Accounting for Retirement of Partnership

Accounting for retirement or death of a partner

When a partner retires or dies, several accounting steps need to be taken to properly reflect the change in the partnership's structure. The treatment involves adjusting the capital accounts, distributing the share of profits, and addressing the valuation of goodwill.

Rights of an outgoing partner on retirement or death

1. Retirement: A retiring partner is entitled to receive their share of the partnership's assets, which includes their capital account balance and any outstanding profits. The retiring partner is also entitled to their share of any goodwill, if applicable.
2. Death: In the case of the death of a partner, their share of the partnership assets is transferred to their heirs or legal representatives. The deceased partner's estate is entitled to the value of their capital account, share of accumulated profits, and any goodwill if applicable.

In both retirement and death, the remaining partners typically agree on how the outgoing partner's share will be settled, either by transferring cash, assets, or through other means.

Accounting treatment for goodwill in case a partner retires or dies

Goodwill is an intangible asset that represents the value of a business above its physical assets, often tied to reputation, customer base, or other factors. When a partner retires or dies, the goodwill of the partnership needs to be treated carefully:

1. Goodwill Adjustment: The value of the goodwill is usually agreed upon by the partners at the time of the retirement or death. It is calculated based on an agreed formula, an appraisal, or other methods such as a multiple of profits or capital employed.
2. Revaluation of Goodwill: If the partnership has accumulated goodwill, it may be revalued to reflect its current value. The outgoing partner is entitled to their share of this goodwill, which is credited to their capital account.
3. Treatment of Goodwill:
   • Retiring Partner: The retiring partner's share of goodwill can either be paid in cash or adjusted within the remaining partners' capital accounts.
   • Deceased Partner: For a deceased partner, the goodwill amount is calculated and transferred to their estate or legal representative.
4. No Recognition of Goodwill (optional): In some cases, the partnership may decide not to recognize or record the goodwill when a partner leaves, and the remaining partners simply adjust their capital accounts to reflect the change.

Accounting entries for retirement or death of a partner

1. Adjusting the Capital Accounts:
   • Retiring Partner: Debit the retiring partner's capital account and credit the accounts of the remaining partners.
   • Deceased Partner: Debit the deceased partner's capital account and credit the accounts of the remaining partners, or credit the estate of the deceased partner if applicable.
2. Goodwill Account:
   • If goodwill is to be recognized, credit the goodwill account and debit the capital accounts of the remaining partners or the retiring/deceased partner's capital account as their share.
3. Settlement of Liabilities: Any liabilities that were directly associated with the outgoing partner's share, such as loans or obligations, must be settled or transferred to the remaining partners.

Example of goodwill treatment on retirement

If the goodwill of the partnership is valued at $50,000, and Partner A retires:

• If Partner A is entitled to 40% of the goodwill, their share of goodwill would be $20,000.
• Debit Goodwill $20,000 and credit Partner A's Capital Account$20,000.

The remaining partners may then adjust their capital accounts to account for the reduction in total goodwill. These steps ensure that the outgoing partner is compensated fairly, and the partnership continues with an updated structure.

Example 1

Ashura, Benjamin and John were partners in a partnership firm with capitals of TZS 10,000,000, TZS 8,000,000 and TZS 6,000,000 respectively and sharing profits in the ratio of 3:2:1. On 31st December, 2021 Benjamin retired. For the purpose of retirement, the goodwill of the firm was valued at TZS 18,000,000. Assume that the assets of the partnership are fairly stated on the date of retirement and that there are no liabilities.

Required:

1. Pass necessary journal entries;
2. Prepare partners' capital accounts; and
3. Prepare a statement of financial position as at 31st December, 2021.

In each of the above requirement consider the following circumstances:

1. Goodwill is raised and maintained in the books.
2. Goodwill is raised but written off later.
3. Only Benjamin's share of goodwill is raised and maintained in the books.
4. Only Benjamin's share of goodwill is raised but later written off.
5. Benjamin is given his share of goodwill without raising goodwill account.

i. Journal Entry for Goodwill

Details	Dr.	Cr.
Goodwill Account	TZS 18,000,000
Ashura's Capital Account		TZS 9,000,000
Benjamin's Capital Account		TZS 6,000,000
John's Capital Account		TZS 3,000,000

Workings

Goodwill amount = TZS 18,000,000

Ashura's share:	3/6 × TZS 18,000,000 = TZS 9,000,000
Benjamin's share:	2/6 × TZS 18,000,000 = TZS 6,000,000
John's share:	1/6 × TZS 18,000,000 = TZS 3,000,000

Dr. Partners' Capital Accounts Cr.

Details	Ashura	Benjamin	John	Details	Ashura	Benjamin	John
Loan	-	19,000,000	19,000,000	Balance c/d	-	14,000,000	14,000,000
Balance b/d	10,000,000	9,000,000	19,000,000	Goodwill	8,000,000	6,000,000	14,000,000
	6,000,000	3,000,000	9,000,000	Total	24,000,000	18,000,000	42,000,000

Statement of Financial Position of Ashura and John After Retirement of Benjamin

Details	TZS	Details	TZS
Goodwill (new raised)	19,000,000	Capital:
Total of assets	24,000,000	- Ashura	18,000,000
		- John	42,000,000
		Benjamin's loan	28,000,000
Total of capital and liabilities	42,000,000