,400
Average 70,800
(ii) Super Profit : `
Average profits earned 70,800
Less : Partner's remuneration 45,000
Less : 8% on capital employed 12,480 57,480
13,320
Super Profits
(iii) Goodwill @ three years' purchase (13,320 x 3) 39,960
Adjustment entries for Goodwill
Journal Entries
Dr. Cr.
` `
Clever's Capital Account Dr. 7,992
14.16
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Dull's Capital Account Dr. 7,992
To Wise’s Capital Account 15,984
(Being goodwill valued @ ` 39,960 adjusted in the
capital accounts of partners on the death of Mr.
Wise)
Illustration 6
Vasudevan, Sunderarajan and Agrawal are in partnership sharing profit and losses at the ratio
of 2:5:3. The Balance Sheet of the partnership as on 31.12.2010 was as follows:
Balance Sheet of M/s Vasudevan, Sunderarajan & Agrawal
Liabilities ` Assets `
Capital A/cs Sundry fixed assets 5,00,000
Vasudevan 85,000 Stock 1,00,000
Sunderarajan 3,15,000 Debtors 50,000
Agrawal 2,25,000 Bank 5,000
Sundry Creditros 30,000
6,55,000 6,55,000
The partnership earned profit ` 2,00,000 in 2010 and the partners withdrew ` 1,50,000
during the year. Normal rate of return 30%.
Find out the value of goodwill on the basis of 5 years' purchase of super profit. For this
purpose calculate super profit using average capital employed.
Solution
Valuation of Goodwill: `
(1) Average Capital Employed
Total Assets less Sundry creditors as on 31.12.2010 6,25,000
Add : 1/2 of the amount withdrawn by partners 75,000
7,00,000
Less : 1/2 of the profit earned in 2010 1,00,000
6,00,000
(2) Super Profit :
Profit of M/s Vasudevan, Sunderarajan & Agrawal 2,00,000
Normal profit @ 30% on ` 6,00,000 1,80,000
Super Profit 20,000
(3) Value of Goodwill
5 Years' Purchase of Super profit (` 20,000 × 5) = ` 1,00,000
14.17
© The Institute of Chartered Accountants of India
Accounting
5. Change in Profit Sharing Ratio
Sometimes, change in profit sharing ratio takes place without any change in the number of
patners (i.e. admission, retirement or death) of the firm.
When such a change takes place, one or more partners purchase interest in the business from
the other partner(s). Therefore, the aggregate amount of gain by one or more partner(s) is
equal to the aggregate amount of sacrifices made by the other partner(s). The required
adjustments in regard to the profit-sharing ratio, revaluation of assets and liabilities, treatment
of goodwill or reserves or partners’ capitals are same as what is done in case of admission or
retirement or death of a partner.
The only exception is that neither a partner is coming into the business nor a partner is going out.
Sometimes a single entry is passed through partners’ capital accounts in gaining/sacrificing ratio,
when such changes are not to be incorporated in the balance sheet, as is passed for adjustment of
goodwill.
Illustration 7
P, Q and R are partners sharing profits and losses in the ratio of 3:2:1. The goodwill of the
firm is valued at ` 12,000. They have decided to change the profit-sharing ratio to 2:2:1.
Pass Journal Entries.
Solution
In the books of the firm
Journal Dr. Cr.
Date Particulars ` `
Q’s Capital A/c (Refer Working Note) Dr. 800
R’s Capital A/c Dr. 400
To P’s Capital A/c 1,200
(Being the adjustment for goodwill through the
Partners’ Capital Accounts)
Working Note:
Calculation of share of sacrifice/gain
P Q R
Old ratio (3:2:1) 3 2 1
6 6 6
New ratio (2:2:1) 2 2 1
5 5 5
1 2 1
(Sacrifice) . (Gain) (Gain)
10 30 30
12,000 x 1/10 12,000 x 2/30 12,000 x 1/30
14.18
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Illustration 8
The following is the Balance sheet of Anil and Bimal, who are equal partners as on
31.12.2010:
Liabilities ` Assets `
Capital Accounts: Anil 12,000 Sundry Assets 28,000
Bimal 6,000
Reserves 6,000
Creditors 4,000
28,000 28,000
From 1.1.2011, the partners decided to share profits and losses in the ratio of 2:1. For this
purpose, the goodwill of the firm is valued at ` 6,000 which will not be shown in the Balance
Sheet.
