Reconstitution of a Partnership Firm - Retirement or Death
Class 12 · Accountancy
4 ideas in Class 12 Accountancy, explained in plain words, with games and quizzes to practise.
New Profit Sharing Ratio after Retirement
Part of: When a partner leaves
When a partner retires or dies, the partnership ends but the firm can go on with those who remain. The new profit sharing ratio lists the shares of only the remaining partners. When they simply continue as before, each keeps her old share of a smaller group. For example, if 4 to 3 to 2 to 1 loses the partner with 3 parts, the rest stand at 4 to 2 to 1.
Why it matters. Every payment to the outgoing partner, from goodwill to reserves, is measured against the old and new ratios. A wrong ratio pays the wrong person, so the first step must be exact.
Formulas
- New ratio = Old shares of those who stay
- Restated total = Old total - Outgoing share
- Check: new shares add to one
Key words
- Retirement
- : A partner leaving the firm while the business continues.
- New profit sharing ratio
- : Shares of the remaining partners after an exit.
- Continuing partners
- : Partners who stay on in the firm.
- Outgoing partner
- : The partner who retires or dies.
Try it in two minutes
- Line up 10 marbles 4, 3, 2 and 1 for four partners.
- Remove the 3 marbles of the retiring partner. Ask: whose marbles changed?
- Read the remaining piles as the new ratio. Ask: do the remaining piles still cover the whole firm?
Try at home. Take partners sharing 5 to 3 to 2, retire the middle one, and write the new ratio of the two who stay.
Gaining Ratio
Part of: When a partner leaves
The gaining ratio shows how much each continuing partner gains from the outgoing partner's share, found by subtracting each old share from the new share. It decides who bears the retiring partner's goodwill. For example, gains of 3 parts and 2 parts give a gaining ratio of 3 to 2.
Why it matters. The partner who gains the most should pay the most for goodwill. Without this ratio, a partner who gained nothing might still be charged.
Formulas
- Gain = New share - Old share
- Gaining ratio = Gains of those who stay
- Goodwill borne = Retiring goodwill share x Gain parts / Total gain parts
Key words
- Gaining ratio
- : Extra profit share each continuing partner picks up.
- Gain
- : Rise in a continuing partner's share after an exit.
- Continuing share
- : A staying partner's portion of the new ratio.
- Goodwill burden
- : Part of goodwill charged to a gaining partner.
Try it in two minutes
- Lay 6 coins 3, 2 and 1 for three partners.
- Remove the 1 coin partner and share her coin by the new deal.
- Count what each stayer added. Ask: who gained more?
- Charge 5 marbles of goodwill in that gained-coins ratio.
Try at home. Partners share 4 to 3 to 2. The last one retires and the rest agree 3 to 2. Find each gain and the gaining ratio.
Treatment of Goodwill on Retirement
Part of: Paying the partner who leaves
The retiring partner helped build the firm's reputation, so she is credited with her share of goodwill while the continuing partners are debited in their gaining ratio. When no goodwill figure exists, it is found from what she is paid over her capital, called hidden goodwill. For example, 30000 paid over capital for a one fourth share reveals total goodwill of 120000.
Why it matters. Goodwill rewards past effort. Skipping this step would let the stayers enjoy a reputation they did not fully build.
Formulas
- Hidden goodwill = Excess paid / Retiring share
- Retiring share = Hidden goodwill x Retiring parts / Total parts
- Debit to gainer = Retiring goodwill share x Gain parts / Total gain parts
Key words
- Hidden goodwill
- : Goodwill found from the price paid to the leaver.
- Excess payment
- : Amount paid over the leaver's capital and dues.
- Retiring share of goodwill
- : Leaver's portion of the firm's total goodwill.
- Gaining partners
- : Continuing partners who pick up extra share.
Try it in two minutes
- Count 30000 extra paid over capital for a one fourth share.
- Multiply by 4 to reveal full hidden goodwill of 120000. Ask: why multiply?
- Split only her 30000 among stayers 2 to 1. Ask: why not the full 120000?
Try at home. A partner with a one fifth share is paid 50000 over her capital. Find the hidden goodwill and split her share of it 3 to 2.
Revaluation, Reserves and the Amount Due
Part of: Paying the partner who leaves
At retirement, assets and liabilities are restated and the net result goes to all old partners, including the leaver, in the old ratio. Past reserves are divided the same way. The amount due to the leaver then adds her capital, her profit up to the exit date, and these shares, minus what she took. For a partner who dies mid-year, profit is estimated from past averages for the months served.
Why it matters. The leaver must walk away with exactly her full due, no more and no less. Each piece has its own rule, and missing one cheats either her family or the stayers.
Formulas
- Amount due = Capital + Profit share + Reserve share - Drawings
- Deceased profit = Average profit x Months served / 12 x Her share
- Average profit = Total of past profits / Number of years
Key words
- Amount due
- : Total payable to the outgoing partner or heirs.
- Revaluation result
- : Net gain or loss from restating values.
- Profit up to exit
- : Estimated profit earned before leaving.
- Executors
- : People who receive the money of a deceased partner.
Try it in two minutes
- Add 3 slips: capital 80000, profit share 6000, reserve share 12000.
- Subtract drawings of 5000. Ask: what is due now?
- For a mid-year death, estimate profit from past average times months served over 12.
- Pay the total to the leaver or her heirs, at once or over time.
Try at home. A leaver holds capital 50000, earns profit share 4000, gains reserve share 8000, and drew 2000. Work out her amount due.
What your child will practise
- Gaining Ratio: Ocean Quick Fire (Quick Fire)
- New Profit Sharing Ratio after Retirement: Jungle Puzzle (Clue Puzzle)
- New Profit Sharing Ratio after Retirement: Jungle Quick Fire (Quick Fire)
- Revaluation, Reserves and the Amount Due: Candy Quick Fire (Quick Fire)
- Treatment of Goodwill on Retirement: Desert Puzzle (Clue Puzzle)
- Quiz: Gaining Ratio (8 questions)
- Quiz: New Profit Sharing Ratio after Retirement (8 questions)
- Quiz: Revaluation, Reserves and the Amount Due (8 questions)
- Quiz: Treatment of Goodwill on Retirement (8 questions)