Naresh, Raj Kumar and Bishwajeet are equal partners. Raj Kumar decides to retire. On the date of his retiremen

Numerical Questions · Q4

Q. Naresh, Raj Kumar and Bishwajeet are equal partners. Raj Kumar decides to retire. On the date of his retirement, the Balance Sheet of the firm showed the following: General Reserves ₹36,000 and Profit and Loss Account (Dr.) ₹15,000. Record the necessary journal entries to the above effect.

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Concept understanding — Goodwill Adjustment on Retirement

Goodwill Adjustment on Retirement – A First Look

Think of a cricket team. Four friends start a team together. Over time, they build a reputation – people come to watch them, sponsors pay them, and their brand becomes valuable. Now one player retires. Should he walk away with nothing for the reputation the team built while he was part of it? Of course not. That reputation – the team's ability to earn more than just its raw assets – is goodwill.

In a partnership, goodwill is that same intangible value: the firm's name, its customer loyalty, its location advantage, its reputation for quality. When a partner retires, the remaining partners continue the business. They will enjoy the benefits of that goodwill going forward. The retiring partner, who helped build it, deserves a share of its value at the time of retirement.

The Precise Meaning

Goodwill on retirement is the compensation paid by the continuing partners to the retiring partner for his/her share of the firm's reputation and earning power. It is not a cash payment for a physical asset – it is an adjustment of the partners' capital accounts to reflect that the retiring partner's share of goodwill is being transferred to the remaining partners.

Important

Goodwill is not brought into the books as a new asset. It is adjusted through the partners' capital accounts. The retiring partner's capital account is credited with his/her share of goodwill, and the continuing partners' capital accounts are debited in their gaining ratio.

Why Does This Matter?

If goodwill were ignored, the retiring partner would be underpaid. The continuing partners would get a free benefit – the firm's reputation – without compensating the person who helped create it. The adjustment ensures fairness: the retiring partner gets his/her rightful share, and the continuing partners pay for the advantage they now exclusively enjoy.

The Accounting Treatment – Step by Step

The NCERT textbook gives a clear procedure. Here is the logic:

Calculate the firm's total goodwill at the time of retirement. This is usually given in the problem or valued using an agreed method (e.g., average profit method, super profit method).
Find the retiring partner's share of that goodwill.

Retiring partner's share = Total goodwill × Retiring partner's profit-sharing ratio.
Determine the gaining ratio of the continuing partners.

Gaining ratio = New ratio – Old ratio (for each continuing partner).

If the new ratio is not given, the continuing partners share the retiring partner's share in their old profit-sharing ratio.
Pass the journal entry:
```
Continuing Partners' Capital A/cs (individually)   Dr.   (in gaining ratio)
     To Retiring Partner's Capital A/c
```
This entry reduces the continuing partners' capital (they pay) and increases the retiring partner's capital (he receives).

Watch out

Do not debit the Goodwill account. The goodwill is not being recorded as an asset – it is an adjustment among partners. Only if the firm decides to raise goodwill as an asset and then write it off would you touch the Goodwill account, but that is a different treatment (usually for admission, not retirement).

Format: Partners' Capital Accounts (after adjustment)

Here is how the capital accounts look after the goodwill adjustment. Assume three partners: A, B, and C. C retires. A and B continue in the ratio 3:2. Total goodwill is ₹1,00,000. Old ratio was 2:2:1 (A:B:C). C's share = 1/5 × ₹1,00,000 = ₹20,000. Gaining ratio of A and B = New ratio – Old ratio = (3/5 – 2/5) : (2/5 – 2/5) = 1/5 : 0. So A gains fully. A's capital is debited ₹20,000; C's capital is credited ₹20,000.

Particulars	A (₹)	B (₹)	C (₹)
To C's Capital A/c (Goodwill)	20,000	–	–

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Journal Entries for Goodwill Adjustment on Retirement

When a partner retires, accumulated reserves and accumulated losses must be distributed among all partners in their old profit-sharing ratio. Since Naresh, Raj Kumar and Bishwajeet are equal partners, the ratio is 1:1:1.

Step 1: Distribute General Reserves

General Reserves of ₹36,000 are a credit balance — this is an accumulated profit. It must be credited to all partners' capital accounts in their old ratio.

Step 2: Distribute Profit and Loss Account (Dr.)

A debit balance of ₹15,000 in the Profit and Loss Account represents an accumulated loss. This must be debited to all partners' capital accounts in their old ratio.

Particulars	Debit (₹)	Credit (₹)
General Reserve A/c Dr.	36,000
To Naresh’s Capital A/c		12,000
To Raj Kumar’s Capital A/c		12,000
To Bishwajeet’s Capital A/c		12,000
(Being general reserve distributed among partners in old ratio 1:1:1)
Naresh’s Capital A/c Dr.	5,000

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On Raj Kumar’s retirement, the accumulated reserves and accumulated losses are distributed among all partners in their old profit-sharing ratio (1:1:1) via journal entries — General Reserve credited to partners’ capital accounts, and the debit balance of Profit & Loss Account debited to partners’ capital accounts.

Concept and Accounting Treatment

When a partner retires, the firm must settle all accumulated profits and losses that belong to the pre-retirement period. These are items that have built up over time but have not yet been transferred to the partners’ capital accounts. The rule is simple: any reserve or accumulated profit is credited to all partners in their old profit-sharing ratio, and any accumulated loss or debit balance is debited to all partners in the same ratio. This ensures that the retiring partner gets his rightful share of the firm’s past earnings, and also bears his share of past losses.

Why do we do this? Because the General Reserve represents profits that were set aside but never distributed. On retirement, these belong to all partners who contributed to earning them — including the retiring partner. Similarly, a debit balance in the Profit and Loss Account represents an accumulated loss that has not yet been charged to partners. The retiring partner must bear his share of that loss before he leaves.

The journal entries are straightforward:

For the General Reserve — Debit General Reserve Account, Credit all partners’ Capital Accounts (individually).
For the debit balance of Profit and Loss Account — Debit all partners’ Capital Accounts (individually), Credit Profit and Loss Account.

The profit-sharing ratio among Naresh, Raj Kumar, and Bishwajeet is equal, i.e., 1:1:1. So each partner gets or bears one-third of the amount.

Solution: Journal Entries

Particulars	Debit (₹)	Credit (₹)
General Reserve A/c ………Dr.	36,000
To Naresh’s Capital A/c		12,000
To Raj Kumar’s Capital A/c		12,000
To Bishwajeet’s Capital A/c		12,000
(Being General Reserve distributed among partners in old ratio on Raj Kumar’s retirement)
Naresh’s Capital A/c ………Dr.	5,000
Raj Kumar’s Capital A/c ………Dr.	5,000
Bishwajeet’s Capital A/c ………Dr.	5,000
To Profit and Loss A/c		15,000
(Being debit balance of Profit and Loss Account written off among partners in old ratio on Raj Kumar’s retirement)

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Q.Naresh, Raj Kumar and Bishwajeet are equal partners. Raj Kumar decides to retire. On the date of his retirement, the Balance Sheet of the firm showed the following: General Reserves ₹36,000 and Profit and Loss Account (Dr.) ₹15,000. Record the necessary journal entries to the above effect.

Concept and Accounting Treatment

Solution: Journal Entries

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