chapter 7 – partnership accounts – unit 1 – introduction · 2020. 9. 29. · CHAPTER 7 – PARTNERSHIP ACCOUNTS – UNIT 1 – INTRODUCTION P a g e 7.3 | 7.33 3. Karim demands

CHAPTER 7 – PARTNERSHIP ACCOUNTS – UNIT 1 – INTRODUCTION

P a g e 7.1 | 7.33

Chapter 7 – Partnership Accounts

Unit 1 – Introduction to Partnership Accounts

Meaning When two or more persons do business together, it is known as partnership.

Features 1. Existence of Agreement

2. Business

3. Sharing of Profit

4. Mutual Agency

Number of Partners in a Firm 1. Minimum = 2

2. Maximum = 50

Partnership Deed

Meaning Written document containing all the terms and conditions of Partnership.

Rules in the Absence of Partnership Deed Issues Provision

1. Salary/Commission to Partners No 2. Interest on Capital No 3. Interest on Drawings No 4. Interest on Partner’s Loan 6% 5. Profit Sharing Ratio Equal

Question 1

State with reasons whether the following statements are True or False:

1. When there is no agreement among the partners, the profit or loss of the firm will be shared in

their capital ratio.

(RTP May, 2018; MTP May, 2018 – 2 Marks; MTP November, 2018 – 2 Marks)

2. When there is no partnership deed prevails, the interest on loan of a partner to be paid @ 6%.

(May, 2018 – 2 Marks)

Answer

1. False: According to the Indian Partnership Act, in the absence of any agreement to the contrary,

profits and losses of the firm are shared equally among partners.


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2. True: When there is no partnership deed, then the provisions of the Indian Partnership Act are to

be applied for settling the dispute. Interest on loan is payable @ 6% p.a. as per Indian Partnership

Act.

Accounts of Partnership Firm

Charge Against Profit vs. Appropriation of Profit S.

No. Charge Against Profit Appropriation of Profit

1. Deducted from Revenue Distribution of Net Profit to Partners under appropriate heads

2. Debited to the Profit & Loss A/c Debited to the Profit & Loss Appropriation A/c

Note – Rent Paid to Partner, and Interest on Partner’s Loan are charges against profit.

Profit & Loss Appropriation A/c

Profit and Loss Appropriation A/c

Dr. for the year ended… Cr.

Particulars ₹ Particulars ₹

To Interest on Capitals: By Profit & Loss A/c (Net Profit) ……..

To A's Capital A/c …….. By Interest on Drawings:

To B's Capital A/c …….. …….. By A's Capital A/c …….. To Partners' Salaries A/c …….. By B's Capital A/c …….. ……..

To Partners' Commissions A/c …….. To Reserve A/c ……..

To Profit transferred to:

To A's Capital A/c ……..

To B's Capital A/c …….. ……..

…….. ……..

Meaning of Divisible Profit Net Profit as per the Profit & Loss A/c is transferred to the Profit and Loss Appropriation A/c. This net

profit is then appropriated as per the terms of the Partnership Deed.

Divisible Profit means profit after crediting Interest on Drawings (if any) to Profit and Loss Appropriation

Account and debiting salary to partners, interest on capital, etc. It is divided among the partners in their

profit sharing ratio. Following questions will make it clear.

Question 2

Ram, Rahim and Karim are partners in a firm. They have no agreement in respect of profit-sharing ratio,

interest on capital, interest on loan advanced by partners and remuneration payable to partners. In the

matter of distribution of profits, they have put forward the following claims:

1. Ram, who has contributed maximum capital demands interest on capital at 10% p.a. and share of

profit in the capital ratio. But Rahim and Karim do not agree.

2. Rahim has devoted full time for running the business and demands salary at the rate of ₹500 p.m.

But Ram and Karim do not agree.


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3. Karim demands interest on loan of ₹2,000 advanced by him at the market rate of interest which is

12% p.a.

How shall you settle the dispute and prepare Profit and Loss Appropriation Account after transferring 10%

of the divisible profit to Reserve? Net profit before taking into account any of the above claims amounted

to ₹45,000 at the end of the first year of their business.

(ICAI Study Material)

Answer

Share of Profit of Ram – ₹13,464; Rahim – ₹13,464; Karim – ₹13,464.

Partners’ Capital Accounts

Interest on Capital Interest on Partner’s Capital A/c …Dr. To Partner’s Capital/Current A/c

Profit & Loss Appropriation A/c …Dr. To Interest on Partner’s Capital A/c

OR

Profit & Loss Appropriation A/c …Dr. To Partner’s Capital/Current A/c


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Note: If the Capital Accounts are maintained following the Fixed Capital Method, then interest is

allowed only on the balance of the Capital A/c and not on the balance of the Current A/c.

Interest on Drawings

Accounting Treatment Partner’s Capital/Current A/c …Dr. To Interest on Partner’s Drawings A/c

Interest on Partner’s Drawings A/c …Dr. To Profit & Loss Appropriation A/c

OR Partner’s Capital/Current A/c …Dr. To Profit & Loss Appropriation A/c

Calculation of Interest on Drawings

Irregular Drawings No particular method. Calculate normally.

Regular Drawings

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝐷𝑟𝑎𝑤𝑖𝑛𝑔𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝐷𝑟𝑎𝑤𝑖𝑛𝑔𝑠 ×𝑅𝑎𝑡𝑒 𝑜𝑓 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡

100×

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑒𝑟𝑖𝑜𝑑

12

where,

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑒𝑟𝑖𝑜𝑑 =𝑀𝑜𝑛𝑡ℎ𝑠 𝐿𝑒𝑓𝑡 𝐴𝑓𝑡𝑒𝑟 𝐹𝑖𝑟𝑠𝑡 𝐷𝑟𝑎𝑤𝑖𝑛𝑔𝑠 + 𝑀𝑜𝑛𝑡ℎ𝑠 𝐿𝑒𝑓𝑡 𝐴𝑓𝑡𝑒𝑟 𝐿𝑎𝑠𝑡 𝐷𝑟𝑎𝑤𝑖𝑛𝑔𝑠

2

Average Period in Various Cases of Regular Drawings

Case Average Period

1. Beginning of Every Month 6.5 2. Middle of Every Month 6 3. End of Every Month 5.5 4. Beginning of Every Quarter 7.5 5. Middle of Every Quarter 6 6. End of Every Quarter 4.5

Note: In case the date of drawings is not given in the question, assume that it was withdrawn evenly

throughout the year, and calculate the interest on drawings for an average period of 6 months.

Question 3

Ram and Rahim start business with capital of ₹50,000 and ₹30,000 on 1st January, 2016. 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 Profit and Loss

Appropriation Account and the Capital and Current Accounts relating to the partners.


P a g e 7.5 | 7.33


Answer

Rahim’s Salary – ₹4,800; Interest on Ram’s Capital – ₹3,000; Interest on Rahim’s Capital – ₹1,800; Interest

on Ram’s Drawings – ₹240; Interest on Rahim’s Drawings – ₹300; Share of Ram’s Profit – ₹10,470; Share

of Rahim’s Profit – ₹10,470; Balance of Capital Account: Ram – ₹50,000; Rahim – ₹30,000; Balance of

Current Account: Ram – ₹5,230; Rahim – ₹6,770.

Past Adjustments The errors or omissions occurred in the past are accounted for by passing one Journal Entry.

Table Showing Adjustments (Adjustment Table)

Question 4

A, B and C are partners in a firm sharing profits and losses equally. For the year ended 31st March, 2018,

₹1,00,000 each was transferred to their capitals as their share of profits. Later on, it was realised that

interest on capital was not allowed to A – ₹12,000, B – ₹9,600 and C – ₹10,500 and also interest was not

charged on drawings of A and B amounting to ₹1,200 and ₹900 respectively. Pass a journal entry for

rectifying the above errors.