Pass necessary Journal Entries and re-draft the Balance Sheet.
Solution In the books of the firm
Journal Entry
Dr. Cr.
Particulars ` `
Reserves A/c Dr. 6,000
To Anil’s Capital A/c 3,000
To Bimal’s Capital A/c 3,000
(Being reserve transferred to the Partners’ Capital Accounts in the
old ratio before change in the constitution)
Anil’s Capital A/c (Refer W.N.) 1,000
To Bimal’s Capital A/c 1,000
(Being the adjustment for goodwill made through the Partners’
Capital Accounts)
Balance Sheet of Anil and Bimal as at 1.1.2011
Liabilities ` Assets `
Capital Accounts: Sundry Assets 28,000
Anil: ` (12,000+3,000-1,000) 14,000
Bimal: ` (6,000+3,000+1,000) 10,000
Creditors 4,000
28,000 28,000
14.19
© The Institute of Chartered Accountants of India
Accounting
Working Note:
Calculation of share of sacrifice/gain
Anil Bimal
Old ratio (1:1) 1 1
2 2
New ratio (2:1) 2 1
3 3
1 1
(Gain) . (Sacrifice)
6 6
6,000 x 1/6 6,000 x 1/6
Illustration 9
Any and Many are partners sharing profits as to ¾ and ¼ and their capitals are ` 90,000 and
` 30,000 respectively. It is decided that with effect from 1st April, 2011 the profit-sharing ratio
will be: Any 5/8 and Many 3/8. The Deed states that goodwill is to be valued at 2 years’
purchase of three years’ profits and that capitals of the two partners should be proportionate
to the profit-sharing ratio. The profits for the years ended 31st March, 2009, 31st March, 2010
and 31st March, 2011 were ` 42,000, ` 39,000 and ` 45,000 respectively. Make necessary
journal entries.
Solution
`
Value of Goodwill: Total profits for 3 years - 2008-09 42,000
2009-10 39,000
2010-11 45,000
Total 1,26,000
Average profit 42,000
Goodwill at 2 years’ purchase 84,000
Calculation of share of sacrifice/gain
Any Many
Old ratio (3:1) 3 1
4 4
New ratio (5:3) 5 3
8 8
1 1
(Sacrifice) . (Gain)
8 8
84,000 x 1/8 = 10,500 84,000 x 1/8=10,500
14.20
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
New capital required after the change in ratio-
`
Total Capital (90,000 + 30,000) 1,20,000
Any’s capital 1,20,000 x 5/8 75,000
Many’s capital 1,20,000 x 3/8 45,000
Journal Entries
` `
Many’s Capital Account Dr. 10,500
To Any’s Capital Account 10,500
[The value of 1/8 share of goodwill (total value ` 84,000)
which Many acquires from Any]
Bank Account Dr. 25,500
To Many’s Capital Account 25,500
[The sum required to make up Many’s capital upto `
45,000 after the debit of ` 10,500, i.e., ` 45,000 –
(30,000 – 10,500)]
Any’s Capital Account Dr. 25,500
To Bank Account 25,500
[The sum to be returned to Any to bring his capital down
to ` 75,000 i.e., ` (90,000 + 10,500 – 75,000).]
6. Admission of a Partner
When a new partner is admitted into the partnership, assets are revalued and liabilities are
reassessed. A Revaluation Account (or Profit and Loss Adjustment Account) is opened for that
purpose.
This account is debited with all reduction in the value of assets and increase in liabilities. The
difference in two sides of the account will show profit or loss. This is transferred to the Capital
Accounts of old partners in the old profit sharing ratio, The entries to be passed are :
1. Revaluation Account Dr.
To the assets (Individually which with the reduction in the value of
show a decrease) the assets.
To the Liabilities (Individually which with the increase in the liabilities.
have to be increased.)
2. Assets Account (Individually) Dr. with the increase in the value of the
Liabilities Account (Individually) Dr. assets.
To Revaluation Account with the reduction in the amount
14.21
© The Institute of Chartered Accountants of India
Accounting
of liabilities
3. Revaluation Account Dr. with the profit in the old profit
To Capital A/cs of the old partners sharing ratio.
or,
Capital A/cs of the old partners Dr. with the loss in old profit sharing
To Revaluation Account ratio.
