Back to: Financial Accounting
Good day, class.
This week, we are focusing on the retirement and death of a partner in a partnership. Just like admission, retirement or death leads to changes in ownership and requires financial adjustments to reflect a fair settlement of the partner’s interest in the business.
Retirement and Death of a Partner
1. Retirement of a Partner
When a partner decides to retire from the partnership, the remaining partners must agree on:
The value of the retiring partner’s share
Adjustments for goodwill and revaluation
New profit-sharing ratios
Settlement terms: whether by cash, transfer of assets, or instalments
Key Adjustments:
a. Revaluation of Assets and Liabilities
Assets and liabilities are revalued to ensure the retiring partner receives their fair share. Any profit or loss from revaluation is shared by all partners (including the retiring one) in their old ratio.
b. Goodwill Adjustment
Goodwill is valued and the retiring partner’s share is compensated by the remaining partners. If goodwill is not brought into the books, adjustments are made through capital accounts.
c. New Profit-Sharing Ratio
The remaining partners agree on a new profit-sharing ratio. The gaining ratio (how much each remaining partner gains from the retiring one) is used to adjust for goodwill.
d. Settlement of Retiring Partner’s Capital
The retiring partner is paid the balance of their capital account, which includes:
Capital balance
Share of goodwill
Share of revaluation profit/loss
Share of reserves (if any)
Payment may be made immediately or in instalments. If not paid immediately, the amount owed becomes a loan to the firm.
2. Death of a Partner
In the event of a partner’s death, similar adjustments are made. However, instead of paying the partner, the payment goes to their legal representative.
In addition to the adjustments made at retirement, the following may apply:
Share of profit up to date of death: Estimated based on time or turnover.
Interest on capital and drawings: Calculated up to date of death.
Life insurance proceeds (if any): Treated as firm income or capital, depending on the agreement.
Example (Simplified):
Partners A, B, and C share profits 3:2:1. B retires. Goodwill is valued at N180,000.
B’s share = 2/6 × 180,000 = N60,000.
A and C agree to share future profits equally, so gain ratio is calculated and goodwill is adjusted through capital accounts.
B is paid out or the amount is transferred to a loan account if cash is not available.