Solution

An adjustment table is prepared as follows:

Particulars A's Capital A/c B's Capital A/c C's Capital A/c Firm

Dr. (₹) Cr. (₹) Dr. (₹) Cr. (₹) Dr. (₹) Cr. (₹) Dr. (₹) Cr. (₹)

Profit Already Distributed 1,00,000 - 1,00,000 - 1,00,000 - - 3,00,000 Interest on Capital - 12,000 - 9,600 - 10,500 32,100 - Interest on Drawings 1,200 - 900 - - - - 2,100 Profit to be Distributed - 90,000 - 90,000 - 90,000 2,70,000 -

1,01,200 1,02,000 1,00,900 99,600 1,00,000 1,00,500 3,02,100 3,02,100

Net Effect 800 (Cr.) 1,300 (Dr.) 500 (Cr.) NIL

The journal entry is passed as follows:

Date Particulars L.F. Dr. (₹) Cr. (₹)

B's Capital A/c Dr. 1,300

To A's Capital A/c 800 To C's Capital A/c 500


P a g e 7.6 | 7.33

Guarantee to a Partner of Minimum Profit • Incoming Partner is given a guarantee that his share of profit will not be less than a certain

amount.

• If his share falls short of the guaranteed amount, the remaining partners bear the deficiency in

the agreed ratio.

• In the absence of agreement, the deficiency is borne in the profit sharing ratio.

Profit & Loss Appropriation A/c

Particulars ₹ Particulars ₹

To Profit transferred to: By Profit & Loss A/c (Net Profit) Xxx To A's Capital A/c xxx To Less: Deficiency borne xxx xxx To B's Capital A/c xxx To Less: Deficiency borne xxx xxx To C's Capital A/c xxx To Add: Deficiency met by A xxx To Add: Deficiency met by B xxx xxx

xxx xxx

Question 5

A, B and C entered into partnership on 1.1.2019 to share profits and losses in the ratio of 5:3:2. A personally

guaranteed that C’s share of profit after charging interest on capitals at 5% p.a. would not be less than

₹30,000 in any year. Capitals of A, B and C were ₹3,20,000, ₹2,00,000 and ₹1,60,000 respectively.

Profits for the year ending 31.12.2019 before providing for interest on partners’ capital was ₹1,59,000.

You are required to prepare the Profit and Loss Appropriation Account.

(RTP May, 2020; RTP May, 2018)

Answer

Share of Profits of A – ₹57,500; B – ₹37,500; C – ₹30,000

CHAPTER 7 – PARTNERSHIP ACCOUNTS – UNIT 2 – TREATMENT OF GOODWILL

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Unit 2 – Treatment of Goodwill in Partnership

Accounts

Meaning of Goodwill Goodwill means Reputation.

Need for Valuation of Goodwill Goodwill needs to be valued in a number of circumstances. Two such circumstances are:

1. When a running business organisation is sold as a going concern; and

2. When there is a change in the constitution of a partnership firm.

Methods of Valuation of Goodwill 1. Average Profit Method

2. Super Profit Method

3. Annuity Method

4. Capitalisation Method

Average Profit Method 𝐺𝑜𝑜𝑑𝑤𝑖𝑙𝑙 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑟𝑜𝑓𝑖𝑡 × 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠′𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒

Average Profit Average Profit could either by Simple Average or Weighted Average.

Following steps are followed to calculate the weighted average:

1. Every year is assigned a weight.

2. Profit of every year is multiplied by the weight assigned to it.

3. The sum of the products as calculated above is divided by the sum of the weights.

Year (a)

Profit/(Loss) (b)

Weight (c)

Product (d) = (b) × (c)

1 1,00,000 1 1,00,000 2 2,50,000 2 5,00,000 3 4,00,000 3 12,00,000

Total 6 18,00,000

𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 =18,00,000

6= 3,00,000

Number of Years’ Purchase Number of year’s purchase means the number of years for which the firm can expect to earn the same

amount of profit after the change in ownership because of the efforts put in the past.


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Algorithm for Calculation of Goodwill Step 1 – Calculation of Normal Business Profit/Adjusted Profit for each year.

In order to calculate the Normal Business Profit or the Adjusted Profit, the following table is made for as

many years as are given in the question:

Particulars Year 1

Year 2

Year 3

Reason

Given Profit/(Loss)

Add:

Abnormal Losses (e.g. Loss by fire, loss by theft, etc.)

Abnormal Losses are not normal business activities. Since the profit gets adversely affected when such losses are debited to the Profit & Loss A/c, they should be added back in order to ascertain the correct, or the normal profit.

Loss on Sale of Fixed Assets

Loss on Sale of Fixed Assets is not a normal business activity. Since the profit gets adversely affected when such losses are debited to the Profit & Loss A/c, they should be added back in order to ascertain the correct, or the normal profit.

Overvaluation of Opening Stock

Overvaluation of Opening Stock results in reduced profit. Therefore, it should be added to ascertain the correct, or the normal profit.

Undervaluation of Closing Stock

Undervaluation of Closing Stock results in reduced profit. Therefore, it should be added to ascertain the correct, or the normal profit.

Non-recurring Expenses

An expense which is non-recurring would not reduce the profit of every year in the future. Therefore, it should be added to ascertain the correct, or the normal profit.

Capital Expenditure charged as Revenue Expenditure

Capital Expenditures are not charged to profit and loss account while revenue expenditures are charged to profit and loss account. If capital expenditure is charged as a revenue expenditure, this means that the profit is reduced to the extent of the capital expenditure. Therefore, it should be added to ascertain the correct, or the normal profit.

Less:

Abnormal Gains Abnormal Gains are not normal business activities. Since the profit increases when such gains are credited to the Profit & Loss A/c, they should be reduced in order to ascertain the correct, or the normal profit.

Overvaluation of Closing Stock

Overvaluation of Closing Stock results in increased profit. Therefore, it should be reduced in order to ascertain the correct, or the normal profit.

Undervaluation of Opening Stock

Undervaluation of opening stock results in increased profit. Therefore, it should be reduced to ascertain the correct, or the normal profit.

Non-Recurring Incomes

An income which is non-recurring would not increase the profit of every year in the future. Therefore, it should be reduced to ascertain the correct, or the normal profit.


P a g e 7.9 | 7.33

Partners’ Remuneration (if it is not deducted)

Partners’ Remuneration, if not deducted, needs to be deducted in order to ascertain the correct, or the normal profit.

Any other future expense

Any other future expense will reduce the profit, and hence, it is deducted in order to ascertain the correct, or the normal profit.

Step 2 – Find out the simple average or the weighted average of the adjusted profits as calculated in step

1 for all the years.

Step 3 – Determine the Number of Years’ Purchase.

Step 4 – Goodwill = Average Profit × Number of Years’ Purchase.

Question 1

Simran purchased Anita’s business as on 1st April, 2018. It was agreed to value goodwill at three years’

purchase of average normal profit of the last four years. The profits of Anita’s business for the last four

years were:

Year Ended ₹

31st March, 2015 90,000 31st March, 2016 1,60,000 31st March, 2017 1,80,000 31st March, 2018 2,20,000

It was observed from the books of account that:

1. During the year ended 31st March, 2015, an asset was sold at a gain (profit) of 10,000.

2. During the year ended 31st March, 2016, a machine got destroyed in accident and 30,000 was

written off as loss in Profit and Loss Account.

3. During the year ended 31st March, 2017, firm’s assets were not insured due to oversight. Insurance

premium being ₹10,000.

Calculate he value of goodwill.

Answer

Goodwill = ₹4,95,000

Super Profit Method


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Question 2

J and K are partners in a firm. Their capitals are J ₹3,00,000 and K ₹2,00,000. During the year ended 31st

March, 2017 the firm earned a profit of ₹1,50,000. Assuming that the normal rate of return is 20%,

calculate the value of goodwill on the firm by Super Profit Method if the goodwill is valued at 2 years’

purchase of Super Profit.