As a result of the above entries, the capital account balances of the old partners will change
and the assets and liabilities will have to be adjusted to their proper values. They will now
appear in the Balance Sheet at revised figures.
Alternatively, the partners may agree that revalued figures will not be shown in the Balance
Sheet. Assets and liabilities would appear in the Balance Sheet at their old values. For this
one additional entry is necessary.
Capital A/cs Dr. With the amount of revaluation
(of all partners including newly admitted partner)
To Revaluation A/c profit in the new profit sharing ratio.
Or
Revaluation A/c Dr. With the amount of revaluation loss
To Capital A/cs in the new profit sharing ratio.
(of all partners including newly admitted partners)
In this case entries 1 and 2 are not required.
Whenever a new partner is admitted, any reserve etc. which may be 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 10
Messers Dalal, Banerji and Mallick is a firm sharing profits and losses in the ratio 2:2:1. Their
Balance Sheet as on 31st March, 2010 is as below :
Liabilities ` Assets `
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. Malick 5,000 29,000
49,850 49,850
The partners have agreed to take Mr. Mistri as a parner with effect from 1st April, 2011 on the
14.22
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
following terms :
(1) Mr. Mistri shall bring 5,000 towards his capital.
(2) The value of stock should be increased by ` 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 ` 15,000.
(5) The value of the goodwill be fixed at ` 15,000.
(6) General Reserve will be transferred to the partner's 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.
(8) The goodwill account shall be written back to the Partner's account in accordance with
the new profit sharing proportion.
The outstanding liabilities include ` 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, and (iii) the
Balance Sheet of the firm as newly constituted (Journal entries are not required)
Solution
Revaluation Account
2011 ` 2011 `
April1 To Provision for April 1 By Stock in trade 2,500
bad and
" doubtful debts 550 " By Land and 5,000
Building
" To Furniture and 650
fittings
Capital A/cs
" Profit on
revaluation
transferred
Dalal 2,520
Banerji 2,520
Mallick 1,260 6,300
7,500 7,500
14.23
© The Institute of Chartered Accountants of India
Accounting
Capital Accounts of Partners
Particulars Dalal Banerji Mallick Mistri Particulars Dalal Benerji Mallick Mistri
` ` ` ` ` ` ` `
To Dalal & − − − 2,000 By Balance 12,000 12,000 5,000 −
Benerjii b/d
To Balance c/d 19,120 18,120 7,560 3,000 By General 2,600 2,600 1,300 −
Reserve
By Cash − − − 5,000
By Mistri 1,000 1,000 − −
By Out-
standing
Liabilities 1,000 - - −
By Reval-
uation A/c 2,520 2,520 1,260 −
19,120 18,120 7,560 5,000 19,120 18,120 7,560 5,000
Balance Sheet of M/s Dalal, Banerji, Mallick and Mistri as on 1-4-2011
Liabilities ` Assets `
Sundry creditors 12,850 Land and Buildings 30,000
Outstanding Liabilities 500 Furniture 5,850
Capital Accounts of Stock of goods 14,250
partners :
Mr. Dalal 19,120 Sundry Debtors 5,500
Mr. Banerji 18,120 Less: Provision 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
6.1 Proportionate capital and goodwill inference:
‘Proportionate Capital’ means Capital Account balances of partners in accordance with
the profit sharing ratio. In other words, ratio of Capital Account balances is equal to profit
sharing ratio. Proportionate capital is maintained generally following ‘fixed capital method’.
For example, A and B are in partnership, sharing profit or loss at the ratio of 3:2. If total capital is `
1,00,000, A should contribute ` 1,00,000 × 3/5 i.e.,` 60,000 and B should contribute ` 1,00,000
× 2/5 i.e., ` 40,000.
The question of inferring goodwill arises only in case of proportionate capital. If the newly
admitted partner brings capital more than what is required as per profit sharing ratio, then it is
to be presumed that he has contributed the excess for goodwill. For example, A and B are in
partnership who contributed proportionate capital of ` 60,000 and Rs, 40,000. Now they want
to admit C giving him 1/5th share for which C agrees to bring ` 30,000. Since total capital is `
14.24
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
1,00,000, C should contribute ` 20,000 (` 1,00,000 × 1/5) for 1/5th share. Instead he agrees
to pay ` 30,000. So for 1/5th share he is paying ` 10,000, for goodwill. Thus total value of
goodwill is ` 10,000 × 5 i.e., 50,000.
