II. Retirement of a Partner

A partner may leave a firm that carries on without him. This part explains why partners retire and the accounting adjustments that settle a retiring partner's account fairly.

Retirement of a Partner has two sub-lessons. Reasons for Retirement looks at age or health, personal reasons and disagreements among partners. Accounting Adjustments covers what follows a retirement: the new profit-sharing ratio of the continuing partners, the gaining ratio, the treatment of the retiring partner's share of goodwill, the revaluation of assets and liabilities, and the settlement of the amount due to him, in cash or as a loan to the firm.

When a partner retires, the firm is reconstituted, not dissolved: the business continues and the remaining partners take over the retiring partner's share of future profits. The two sub-lessons cover why this happens and how the books are adjusted.

1. Reasons for Retirement. A partner may retire because of age or poor health, for personal reasons such as family responsibilities, a change of career or moving to another place, or because of conflict with the other partners over how the business should be run. Whatever the reason, the retiring partner is entitled to what the firm owes him: his capital, his share of profits and reserves up to the date of retirement, his share of goodwill and his share of any gain on revaluation.

2. Accounting Adjustments. The sub-lesson sets out the steps:

• Fix the new profit-sharing ratio of the continuing partners.
• Work out the gaining ratio: for each continuing partner, Gain = New share − Old share. If the partners say nothing about a new ratio, they are taken to continue in their old ratio, and that old ratio is then also the gaining ratio.
• Adjust goodwill: the retiring partner's share of goodwill is credited to his capital account and debited to the continuing partners in their gaining ratio.
• Revalue the assets and liabilities, sharing the profit or loss among all the partners, including the retiring one, in the old ratio.
• Settle the account: the final balance of the retiring partner's capital account is paid in cash, transferred to his loan account, or settled partly in each way.

Worked example. X, Y and Z share profits 5 : 3 : 2. Z retires, and X and Y agree to share future profits 3 : 2. The goodwill of the firm is valued at ₹1,00,000.

• New shares: X 3/5 = 6/10 and Y 2/5 = 4/10. Old shares: X 5/10 and Y 3/10.
• Gaining ratio: X gains 6/10 − 5/10 = 1/10 and Y gains 4/10 − 3/10 = 1/10, so the gaining ratio is 1 : 1.
• Z's share of goodwill = 2/10 × ₹1,00,000 = ₹20,000. X and Y bear it equally, so X's Capital Account and Y's Capital Account are each debited ₹10,000, and Z's Capital Account is credited ₹20,000.

Getting the gaining ratio right first makes every later step, especially goodwill, straightforward.