(RTP November, 2020; RTP May, 2020; RTP November, 2019; RTP May, 2018)

Answer


Question 3

The profits and losses for the previous years are: 2015 Profit ₹10,000, 2016 Loss ₹17,000, 2017 Profit

₹50,000, 2018 Profit ₹75,000. The average Capital employed in the business is ₹2,00,000. The rate of

interest expected from capital invested is 10%. The remuneration from alternative employment of the

proprietor ₹6,000 p.a. Calculate the value of goodwill on the basis of 2 years’ purchases of Super Profits

based on the average of 3 years.

(RTP May, 2019)

Answer

Goodwill = ₹20,000

Determination of Capital Employed In order to calculate the Normal Profit, we need to multiply the normal rate of return with the Capital

Employed. Therefore, it is important to understand how to calculate the Capital Employed. Consider the

following balance sheet:

Liabilities ₹ Assets ₹

Capital A/cs: Land 2,00,000 A 50,000 Building 5,00,000 B 1,50,000 Plant 1,00,000 C 3,00,000 Stock 45,000 General Reserve 4,50,000 Debtors 50,000 Bank Loan 5,00,000 Cash 2,00,000 Creditors 45,000 Bank 4,00,000

14,95,000 14,95,000

The boxed portion in the above balance sheet, i.e. the capital accounts of A, B, and C, and the General

Reserve is the capital employed. Capital employed is basically what belongs to the owners.

There are two ways of calculating the capital employed:

1. Liabilities Side Approach

2. Asset Side Approach

Average Capital Employed

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 =𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

2


P a g e 7.11 | 7.33

OR

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + (1

2 × 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟′𝑠 𝐷𝑟𝑎𝑤𝑖𝑛𝑔𝑠)

− (1

2 × 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟′𝑠 𝑃𝑟𝑜𝑓𝑖𝑡)

Question 4

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 31.12.2017 was as follows:

Balance Sheet


Capital A/cs: Sundry Fixed Assets 5,00,000 Vasudevan 85,000 Inventory 1,00,000 Sunderarajan 3,15,000 Trade Receivables 50,000 Agrawal 2,25,000 Bank 5,000 Trade Payables 30,000

6,55,000 6,55,000

The partnership earned profit ₹2,00,000 in 2017 and the partners withdrew ₹1,50,000 during the year.

Normal rate of return 30%.

You are required to calculate the value of goodwill on the basis of 5 years' purchase of super profit. For

this purpose, calculate super profit using average capital employed.

(RTP November, 2019; RTP November, 2018)

Answer


Annuity Method Question 5

A firm of A, B, and C has a total capital investment of ₹4,50,000. The firm earned net profits during the last

four years as I – ₹70,000; II – ₹80,000; III – ₹1,20,000 and IV – ₹1,00,000. The reasonable expected return

is 15% having regard to the risk involved. Find out the value of goodwill of the business if it is based on 3

years’ purchase of the average super profits of the past four years. Also, calculate the goodwill using the

Annuity method.

(ICAI Study Material – Modified)

Answer

Goodwill using Super Profit Method = ₹75,000; Goodwill using Annuity Method = ₹57,080.63


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Capitalisation Method

Question 6

J and K are partners in a firm. Their capitals are J ₹3,00,000 and K ₹2,00,000. During the year ended 31st

March, 2017 the firm earned a profit of ₹1,50,000. Assuming that the normal rate of return is 20%,

calculate the value of goodwill on the firm by Capitalisation Method.

(RTP November, 2020; RTP May, 2020; RTP November, 2019; RTP May, 2018)

Answer


CHAPTER 7 – PARTNERSHIP ACCOUNTS – UNIT 3 – ADMISSION

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Unit 3 – Admission of a New Partner

Incoming Partner An incoming partner brings two things:

1. Capital

2. Share of Goodwill

Issues to be Dealt With at the time of Admission of a Partner 1. Determining the new Profit Sharing Ratio;

2. Determining the Gaining and the Sacrificing Ratio;

3. Valuation and Adjustment of Goodwill;

4. Adjustment of Gain (Profit)/Loss arising from Revaluation of Assets and Reassessment of

Liabilities;

5. Adjustment of Reserves, Accumulated Profits and Losses;

6. Adjustment of Capitals.

We shall understand each such issue one by one.

Determining the new Profit Sharing Ratio This is simple mathematics. Read the requirement of the question, and calculate.

Determining the Gaining and the Sacrificing Ratio New Share – Old Share = Gain/(Sacrifice)

Valuation and Adjustment of Goodwill 1. Goodwill (Premium for Goodwill) is paid privately;

2. Goodwill (Premium for Goodwill) is brought in cash or by cheque by the new or Incoming Partner

and is retained in the business;

3. Goodwill (Premium for Goodwill) is brought in cash or by cheque by the new or Incoming Partner

and is withdrawn by Sacrificing Partners fully or partly;

4. Goodwill (Premium for Goodwill) is brought in kind;

5. Goodwill (Premium for Goodwill) is not brought in full or part by the new or Incoming Partner.

Goodwill (Premium for Goodwill) is paid privately When goodwill or premium for goodwill is paid by the new partner to the old partners privately, no

question of entry in the books of accounts arises.

Goodwill (Premium for Goodwill) is brought in cash or by cheque by the new or Incoming

Partner and is retained in the business The journal entries are:

1. On admission of the incoming partner:


P a g e 7.14 | 7.33

Cash/Bank A/c Dr. (his share of capital + his share of goodwill)

To Incoming Partner’s Capital A/c

2. On transferring the goodwill to the existing partners:

Incoming Partner’s Capital A/c Dr. (his share of goodwill)

To Sacrificing Partners’ Capital A/c (Individually) (in sacrificing ratio)

Note, if some balance of the previously purchased goodwill is being shown in the books of accounts at the

time of admission of a new partner, such balance is transferred to the old partners’ capital account in

their old profit sharing ratio.

Goodwill (Premium for Goodwill) is brought in cash or by cheque by the new or Incoming

Partner and is withdrawn by Sacrificing Partners fully or partly The journal entries are:


Cash/Bank A/c Dr. (his share of capital + his share of goodwill)





3. On withdrawal of goodwill fully/partly by the sacrificing partners:

Sacrificing Partners’ Capital A/cs Dr. (amount withdrawn)

To Cash/Bank A/c

Goodwill (Premium for Goodwill) is brought in kind The journal entries are:


Cash/Bank A/c Dr. (his share of capital)

Assets A/c Dr. (his share of goodwill)





Goodwill (Premium for Goodwill) is not brought in full or part by the new or Incoming

Partner Sometimes, the incoming partner is unable to bring his share of goodwill in cash or kind. In such situation,

the adjustment is still made through the capital account of the incoming partner. If the capital account is

maintained using the fixed capital method, then the adjustment of goodwill is made through the current

account of the incoming partner.

Hidden Goodwill Sometimes, the value of goodwill of the firm is not specifically given in the question. Also, no information

is given in the question regarding the method of valuing the goodwill of the firm. In such case, the goodwill

of the firm is inferred using the following format:

Particulars ₹

Incoming Partner’s Capital × Reciprocal of share of Incoming Partner 500xxx


P a g e 7.15 | 7.33

Less: Total capital after taking into consideration the capital brought in by incoming partner xxx

Value of Goodwill xxx

Question 1

A and B are in partnership sharing profits and losses equally. The Balance Sheet of M/s A and B as on 31-

12-2016 was as follows:


Capital A/cs: Sundry Fixed Assets 60,000 A 45,000 Inventories 30,000 B 45,000 Bank 20,000 Trade Payables 20,000

1,10,000 1,10,000

On 01-01-2017, 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 and prepare partners’ capital accounts.


