ACCOUNTANCY A LEVEL(FORM SIX) NOTES – RETIREMENT OF A PARTNER:(3)

Retirement of a Partner:

We have discussed the accountancy problems that arise on admission of a new partner.

In this chapter, we shall look at the problems that arise on retirement or death of a partner, which include:

• Treatment of Goodwill
• Revaluation of Assets and Liabilities

Treatment of Goodwill

On the retirement or death of a partner, his share of goodwill must be valued in accordance with the terms of the partnership deed. In the absence of such provision, valuation is done by mutual agreement or understanding among the partners. Then one of the following courses may be adopted to give effect to the distribution in the books of accounts.

1. Goodwill raised in the books:

Entries are:

Debit: Goodwill Account,

Credit: all partners’ (including retiring) Capital Accounts in their profit-sharing proportions.

ii) Goodwill raised in the books but immediately written off. Entries are:

Debit: Goodwill Account

Credit: All partners’ (including retiring) capital accounts in their profit-sharing proportions.

Debit: Remaining partners’ (in new profit-sharing proportion)

Credit: Goodwill Account.

iii) Only the goodwill share of the retiring partner is brought into the books. The entry is:

Debit: Goodwill Account

Credit: Retiring partner (with his share)

It is advisable to write off the goodwill to the remaining partners in the ratios in which they gain on the retirement.

It should be noted carefully that if a Goodwill Account already exists in the books, entries for raising goodwill should be made only for the difference.

Illustration:

Mukosa, Mosoke, and Ochieng are partners sharing profit in the proportion of 4:3:2 respectively. Mosoke retires and the goodwill is valued at Tshs 21,600/=. No goodwill account appears in the books of the firm. Assuming that Mukasa and Ochieng share future profit in the ratio of 5:3, pass entries for goodwill if:

1. Goodwill is raised in the books
2. Goodwill is raised and written off
3. Goodwill share of the retiring partner only is brought into the books.

Revaluation of Assets and Liabilities

After ascertaining the share of goodwill payable to the retiring partner, the next problem that arises is the revaluation of assets and liabilities. This is done to ascertain the fair amount due to the outgoing partner in respect of his share of the firm’s assets.

Even if the partnership deed is silent on this point, assets and liabilities should normally be valued. The partners can, of course, agree not to revalue the assets and liabilities either on retirement or death or on both, but such provision in the deed means that the balance of the retiring partner’s capital account represents his true interest in the partnership. Apart from the question of goodwill which has already been dealt with, some of the assets may have appreciated in value without any adjustment having been made in the books, while others may have been insufficiently depreciated or completely written off.

A Revaluation Account for profit and loss adjustment is prepared, to which all differences in value are debited or credited as the case may be. The resultant balance is transferred to all the partners including the retiring partner in the old profit-sharing ratios. The assets and liabilities then appear in the books of the new firm at the changed values.

If it is desired that assets and liabilities should continue to appear in the books at the old values, a memorandum Revaluation Account is prepared. Its balance will be transferred to all the partners in the profit-sharing ratios, and then the same account will be reversed and transferred to the remaining partners in the new profit-sharing ratio.

Important Hints: Any reserve or accumulated profit appearing in the books should be transferred to all partners in their old profit-sharing ratios. Alternatively, only the retiring partner may be credited with his share, and the remaining reserve side transferred to the remaining partners. The reserve may continue to appear in the books at the reduced figure.

Payment to the Retiring Partner

When the accounting formalities are over, the final balance standing to the credit of a retiring partner’s capital account is paid either in cash (if the cash position permits) or transferred to his loan account until it is paid off. In the modern business world, some other methods have also been developed for payment of the amount, such as:

• Policy of survivorship assurance
• Annuity method
• Installment method

Example 1

The balance sheet of A and B partnership, who are sharing profits and losses in the ratio 2:1 between A and B respectively as on 31^st Dec 1984:

On 1^st January 1985 they decided to admit C into partnership on the following terms:

1. C to bring in Tshs. 75,000 in cash for his capital.
2. Profit sharing ratio to be 3:2:1 for A, B, and C respectively.
3. Goodwill to be revalued at Tshs. 12,000 but is not to be maintained in the books. C is to pay for his share of goodwill.
4. Plant and Machinery, Furniture and Fittings, and Vehicles to be revalued at Tshs. 120,000, 15,000, and 70,000 respectively.
5. 5% of stock is obsolete. 10% of Debtors to be written off.
6. Current liabilities amounting to Tshs. 500 were overlooked.
7. Long-term liabilities to be reduced by Tshs. 2,000.
8. A and B are to pay Tshs. 8,000 in respect of the revaluation costs.

Required: Show the following:

1. Revaluation account
2. Bank account

DR Revaluation Account CR

DR Partner’s Current Account CR

A, B & C Balance Sheet as at Date

Balance Sheet as at 1^st Jan 1998