Illustration 11
A and B are in partnership sharing profits and losses equally. The Balance Sheet of M/s A and
B as on 31-12-10 was as follows :
Liabilities ` Assets `
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 1-1-11 they agreed to take C as 1/3rd partner to increase the capital base to
` 1,35,000. C agrees to pay ` 60,000. Show the necessary journal entries, Partners’ Capital
A/cs and Balance Sheet as on 1-1-11.
Solution
In the Books of M/s A, B and C
Journal Entries
` `
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
(Inferred value of goodwill adjusted in the books through
capital accounts)
A’s Capital A/c Dr. 7,500
B’s Capital A/c Dr. 7,500
To Bank 15,000
(To keep capital intact by ` 1,35,000, excess capital (due to
goodwill) withdrawn)
Working Notes :
(1) Old profit sharing ratio - 1:1
(2) New profit sharing ratio - 1:1:1
14.25
© The Institute of Chartered Accountants of India
Accounting
1
(3) C’s share of Capital = ` 1,35,000 × = ` 45,000
3
(4) Goodwill : ` 60,000 — ` 45,000 = ` 15,000 for 1/3rd share.
Total Goodwill : ` 15,000 × 3 = ` 45,000
Partner’s Capital A/cs
Dr. Cr.
Particulars A B C Particulars A B C
` ` ` ` ` `
To A & B - - 15,000 By Balance b/d 45,000 45,000 -
To Bank 7,500 7,500 - By Bank - - 60,000
To Balance c/d 45,000 45,000 45,000 By C 7,500 7,500 -
52,500 52,500 60,000 52,500 52,500 60,000
Balance Sheet of M/s A, B & C as on 1-1-2011
Liabilities ` Assets `
Capital A/cs : Sundry Fixed Assets 60,000
A 45,000 Stock 30,000
B 45,000 Bank 65,000
C 45,000 1,35,000
Sundry Creditors 20,000
1,55,000 1,55,000
7. 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.
• If there is loss on revaluation such 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
only counting the amount payable or chargeable to the retiring partner which the
continuing partners will share at the ratio of gain.
14.26
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
• 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/c
(For profit on revaluation)
Or,
Partners’ Capital A/c Dr.
To Revaluation A/c
(For loss on revaluation)
Now let us see how to deal with a situation where revaluation profit will not appear in the
Balance Sheet.
If A, B & C share profits and losses equally and there is a revaluation profit of ` 30,000
calculated on A’s retirement, then ` 10,000 becomes due to A which is to be borne by B and
C equally. So the journal entry will be as follows :
` `
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 Accounts at the existing profit sharing ratio. Simultaneously the partners’ Capital Accounts
are to be debited for such gain at the new profit sharing ratio and the respective assets/liabilities
account is to be credited again. So the following journal entries are necessary for ` 10,000
increase in sundry fixed assets and ` 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 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
14.27
© The Institute of Chartered Accountants of India
Accounting
In this case it is not necessary to open a separate Revaluation Account.
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 of 5:3:2. A
retired and B and C agreed to share profit and loss at the ratio 3:2. Reserve balance was `
10,000. In this case either of the following journal entries can be passed :
` `
(1) Reserves 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 A/c to partners’
capital A/cs in 5:3:2 ratio on A’s retirement)
Or
(2) Reserves A/c Dr. 5,000
To A’s Capital A/c 5,000
(Transfer of A’s share of reserve to
his Capital Account on his retirement)
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 in the ratio 3:2. Reserve standing at the date of retirement of Z was ` 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.
` `
Reserve A/c Dr. 9,000
14.28
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
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 :
` `
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 of reserve)
7.1 Final payment to retiring partner
The following adjustments are necessary in the Capital A/cs :
(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.
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 Partners’ Loan A/c
To Bank A/c
7.2 Liability of Retiring partner
In the absence of an agreement, the retiring partner or the representative of a deceased
partner can recover his share in the partnership assets (including goodwill), after having them
revalued on a proper basis as at the date of his ceasing to be a partner; appreciation or
depreciation determined on such a revaluation is adjusted in his account before the amount
due to him is paid.