Adjustment of Gain (Profit)/Loss arising from Revaluation of Assets and

Reassessment of Liabilities This revaluation is done through an account titled “Revaluation Account” or “Profit & Loss Adjustment

Account”. Following adjustments are carried out through this account:

S. No. Adjustment A/c Debited A/c Credited

1. Increase in the value of Asset Asset Revaluation

2. Decrease in the value of Asset Revaluation Asset

3. Increase in the value of Liability Revaluation Liability

4. Decrease in the value of Liability Liability Revaluation

At the end, the balance of the revaluation account is transferred to the old partners in their old profit

sharing ratio.

Memorandum Revaluation Account If the firm wishes to keep showing the assets and liabilities in the balance sheet at old figures, it can make

the adjustments through an account called the “Memorandum Revaluation A/c”, instead of Revaluation

A/c. A “Memorandum Revaluation A/c” is a temporary Revaluation A/c, wherein, first we make the entries

for the revaluation of assets and liabilities, and transfer the gain or loss to the old partners in their old

profit sharing ratio. Thereafter, we reverse those entries, and the balance is transferred to all the partners,

including the new partner, in their new profit sharing ratio.

Adjustment of Reserves, Accumulated Profits and Losses The balance of any reserves, accumulated profits, and accumulated losses should be transferred to the

old partners in their old profit sharing ratio.

Some of the common reserves and accumulated profits/losses are in the form of:

1. On the Liability side of the Balance Sheet

a. Workmen Compensation Reserve

i. When liability for Workmen Compensation is less than the Reserve


P a g e 7.16 | 7.33

Workmen Compensation Reserve A/c Dr. (Full Value)

To Workmen Compensation Claim A/c (Amount of Liability)

To Old Partners’ Capital A/c in Old PSR (Remaining Amount)

ii. When liability for Workmen Compensation is more than the Reserve


Revaluation A/c Dr. (Remaining Amount of Liability)


iii. When liability for Workmen Compensation is equal to the Reserve



b. Investment Fluctuation Fund/Reserve

i. When the amount of fall in investment is less than the Fund

Investment Fluctuation Fund/Reserve A/c Dr. (Full Value)

To Investment A/c (Amount of fall)

To Old Partners’ Capital A/c in Old PSR (Remaining Amount)

ii. When the amount of fall in investment is more than the Fund


Revaluation A/c Dr. (Remaining amount of fall)


iii. When the amount of fall in investment is equal to the Fund



c. Credit Balance of Profit & Loss A/c

Profit & Loss A/c Dr.

To Old Partners’ Capital A/c in Old PSR

2. On the Asset side of the Balance Sheet

a. Advertisement Suspense

Old Partners’ Capital A/c Dr. (In Old PSR)

To Advertisement Suspense A/c

b. Debit Balance of Profit & Loss A/c

Old Partners’ Capital A/c Dr. (In Old PSR)

To Profit & Loss A/c

Adjustment of Capitals Sometimes, the question mentions that after the adjustments of the assets, liabilities, goodwill, etc., the

closing balance of the capitals of the partners should be in their profit sharing ratio on the basis of the

capital of the new partner. Therefore, if any partner has any excess balance than what is required as per

the profit sharing ratio, he or she withdraws it from the firm. Similarly, if any partner is short of the

required capital as per the profit sharing ratio, he or she brings it to the firm. The following question will

make this point clear.

Note: In order to understand when to use the New PSR, the Old PSR, or the Sacrificing Ratio, always

remember:

1. Koi bhi puraani cheez puraane partners me puraane PSR me jaayegi – example, reserves, profit

or loss on revaluation, past adjustments, etc. are transferred to the old partners in their old PSR;


P a g e 7.17 | 7.33

2. Koi bhi nayi cheez naye partners me naye PSR me jaayegi – example, in case of memorandum

revaluation, the profit or loss obtained in the second part is transferred to all the partners in

their new PSR;

3. Koi bhi compensation sacrificing ratio me jaayega – example, goodwill paid by the incoming

partner to the existing partners for their sacrifice is shared by the existing partners in their

sacrificing ratio.

Question 2

A and B are partners in a firm, sharing Profits and Losses in the ratio of 3:2. The Balance Sheet of A and B

as on 1.1.2018 was as follows:


Sundry Creditors 12,900 Building 26,000 Bills Payable 4,100 Furniture 5,800 Bank Overdraft 9,000 Stock-in-Trade 21,400 Capital Account: Debtors 35,000 A 44,000 Less: Provision 200 34,800

B 36,000 80,000 Investment 2,500

Cash 15,500

1,06,000 1,06,000

‘C’ was admitted to the firm on the above date on the following terms:

1. He is admitted for 1/6th share in future profits and to introduce a Capital of ₹25,000.

2. The new profit sharing ratio of A, B and C will be 3:2:1 respectively.

3. ‘C’ is unable to bring in cash for his share of goodwill, partners therefore, decide to raise goodwill

account in the books of the firm. They further decide to calculate goodwill on the basis of ‘C’s share

in the profits and the capital contribution made by him to the firm.

4. Furniture is to be written down by ₹870 and Stock to be depreciated by 5%. A provision is required

for Debtors @ 5% for Bad Debts. A provision would also be made for outstanding wages for ₹1,560.

The value of Buildings having appreciated be brought upto ₹29,200. The value of investment is

increased by ₹450.

5. It is found that the creditors included a sum of ₹1,400, which is not to be paid off.

Prepare the following:

1. Revaluation Account.

2. Partners’ Capital Accounts.

3. Balance Sheet of New Partnership firm after admission of ‘C’.

(RTP May, 2019)

Question 3

Dinesh, Ramesh and Naresh are partners in a firm sharing profits and losses in the ratio of 3:2:1. Their

Balance Sheet as on 31st March, 2018 is as below:


Trade Payables 22,500 Land & Buildings 37,000 Outstanding Liabilities 2,200 Furniture & Fixtures 7,200 General Reserve 7,800 Closing Stock 12,600 Capital Accounts: Trade Receivables 10,700


P a g e 7.18 | 7.33

Dinesh 15,000 Cash in Hand 2,800 Ramesh 15,000 Cash at Bank 2,200 Naresh 10,000 40,000 72,500 72,500

The partners have agreed to take Suresh as a partner with effect from 1st April, 2018 on the following

terms:

1. Suresh shall bring ₹8,000 towards his capital.

2. The value of stock to be increased to ₹14,000 and Furniture & Fixtures to be depreciated by 10%.

3. Reserve for bad and doubtful debts should be provided at 5% of the Trade Receivables.

4. The value of Land & Buildings to be increased by ₹5,600 and the value of the goodwill be fixed at

₹18,000.

5. The new profit sharing ratio shall be divided equally among the partners.

The outstanding liabilities include ₹700 due to Ram which has been paid by Dinesh. Necessary entries were

not made in the books.

Prepare (i) Revaluation Account, (ii) Capital Accounts of the partners, (iii) Balance Sheet of the firm after

admission of Suresh.

(November, 2018 – 15 Marks)

Question 4

Laurel and Hardy are partners of the firm LH & Co., from 1.4.2013. Initially both of them contributed

₹1,00,000 each as capital. They did not contribute any capital thereafter. They maintain accounts of the

firm on mercantile basis. They were sharing profits and losses in the ratio of 5:4. After the accounts for the

year ended 31.3.2017 were finalized, the partners decided to share profits and losses equally with effect

from 1.4.2013.

It was also discovered that in ascertaining the results in the earlier years, certain adjustments, details of

which are given below, had not been noted:

Years ended 31st March 2014 2015 2016 2017

₹ ₹ ₹ ₹

Profits as per accounts prepared and finalized 1,40,000 2,60,000 3,20,000 3,60,000 Expenses not provided for (as at 31st March) 30,000 20,000 36,000 24,000 Incomes not taken into account (as at 31st March) 18,000 15,000 12,000 21,000

The partners decided to admit Chaplin as a partner with effect from 1.4.2017. It was decided that Chaplin

would be allotted 20% share in the firm and he must bring 20% of the combined capital of Laurel and

Hardy.

Following is the Balance sheet of the firm as on 31.3.2017 before admission of Chaplin and before

adjustment of revised profits between Laurel and Hardy.


Capital Accounts: Plant and Machinery 60,000 Laurel 2,11,500 Cash on Hand 10,000 Hardy 1,51,500 Cash at Bank 5,000 Trade Payables 2,27,000 Stock in Trade 3,10,000

Trade Receivables 2,05,000

5,90,000 5,90,000


P a g e 7.19 | 7.33

You are required to prepare:

1. Profit and Loss Adjustment account;

2. Capital accounts of the partners; and

3. Balance Sheet of the firm after the admission of Chaplin.

(MTP November, 2018 – 20 Marks)

CHAPTER 7 – PARTNERSHIP ACCOUNTS – UNIT 4 – RETIREMENT

P a g e 7.20 | 7.33

Unit 4 – Retirement of a Partner

Issues to be Dealt With at the time of Retirement of a Partner 1. Determining the new Profit Sharing Ratio;

2. Determining the Gaining and the Sacrificing Ratio;

3. Valuation and Adjustment of Goodwill;

4. Adjustment of Gain (Profit)/Loss arising from Revaluation of Assets and Reassessment of

Liabilities;

5. Adjustment of Reserves, Accumulated Profits and Losses;

6. Final Payment to the Retiring Partner;

7. Adjustment of Capitals;

8. Treatment of Joint Life Policy.

Determining the new Profit Sharing Ratio This is simple mathematics. Read the requirement of the question, and calculate.

Determining the Gaining and the Sacrificing Ratio New Share – Old Share = Gain/(Sacrifice)

Valuation and Adjustment of Goodwill If there exists some goodwill in the Balance Sheet at the time of retirement of a partner, that old goodwill

is transferred all the partners in their old profit sharing ratio.

Thereafter, goodwill is valued at the time of retirement, and the retiring partner is credited with his share

of goodwill by the gaining partners in their gaining ratio.

Adjustment of Gain (Profit)/Loss arising from Revaluation of Assets and

Reassessment of Liabilities AND Adjustment of Reserves, Accumulated

Profits and Losses The adjustment of Gain (Profit)/Loss arising from Revaluation of Assets and Reassessment of Liabilities

AND Adjustment of Reserves, Accumulated Profits and Losses in case of retirement of a partner is done

in the same manner as it was done at the time of admission of a partner. Thereafter, the balance in the

capital account of the retiring partner is treated as a loan, and hence it is transferred to a “Retiring

Partner’s Loan A/c”.

Final Payment to the Retiring Partner After the adjustments are done, the balance in the capital account of the retiring partner is transferred to

his loan account until it is paid. The mode and the method of payment will be mentioned in the question.

We simply need to follow the question’s instructions.


P a g e 7.21 | 7.33

Adjustment of Capitals After the retirement of a partner, the remaining partners may decide to keep their capitals in the

proportion of their profit sharing ratio. For this purpose, some of the partners might need to bring in

additional capital, and some might need to withdraw the excess capital. It is discussed under 5 different

cases for the sake of simplicity –

1. Case 1 – When total capital of the new firm is given.

2. Case 2 – When existing total capital of remaining partners is to be in their new profit-sharing ratio.

3. Case 3 – When total capital of new firm is equal to the total capital before retirement of the

partner.

4. Case 4 – When the retiring partner is to be paid through amount brought in by the remaining

partners in a manner to make their capitals proportionate to their new profit-sharing ratio.

5. Case 5 – When the retiring partner is to be paid through amount brought in by the remaining

partners in a manner to make their capitals proportionate to their new profit-sharing ratio and

also, leave a desired cash balance.

Case 1 – When total capital of the new firm is given The total capital requirement of the firm is mentioned in the question. Using the new profit sharing ratio,

each partner’s capital is determined, and it is compared with the existing adjusted capital of the partner.

Any excess or shortage is met by the partner by taking out, or bringing in cash by the respective partner.

Example: The total capital of the reconstituted firm should be ₹6,00,000. The adjusted capitals of the

remaining partners A and B are ₹4,00,000 and ₹1,00,000 respectively. The new profit sharing ratio is 1:2.

Find the amount to be brought in or to be taken out by the partners.

Now, based on the total capital given in the question and the new profit sharing ratio, we determine that

A’s capital should be 1/3 × ₹6,0,000 = ₹2,00,000. However, since A’s adjusted capital is ₹4,00,000, i.e.

excess by ₹2,00,000, A would withdraw ₹2,00,000 from the firm. On the other hand, B’s capital should be

2/3 × ₹6,00,000 = ₹4,00,000. Since B’s adjusted capital is only ₹1,00,000, i.e., short by ₹3,00,000, B would

bring additional cash of ₹3,00,000 as his capital.

Case 2 – When existing total capital of remaining partners is to be in their new profit-

sharing ratio In this case, we need to add the adjusted capitals of the remaining partners. This gives us the total capital

of the reconstituted firm. Again, with the help of the new profit sharing ratio, each partner’s capital is

determined, and any excess or shortage is met by taking out or brining in cash by the respective partner.

Case 3 – When total capital of new firm is equal to the total capital before retirement of

the partner In this case, we need to add the capitals of all the partners even before the retirement process begins. For

example, suppose there are three partners A, B, and C, with capitals ₹1,00,000, ₹2,00,000, and ₹3,00,000

respectively. Now, C decides to retire. So, we’ll have to carry out the procedures for retirement, i.e.,

valuation of goodwill, revaluation of assets, etc. Before doing any such thing, we would add up the capitals

of all the three partners. This comes out to ₹6,00,000. Now, after the partner C retires, we need to ensure

that the total capital of the firm is ₹6,00,000. Therefore, again, on the basis of this, with the help of the

new profit sharing ratio, we will calculate each partner’s capital, and any excess or shortage will be met

by taking out or bringing in cash by the respective partner.


P a g e 7.22 | 7.33

Case 4 – When the retiring partner is to be paid through amount brought in by the

remaining partners in a manner to make their capitals proportionate to their new profit-

sharing ratio In this case, following steps are followed:

1. Step 1 – After all the adjustments are done, the partners’ capitals are totalled (including the

retiring partner). This gives the total capital of the reconstituted firm.

2. Step 2 – The total capital of the reconstituted firm is then apportioned in the ratio of the profit-

sharing ratio of the remaining partners.

3. Step 3 – This is compared with the existing adjusted capitals of the remaining partners, and any

shortage of any partner is brought by him in cash, and any excess of any partner is withdrawn by

him from the firm.

Question 1

Naresh, David and Aslam are partners sharing profits in the ratio of 5:3:7. On 1st April, 2018, Naresh gave

a notice to retire from the firm. David and Aslam decided to share future profits in the ratio of 2:3. The

adjusted Capital Accounts of David and Aslam show a balance of ₹33,000 and ₹70,500 respectively. The

total amount to be paid to Naresh is ₹90,500. This amount is to be paid by David and Aslam in such a way

that their capitals become proportionate to their new profit sharing ratio.

Pass necessary journal entries for the above transactions in the books of the firm. Show your working

clearly.