The amount due to the retiring partner is liability of the firm except where a partnership
agreement provides that upon the retirement or death of a partner his share in the assets of
14.29
© The Institute of Chartered Accountants of India
Accounting
the firm will be taken over by the continuing partners in the proportion in which they were
sharing the profits or losses of the firm. When the continuing partners take over the assets
they also become personally liable to repay the amount due to the retiring partner. (Such was
the view taken in the well known case of Elliott vs. Elliott)
Points to be remembered :
(1) the retiring partner or the estate of the deceased partner is liable for the whole of the
debts due by the firm at the date of retirement or death though, as between the partners
they are responsible to pay only their respective share of liabilities [Section 42(2) of the
Partnership Act].
(2) the retiring partner may also be held liable for debts contracted after his retirement, unless
a notice of retirement is published as contemplated by the Law [Section 32(2) of the Part-
nership Act]; and
(3) the estate of a deceased or a bankrupt partner cannot be held liable for debts contracted
by the firm after the death or bankruptcy, as the case may be. [Sections 34(2) and 35 of
the Partnership Act].
Illustration 12
Fairbrother, Greatbatch and Kristen were partners sharing profit and losses at the 2:2:1.
Kristen wants to retire on 31-12-2010. Given below the Balance Sheet of the partnership as
well as other information:
Balance Sheet as on 31-12-2010
Liabilities ` Assets `
Capital A/cs. Sundry Fixed Assets 1,50,000
Fairbrother 1,20,000 Stock 50,000
Greatbatch 80,000 Debtors 50,000
Kristen 60,000 Bills Receivable 20,000
Reserve 10,000 Bank 50,000
Sundry creditors 50,000
3,20,000 3,20,000
Fairbrother and Greatbatch agree to share profits and losses at the ratio of 3:2 in future. Value
of goodwill is taken to be ` 50,000. Sundry Fixed Assets are revalued upward by ` 30,000
and stock by ` 10,000. Bills Receivable dishonoured ` 5,000 on 31-12-2010 but not
recorded in the books. Dishonour of bill was due to insolvency of the customer. Fairbrother
and Greatbatch agree to bring sufficient cash to discharge claim of Kristen and to make their
capital proportionate. Also they wanted to maintain ` 75,000 bank balance for working
capital. However they did not want to show goodwill in the books of accounts. Pass necessary
journal entries and draft the Balance Sheet of M/s Fairbrother and Greatbatch.
14.30
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Solution
Journal Entries
` `
(1) 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).
(2) 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).
(3) Profit and Loss Adjustment A/c Dr. 5,000
To Bills Receivable A/c 5,000
(Loss arising out of dishonoured bill recorded).
(4) 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)
(5) F’s Capital A/c Dr. 10,000
To K’s Capital A/c 10,000
(Adjusting off the value of goodwill in the profit
sacrificing ratio of partners)
(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)
14.31
© The Institute of Chartered Accountants of India
Accounting
Balance Sheet
(After K’s retirement)
Liabilities ` Assets `
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 Bill Receivable 15,000
Bank 75,000
3,80,000 3,80,000
Working Notes :
1. Partner’s Capital A/cs
F G K F G K
` ` ` ` ` `
To K 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 E - - 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
2. Total capital `
Sundry Fixed Assets (` 1,50,000 + 30,000) 1,80,000
Stock (` 50,000 + ` 10,000) 60,000
Debtors 50,000
Bills Receivable (` 20,000—` 5,000) 15,000
Bank 75,000
3,80,000
Less: Sundry Creditors 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
14.32
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
3. Bank A/c
` `
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
Often the retiring partner’s claim is not fully paid but kept in the business as loan. As per
arrangement such loan is repaid by instalments alongwith agreed interest. Sometimes joint life
policy is taken to meet the claim of the retiring partner.
8. Death of a Partner
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. 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 profit earned for the amount due to
the deceased partner.
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, 2010. 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 2007 can be taken as base for calculating 3½ months profit in 2008. If M/s. A, B
& C earned ` 96,000 in 2007, then 3½ months profit is ` 28,000. A’s share comes to `
28,000 × 2/5 i.e., ` 11,200.