Case 5 – When the retiring partner is to be paid through amount brought in by the

remaining partners in a manner to make their capitals proportionate to their new profit-

sharing ratio and also, leave a desired cash balance In this case, following steps are followed:

1. Step 1 – Total capital of the reconstituted firm is calculated as follows:

Particulars ₹

Adjusted Capitals of the Continuing Partners xxx Add: Amount to be discharged to the Retiring Partner xxx Add: Desired Minimum Cash/Bank Balance xxx

xxx Less: Existing Cash/Bank Balance xxx

Total Capital of the Reconstituted Firm xxx

2. Step 2 – The total capital of the reconstituted firm is then apportioned in the ratio of the profit-

sharing ratio of the remaining partners.

3. Step 3 – This is compared with the existing adjusted capitals of the remaining partners, and any

shortage of any partner is brought by him in cash, and any excess of any partner is withdrawn by

him from the firm.

Question 2

F, G and K were partners sharing profits and losses in the ratio of 2:2:1. K wants to retire on 31.12.2015.

Given below is the Balance Sheet of the partnership as well as other information:


Capital A/cs: Sundry Fixed Assets 1,50,000


P a g e 7.23 | 7.33

F 1,20,000 Inventories 50,000 G 80,000 Trade Receivables 70,000 K 60,000 (including Bills Receivables ₹20,000) Reserve 10,000 Bank 50,000 Trade Payables 50,000 3,20,000 3,20,000

F and G agree to share profits and losses in the ratio of 3:2 in future. Value of Goodwill is to be ₹50,000.

Sundry Fixed Assets are revalued upwards by ₹30,000 and Inventories by ₹10,000. Bills Receivable

dishonoured ₹5,000 on 31.12.2015 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 ₹75,000 bank balance for working capital.

Required

Pass necessary journal entries. Also, prepare capital accounts of partners and draft the balance sheet of

M/S F & G after K’s retirement.


Joint Life Policy The partners may take a life insurance policy jointly so that if any partner dies, the amount received from

the Insurance Company can be paid to his representatives. The firm pays the premium for such policy

every year.

Now, when admission or retirement of any partner happens before the maturity of the policy, the total

number of partners in the firm obviously changes, and therefore, the policy needs to be discontinued, i.e.

surrendered, and a new policy in the name of all the new partners is taken. When the original policy is

surrendered, the firm does not receive the entire insured value from the insurance company, instead, it

gets around 70% to 80% of the total premiums paid till the date of surrender. Such value, which is received

by the firm on the surrender of the policy to the insurance company before maturity is known as

“Surrender Value”. This value will be given in the question in exams, so you don’t have to worry about it.

The accounting treatment of Joint Life Policy is done in either of the following three ways:

1. When the premium paid is treated as a revenue expenditure.

2. When the premium paid is treated as a capital expenditure.

3. When premium paid is treated as a capital expenditure and reserve is maintained.

When the premium paid is treated as a revenue expenditure When the premium paid is treated as a revenue expenditure, i.e., as an expense, its treatment is similar

to any other expense, i.e., at the end of the year, the account is closed by transferring its balance to the

Profit and Loss A/c. In such case, the entire amount received at the end of the policy’s life is treated as a

gain to the firm, and it is transferred to the partners’ capital accounts in their profit sharing ratio. This is

due to the following reason: When the premium paid is debited to the Profit & Loss A/c, the profit reduces

by the amount of the premium. Therefore, the divisible profit automatically reduces. This means that the

effect of the premium is borne by all the partners indirectly in their profit sharing ratio. Therefore, when

any amount is received from the insurance company either on surrender of policy or on the death of any

partner, it should be credited to all the partners in their profit sharing ratio.


P a g e 7.24 | 7.33

Note – Since the premium is treated as a revenue expenditure, and is therefore transferred to the Profit

& Loss A/c, nothing by the name of “Joint Life Policy” is shown in the Balance Sheet.

The journal entries are:

1. On paying the premium:

Joint Life Policy Premium A/c Dr.

To Bank A/c

(Being premium paid for Joint Life Policy)

2. At the end of the year:

Profit and Loss A/c Dr.

To Joint Life Policy Premium A/c

(Being amount of premium charged to Profit & Loss A/c)

3. On maturity or surrender of policy:

Insurance Company A/c/Bank A/c Dr.

To Partners’ Capital A/c (Individually)

(Being amount received transferred to partners in their PSR)

Question 3

On 31st March, 2017, the Balance Sheet of P, Q and R sharing profits and losses in proportion to their

Capital stood as below:


Capital Account: Land and Building 30,000 Mr. P 20,000 Plant and Machinery 20,000 Mr. Q 30,000 Stock of Goods 12,000 Mr. R 20,000 Sundry Debtors 11,000 Sundry Creditors 10,000 Cash and Bank Balances 7,000

80,000 80,000

On 1st April, 2017, P desired to retire from the firm and remaining partners decided to carry on the business.

It was agreed to revalue the assets and liabilities on that date on the following basis:

1. Land and Building be appreciated by 20%.

2. Plant and Machinery be depreciated by 30%.

3. Stock of goods to be valued at ₹10,000.

4. Old credit balances of Sundry creditors, ₹2,000 to be written back.

5. Provisions for bad debts should be provided at 5%.

6. Joint life policy of the partners surrendered and cash obtained ₹7,550.

7. Goodwill of the entire firm is valued at ₹14,000 and P’s share of the goodwill is adjusted in the

A/cs of Q and R, who would share the future profits equally. No goodwill account being raised.

8. The total capital of the firm is to be the same as before retirement. Individual capital is in their

profit sharing ratio.

9. Amount due to Mr. P is to be settled on the following basis:

50% on retirement and the balance 50% within one year.

Prepare (a) Revaluation account, (b) The Capital accounts of the partners, (c) Cash account and (d) Balance

Sheet of the new firm M/s Q & R as on 01.04.2017.

(RTP November, 2020; RTP May, 2018; ICAI Study Material (Similar))


P a g e 7.25 | 7.33

When the premium paid is treated as a capital expenditure When the premium paid is treated as a capital expenditure, it is not transferred to the profit and loss

account at the end of the year. The journal entry passed on the payment of premium is:

Joint Life Policy A/c Dr. To Bank A/c

This “Joint Life Policy A/c” is shown on the Assets side of the Balance Sheet as an Asset. The balance of

the Joint Life Policy A/c in the balance sheet every year should be shown at that year’s surrender value.

This is because even if the firm surrenders the policy at any time, it will at least receive the surrender

value. Thus, it becomes an asset for the firm. Therefore, any excess balance is transferred to the Profit

and Loss A/c.

When the policy is surrendered, the amount that is received from the insurance company is the same as

that appearing in the Joint Life Policy Account in the Balance Sheet of the firm. Therefore, the following

entry is passed:

Bank A/c Dr. To Joint Life Policy A/c

Question 4

A, B and C are partners sharing profits in the ratio of 3:2:1. Their Balance Sheet as at 31st March, 2018

stood as:


Capital Accounts Building 10,00,000 A 8,00,000 Furniture 2,40,000 B 4,20,000 Office Equipment 2,80,000 C 4,00,000 16,20,000 Stock 2,50,000

Sundry Creditors 3,70,000 Sundry Debtors 3,00,000 General Reserves 3,60,000 Less: Provision for Doubtful Debts 30,000 2,70,000

Joint Life Policy 1,60,000

Cash at Bank 1,50,000

23,50,000 23,50,000

B retired on 1st April, 2018 subject to the following conditions:

1. Office Equipments revalued at ₹3,27,000.

2. Building revalued at ₹15,00,000. Furniture is written down by ₹40,000 and Stock is reduced to

₹2,00,000.

3. Provision for Doubtful Debts is to be created @ 5% on Debtors.

4. Joint Life Policy will appear in the Balance Sheet at surrender value after B's retirement. The

surrender value is ₹1,50,000.

5. Goodwill was to be valued at 3 years’ purchase of average 4 years’ profit which were:

Year ₹

2014 90,000 2015 1,40,000 2016 1,20,000 2017 1,30,000

6. Amount due to B is to be transferred to his Loan Account.


P a g e 7.26 | 7.33

Prepare the Revaluation Account, Partners' Capital Accounts and the Balance Sheet immediately after B's

retirement.

(May, 2018 – 10 Marks)

When premium paid is treated as a capital expenditure and reserve is maintained Following steps are followed:

1. The premium which is paid annually is debited to the Joint Life Policy A/c and the Bank A/c is

credited.

2. At the end of the year, the Joint Life Policy A/c is to be shown at the surrender value of that year,

so any excess amount is transferred to the Profit & Loss A/c.

3. Thereafter, the amount of surrender value is transferred from the Profit & Loss Appropriation A/c

to a newly opened A/c called the “Joint Life Policy Reserve A/c”. This has the following two effects:

a. First, the amount of surrender value is not distributed to the partners in their profit

sharing ratio; and

b. Second, in the Balance Sheet, the Joint Life Policy A/c is shown on the Assets Side at

surrender value, and the Joint Life Policy Reserve A/c is shown on the Liabilities Side at

the surrender value.

4. On the death of the partner, the following steps are followed:

a. The entire balance in the Joint Life Policy Reserve A/c is transferred to the Joint Life Policy

A/c.

b. The amount is received from the Insurance company by debiting the Bank A/c and

crediting the Joint Life Policy A/c.

c. Thereafter, the balance in the Joint Life Policy A/c is distributed to the partners in their


However, ICAI treats it a little differently. Following are the steps that ICAI follows, and therefore, you also

have to follow the following steps only:

1. The premium which is paid annually is debited to the Joint Life Policy A/c and the Bank A/c is

credited.

2. At the end of the year, Profit and Loss Appropriation A/c is debited with the amount of premium

and a new account “Joint Life Policy Reserve A/c” is credited.

3. Thereafter, the Joint Life Policy A/c is needed to be shown at its surrender value. To do this, such

amount is transferred from the Joint Life Policy Reserve A/c to the Joint Life Policy A/c so as to

show the Joint Life Policy A/c at its surrender value.

4. The effect of this is that in the Balance Sheet, a “Joint Life Policy A/c” is shown in the Assets side

at the surrender value, and at the same time, a “Joint Life Policy Reserve A/c” is shown in the

Liabilities side at the same value.

5. On the death of the partner, the following steps are followed:

a. The entire balance in the Joint Life Policy Reserve A/c is transferred to the Joint Life Policy

A/c.

b. The amount is received from the Insurance company by debiting the Bank A/c and

crediting the Joint Life Policy A/c.

c. Thereafter, the balance in the Joint Life Policy A/c is distributed to the partners in their


Question 5


P a g e 7.27 | 7.33

A, B and C are partners in the business sharing profits and losses in the ratio of 2:2:1. The firm has taken a

joint life insurance policy for a sum of ₹30,000 with effect from 1st January, 2014. The annual premium is

₹2,000. The surrender value of the policy at the end of 2014, 2015 and 2016 are NIL, ₹1,000 and ₹2,000

respectively.

On 15th June, 2017, C dies and the firm gets the full money of the policy on 30th June.

You are required to prepare the Joint Life Policy Account, P&L Appropriation A/c, and Joint Life Policy

Reserve Account in the books of the firm. Also, pass the necessary Journal Entries.

Solution

Journal Entries

Date Particulars Dr. (₹) Cr. (₹)

2014 Jan. 1 Joint Life Policy A/c Dr. 2,000 To Bank A/c 2,000

(Being premium paid) Dec. 31 P&L Appropriation A/c Dr. 2,000 To Joint Life Policy Reserve A/c 2,000

(Being amount of premium charged to P&L Appropriation A/c) Dec. 31 Joint Life Policy Reserve A/c Dr. 2,000

To Joint Life Policy A/c 2,000

(Being amount written off) 2015

Jan. 1 Joint Life Policy A/c Dr. 2,000 To Bank A/c 2,000











(Being premium paid) Jun. 15 Joint Life Policy Reserve A/c Dr. 2,000 To Joint Life Policy A/c 2,000

(Being amount transferred)


P a g e 7.28 | 7.33

Bank A/c Dr. 30,000 To Joint Life Policy A/c 30,000

(Being amount recovered from Insurance Co. on death of C)

Joint Life Policy A/c Dr. 28,000 To A's Capital A/c 11,200

To B's Capital A/c 11,200

To C's Capital A/c 5,600 (Being net profit on policy distributed among the partners)

Retirement cum Admission Question 6

Neha & Co. is a partnership firm with partners Mr. P, Mr. Q and Mr. R, sharing profits and losses in the

ratio of 10:6:4. The balance sheet of the firm as at 31st March, 2018 is as under:


Capitals: Land 10,000 Mr. P 80,000 Buildings 2,00,000 Mr. Q 20,000 Plant and Machinery 1,30,000 Mr. R 30,000 1,30,000 Furniture 43,000

Reserves 20,000 Investments 12,000 (Un-appropriated profit) Inventories 1,30,000 Long Term Debt 3,00,000 Trade Receivables 1,39,000 Bank Overdraft 44,000 Trade Payables 1,70,000 6,64,000 6,64,000

It was mutually agreed that Mr. Q will retire from partnership and in his place Mr. T will be admitted as a

partner with effect from 1st April, 2018. For this purpose, the following adjustments are to be made:

1. Goodwill is to be valued at ₹1 lakh but the same will not appear as an asset in the books of the

reconstituted firm.

2. 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 ₹15,000. Provision of 20% is to be made on Trade

receivables to cover doubtful debts.

3. In the reconstituted firm, the total capital will be ₹2 lakhs which will be contributed by Mr. P, Mr.

R and Mr. T 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.

Required:

Prepare

1. Revaluation Account;

2. Partners’ Capital Accounts;

3. Bank Account; and

4. Balance sheet of the reconstituted firm as on 1st April, 2018.

(MTP May, 2019 – 10 Marks; RTP November, 2018; ICAI Study Material – Similar)

CHAPTER 7 – PARTNERSHIP ACCOUNTS – UNIT 5 – DEATH

P a g e 7.29 | 7.33

Unit 5 – Death of a Partner

Introduction The issues arising in case of death of a partner are similar to that of retirement of partner. Goodwill needs

to be valued; assets are needed to be revalued and liabilities are needed to be reassessed and the profit

or loss on revaluation is to be distributed to the partners in their old profit sharing ratio. However, there

are a few differences –

1. In case of retirement, the amount payable to the retiring partner was transferred to his Loan A/c;

whereas in case of death, the amount payable to the dead partner would be transferred to his

Executors’ A/c.

2. In case of retirement, the firm used to receive the surrender value of the Joint Life Policy; whereas

in case of death, the firm would receive the maturity value of the Joint Life Policy. The treatment,

however, would be the same.

Apart from above, we need to study a few new issues.

Application of Section 37 of the Partnership Act This would be best understood with an example. Suppose A, B and C are in a partnership business-sharing

profits and losses equally. C dies on 31st October, 2017. 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, 2018. The

profit made during the period of three months amounts to ₹28,000.

Now, in the above example, the firm continued the business for three months after C’s death without

settling the account of C. This means that along with the capitals of A and B, the firm also utilised the

₹1,20,000 payable to C on his death for earning the ₹28,000 profit in these three months. Now, the legal

executors of C are entitled to either of the following:

1. Amount of profit attributable to C’s capital. For this, our good old unitary method will come into

play.

Total capital used to earn the profit of ₹28,000 = ₹50,000 + ₹75,000 + ₹1,20,000 = ₹2,45,000.

This means that ₹2,45,000 Capital was required to earn the profit of ₹28,000.