Journal entry is :
Profit and Loss Suspense A/c Dr. ` 11,200
To A’s Capital A/c ` 11,200
(Share of A in 3½ months profit in 2008
is transferred to his Capital Account on death)
Students are advised to see CPT study material chapter 8-unit 5 for details.
14.33
© The Institute of Chartered Accountants of India
Accounting
9. Right of Outgoing Partner in Certain Cases to Share Subsequent
Profits
As per provisions of Section 37 of the Indian Partnership Act :
Where any member of a firm has died or otherwise ceased to be a partner, and the surviving
or continuing partners carry on the business of the firm with the property of the firm without
any final settlement of accounts as between them and the outgoing partner or his estate, then,
in the absence of a contract to the contrary, the outgoing partner or his estate is entitled at the
option of himself or his representatives to such share of the profits made since he ceased to
be a partner as may be attributable to the use of his share of the property of the firm or to
interest at the rate of six per cent per annum on the amount of his share in the property of the
firm :
Provided that where by contract between the partners an option is given to surviving or
continuing partners to purchase the interest of a deceased or outgoing partner, and that option
is duly exercised, the estate of the deceased partner, or the outgoing partner or his estate, as
the case may be, is not entitled to any further or other share of profits; but if any partner
assuming to act in exercise of the option does not in all material respects comply with the
terms thereof, he is liable to account under the foregoing provisions of this section. This way,
the outgoing partner has the option to receive, interest at the rate of 6% p.a. or the share of
profit earned on the unsettled amounts for the period till his dues are settled by the firm in the
absence of any contract made to the contrary.
It may be noted that the outgoing partner is not bound to make election until the share of the
profit that would be payable to him has been ascertained.
For example, A, B and C are in a partnership business-sharing profits and losses equally. C
retires on 31st October, 2008. The capitals of the partners, after all necessary adjustments
stood at ` 50,000, ` 75,000 and ` 1,20,000 respectively. A and B continued to carry on the
business further without settling the accounts of C. Final payment to C is made on February 1,
2011. The profit made during the period of three months amounts to ` 28,000.
Under Section 37 of the Partnership Act, C can exercise any of the following two options.
(i) Share in subsequent profits of firm :
Profit made—` 28,000
1,20,000
C’s share – 28,000 × = ` 13,714
2,45,000
(ii) Interest at 6% p.a.
6 3
1,20,000 × × = ` 1,800
100 12
Since, (i) option is beneficial for C, he will necessarily go for his proportionate share in profits.
14.34
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
Illustration 12
Rohan, Sohan and Mohan were partners sharing profits and losses in the ratio of 2:2:1. Their
Balance Sheet as on 1-1-2010 stood as follows :
Liabilities ` ` Assets `
Capital Accounts : Fixed Assets 1,00,000
Rohan 50,000 Stock 25,000
Sohan 40,000 Debtors 35,000
Mohan 30,000 1,20,000 Cash and bank 10,000
Reserves 10,000
Creditors 40,000
1,70,000 1,70,000
On 1st July, 2010 Mohan died. His representatives agreed that :
(i) Goodwill of the firm be valued at ` 50,000;
(ii) Fixed Assets be written down by ` 10,000; and
(iii) In lieu of profits, Mohan should be paid at the rate of 25% per annum on his capital as on
1-1-2010.
Current years (2010) profit after charging depreciation of ` 9,500 (` 5,000 related to the 1st
half) was ` 40,500. The year-end figures of Stock, Debtors and Creditors and Cash and Bank
Balances were respectively ` 23,000, 19,000, 35,000 and 4,377. The particulars regarding
their drawings are given below :
Upto 1-7-2010 April 1-7-2010
` `
Rohan 4,125 5,000
Sohan 4,125 5,000
Mohan 1,750
Prepare the balance sheet of the firm as on 31st December, 2010.
Solution
`
(a) Profit after Depreciation 40,500
Add : Depreciation 9,500
Profit before Depreciation 50,000
(b) Profit for the 1st half (assumed : evenly spread) 25,000
Less : Depreciation with respect to 1st half 5,000
Post Depreciation profit 20,000
14.35
© The Institute of Chartered Accountants of India
Accounting
(c) Profit for the 2nd half 25,000
Less : Depreciation for the 2nd half 4,500
2nd half profit after Depreciation 20,500
(d) Profit and Loss Appropriation A/c
(for the first half)
Dr. Cr.