Therefore, ₹1,20,000 Capital was required to earn the profit of ? ₹1,20,000 × ₹28,000

₹2,45,000= ₹13,714

2. Interest on ₹1,20,000 @ 6% p.a. for 3 months.

₹1,20,000 ×6

100×

3

12= ₹1,800

Clearly, the executors would go for the first option.

What we saw above was as per Section 37 of the Partnership Act.

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


P a g e 7.30 | 7.33

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.”

Share of Profits from the Beginning of the Year till the Date of Death Since Mohabbat and Maut are bin bulaaye mehmaan, a partner won’t usually die on the first day of the

year or on the last day of the year. Therefore, he is entitled to the share in the profits from the beginning

of the year till the date of his death. There are two methods of determining this:

1. Time Basis

2. Turnover or Sales Basis

Time Basis In this case, it is assumed that the profit is earned uniformly throughout the year. For example, if the profit

for the year 2017-18 was ₹1,20,000 and a partner, whose share of profit was 1/5 dies on 1st July, 2018,

i.e. three months after the beginning of the year, the profit from 01-04-2018 to 30-06-2018 will be

calculated as follows:

₹1,20,000 ×3

12= ₹30,000

Out of this, the dead partner’s share will come to:

1

5× ₹30,000 = ₹6,000

Turnover or Sales Basis In this method, the profit is determined based on the Sales value and the Gross Profit of the previous year.

For example, Arun, Tarun and Neha are partners sharing profits in the ratio of 3:2:1. Neha dies on 31st

May, 2016. Sales for the year 2015-2016 amounted to ₹4,00,000 and the profit on sales is ₹60,000.

Accounts are closed on 31st March every year. Sales from 1st April, 2016 to 31st May, 2016 is ₹1,00,000.

Here, we can see that in 2015-16, the total sales were ₹4,00,000 and the profit was ₹60,000, i.e. 15%.

Now, applying the same percentage of profit on the sales between 1st April, 2016 to 31st May, 2016, we’ll

arrive at the profit for these 2 months = 15% of ₹1,00,000 = ₹15,000. Neha’s share of profit = 1/6,

therefore, Neha will be entitled to 1/6 × ₹15,000 = ₹2,500.

Question 1

The following is the Balance Sheet of M/s. LMN Bros as at 31st December, 2017, they share profit equally:


Capital Machinery 10,000 L 8,200 Furniture 5,600 M 8,200 Fixture 4,200 N 9,000 Cash 3,000 General Reserve 3,000 Inventories 1,900 Trade Payables 4,700 Trade Receivable 9,000 Less: Provision for Doubtful Debts 600 8,400


P a g e 7.31 | 7.33

33,100 33,100

N died on 3rd January, 2018 and the following agreement was to be put into effect.

1. Assets were to be revalued: Machinery to ₹11,700; Furniture to ₹4,600; Inventory to ₹1,500.

2. Goodwill was valued at ₹6,000 and was to be credited with his share, without using a Goodwill

Account

3. ₹2,000 was to be paid away to the executors of the dead partner on 5th January, 2018.

4. After death of N, L and M share profit equally.


1. Journal Entry for Goodwill adjustment.

2. Revaluation Account and Capital Accounts of the partners.

(RTP November, 2019; MTP May, 2018 – 10 Marks)

Question 2

Arup and Swarup were partners. The partnership deed provides inter alia:

1. That the annual accounts be balanced on 31st December each year;

2. That the profits be allocated as follows:

Arup: One-half; Swarup: One-third and -Carried to reserve account: One sixth;

3. That in the event of death of a partner, his executor will be entitled to the following:

a. The capital to his credit at the date of death;

b. His proportionate share. of profit to date of death based on the average profits of the last

three completed years; and

c. His Share of goodwill based on three years' purchase of the average profits for the three

preceding completed years.

Trial Balance on 31st December, 2018

Particulars Dr. (₹) Cr. (₹)

Arup’s Capital 90,000 Swarup’s Capital 60,000 Reserve 45,000 Bills Receivable 50,000 Investments 55,000 Cash 1,10,000 Trade Payables 20,000

Total 2,15,000 2,15,000

The profits for the three years were 2016: ₹51,000; 2017: ₹39,000 and 2018: ₹45,000. Swarup died on 1st

May, 2019. Show the calculation of Swarup (i) Share of Profits; (ii) Share of Goodwill; (iii) Draw up Swarup’s

Executors Account as would appear in the firms’ ledger transferring the amount to the Loan Account.

(November, 2019 – 10 Marks; ICAI Study Material (Similar))

Question 3

The Balance Sheet of Amitabh, Abhishek and Amrish as at 31.12.2017 stood as follows:


Capital: Land & Buildings 74,000 Amitabh 60,000 Investments 10,000


P a g e 7.32 | 7.33

Abhishek 40,000 Advertisement Suspense 37,800 Amrish 40,000 1,40,000 Life Policy (at Surrender Value): Creditors 25,800 Amitabh 2,500 General Reserve 8,000 Abhishek 2,500 Investment Fluctuation Reserve 2,400 Amrish 1,000

Stock 20,000

Debtors 20,000 Less: Provision for Doubtful Debts 1,600 18,400

Cash & Bank Balance 10,000

1,76,200 1,76,200

Amrish died on 31st March, 2018, due to this reason the following adjustments were agreed upon:

1. Land and Buildings be appreciated by 50%.

2. Investment be valued at 6% less than the cost.

3. All debtors (except 20% which are considered as doubtful) were good.

4. Stock to be reduced to 94%.

5. Goodwill to be valued at 1 year’s purchase of the average profits of the past five years.

6. Amrish’s share of profit to the date of death be calculated on the basis of average profits of the

three completed years immediately preceding the year of death.

The profits of the last five years are as follows:

Year ₹

2013 23,000 2014 28,000 2015 18,000 2016 16,000 2017 20,000

1,05,000

The life policies have been shown at their surrender values representing 10% of the sum assured in each

case. The annual premium of ₹1,000 is payable every year on 1st August.

You are required to pass necessary Journal Entries in the books of account of the reconstituted firm.

(MTP November, 2018 – 12 Marks)

Question 4

Monika, Yedhant and Zoya are in partnership, sharing profits and losses equally. Zoya died on 30th June

2018. The Balance Sheet of Firm as at 31st March 2018 stood as:

Liabilities Amount Assets Amount

Creditors 20,000 Land and Building 1,50,000 General Reserve 12,000 Investments 65,000 Capital Accounts: Stock in Trade 15,000 Monika 1,00,000 Trade Receivables 35,000 Yedhant 75,000 Less: Provision for Doubtful Debts 2,000 33,000

Zoya 75,000 Cash in Hand 7,000

Cash at Bank 12,000

2,82,000 2,82,000

In order to arrive at the balance due to Zoya, it was mutually agreed that:


P a g e 7.33 | 7.33

1. Land and Building be valued at ₹1,75,000

2. Debtors were all good, no provision is required

3. Stock is valued at ₹13,500

4. Goodwill will be valued at one Year's purchase of the average profit of the past five years. Zoya's

share of goodwill be adjusted in the account of Monika and Yedhant.

5. Zoya's share of profit from 1st April 2018, to the date of death be calculated on the basis of

average profit of preceding three years.

6. The profit of the preceding five years ended 1st March were:

2018 2017 2016 2015 2014 25,000 20,000 22,500 35,000 28,750


1. Revaluation Account

2. Capital Accounts of Partners

3. Balance Sheet of the Firm as on 1st July, 2018.

(MTP November, 2020 – 10 Marks; June, 2019 – 10 Marks)

Documents

chapter 7 – partnership accounts – unit 1 – introduction · 2020. 9. 29. · CHAPTER 7 – PARTNERSHIP ACCOUNTS – UNIT 1 – INTRODUCTION P a g e 7.3 | 7.33 3. Karim demands