` ` `
To Interest on Mohan’s 3,750 By Profit 20,000
Capital (30,000 × 25%
for 6 months)
To Rohan 8,125
Sohan 8,125 16,250
20,000 20,000
(e) Capital Account as on 1-7-2010
Rohan Sohan Mohan Rohan Sohan Mohan
To Revaluation Loss By Balance b/d 50,000 40,000 30,000
of Fixed Assets 4,000 4,000 2,000 By Reserves 4,000 4,000 2,000
To Drawings 4,125 4,125 1,750 By Rohan &
To Mohan 5,000 5,000 — Sohan — — 10,000
To Executors A/c − − 42,000 By Profit and Loss
To Balance c/d 49,000 39,000 − Appn. A/c 8,125 8,125 3,750
62,125 52,125 45,750 62,125 52,125 45,750
(f) Application of Section 37 of the Partnership Act
Either
6 6
(i) Interest of 42,000 × × = ` 1,260
100 12
Or
(ii) Profit earned out of unsettled capital
42,000
20,500 × = ` 6,623
(49,000+39,000+42,000)
(g) In the absence of specific agreement amongst partners on the above subject matter, the
representatives of the deceased partner can receive at their option, interest at the rate of
6% p.a. or the share of profit earned for the amount due to the decease partner.
In the above case, it would be rational to assume that the representatives would opt for ` 6,623.
(h) Profit and Loss Appropriation A/c for the second half
Dr. Cr.
` `
To Executors A/c 6,623 By Net Profit 20,500
14.36
© The Institute of Chartered Accountants of India
Issues in Partnership Accounts
To Rohan 6,938
Sohan 6,939 13,877
20,500 20,500
(i) Capital Accounts as on 31-12-2010
Dr. Cr.
Rohan Sohan Rohan Sohan
` ` ` `
To Drawings 5,000 5,000 By Balance b/d 49,000 39,000
To Balance c/d 50,938 40,939 By Profit & Loss Appn. A/c 6,938 6,939
55,938 45,939 55,938 45,939
(j) Executors Account
Dr. Cr.
` `
To Bank 48,623 By Mohan’s Capital A/c 42,000
By Profit & Loss Appn. A/c 6,623
48,623 48,623
(k) Balance Sheet as on 31-12-2010
Liabilities ` ` Assets ` `
Capital Accounts Fixed Assets 1,00,000
Rohan 50,938 Less : Written down 10,000
Sohan 40,939 91,877 90,000
Creditors 35,000 Less : Depreciation 9,500 80,500
Debtors 19,000
Stock 23,000
Cash and Bank 4,377
1,26,877 1,26,877
Summary
• Partnership is defined as the relationship between persons who have agreed to share the
profit or loss of a business carried on by all or any of them acting for all.
• Two methods of accounting
(cid:57) Fixed capital method
(cid:57) Fluctuating capital method.
• Goodwill is the value of reputation of a firm in respect of profits expected in future over
and above the normal rate of profits.
14.37
© The Institute of Chartered Accountants of India
Accounting
• Necessity for valuation of goodwill in a firm arises in the following cases:
(cid:57) When the profit sharing ratio amongst the partners is changed;
(cid:57) When a new partner is admitted;
(cid:57) When a partner retires or dies, and
(cid:57) When the business is dissolved or sold.
• Methods for valuation of goodwill:-
(1) Average profit basis :
Total profit
Average Profit =
NumberofYears
Goodwill = Average Profit x No. of Years’ purchased
The profits taken into consideration are adjusted with abnormal losses, abnormal
gains, errors, return on non-trade investments and errors.
(2) Super profit basis :
Calculate Capital Employed
Assets …….
Less: Liability …….
Capital Employed ……..
(cid:57) Find the normal Rate of Return(NRR)
(cid:57) Find Normal Profit=Capital Employed X Normal rate of Return
(cid:57) Find Average Actual Profit
(cid:57) Find Super Profit=Average Actual Profit-Normal Profit
(cid:57) Find Goodwill=Super Profit X Number of Years Purchased
(3) Annuity basis :
Goodwill=Super Profit X Annuity Number
(4) Capitalization basis :
Super profit
Goodwill =
Normal RateofReturn
14.38
© The Institute of Chartered Accountants of India