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Illustrations · Illustration 13
Q.

Shyam, Gagan and Ram are partners sharing profit in the ratio of 2 : 2 : 1. Their Balance Sheet as on March 31, 2017 is as under:

LiabilitiesAmount (₹)AssetsAmount (₹)
Sundry Creditors49,000Cash8,000
Employees' Provident Fund4,000Debtors19,000
General Reserve14,500Stock42,000
Capital:Machinery85,000
Shyam80,000Building1,22,000
Gagan62,500Patents9,000
Ram75,000
Total2,85,000Total2,85,000

Gagan decided to retire on that date and it was decided that Shyam and Ram would share the future profits in the ratio of 5 : 3. Goodwill was valued at ₹70,000; Machinery at ₹78,000; Buildings at ₹1,52,000; Stock at ₹30,000; and bad debts amounting to ₹1,550 were to be written off. Record journal entries in the books of the firm and prepare the Balance Sheet of the new firm.

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On Gagan's retirement the firm revalues its assets, and the net revaluation profit of ₹9,450 plus the General Reserve of ₹14,500 are credited to all three partners in the old 2 : 2 : 1 ratio. Gagan's ₹28,000 share of goodwill is borne by Shyam and Ram in their gaining ratio of 9 : 7. Gagan's total dues of ₹1,00,080 are transferred to a Loan Account (the firm has no cash to pay him), and Shyam and Ram close at ₹73,830 and ₹67,540. The reconstituted Balance Sheet totals ₹2,94,450.

When a partner retires, the firm must first revalue its assets and liabilities so the books reflect their current worth. Any gain or loss on this revaluation belongs to the period before retirement, so it is shared among all partners — including the retiring one — in the old profit-sharing ratio (here 2 : 2 : 1). Goodwill, though valued, is not brought into the books; instead the retiring partner is compensated for his share of goodwill by the continuing partners, who debit their own capital accounts in their gaining ratio. Finally the reserves standing in the books are distributed, the retiring partner's balance is settled (transferred to a Loan Account when cash is short), and a fresh Balance Sheet of the continuing firm is drawn up.

Revaluation. Machinery falls from ₹85,000 to ₹78,000 (loss ₹7,000), Stock from ₹42,000 to ₹30,000 (loss ₹12,000), and ₹1,550 of debtors is written off as bad (loss ₹1,550) — total losses of ₹20,550. Against this, Building rises from ₹1,22,000 to ₹1,52,000 (gain ₹30,000). The net profit on revaluation is ₹30,000 − ₹20,550 = ₹9,450, credited in the old ratio: Shyam ₹3,780, Gagan ₹3,780, Ram ₹1,890.

Reserve and goodwill. The General Reserve of ₹14,500 is likewise shared 2 : 2 : 1 — Shyam ₹5,800, Gagan ₹5,800, Ram ₹2,900. Goodwill of the firm is ₹70,000, so Gagan's share is 2/5 × ₹70,000 = ₹28,000. Since goodwill is not to appear in the books, Shyam and Ram bear it in their gaining ratio of 9 : 7 — ₹15,750 and ₹12,250 — credited to Gagan's capital account.

Let us now record the journal entries and prepare the Revaluation Account, the Partners' Capital Accounts, and the Balance Sheet of the reconstituted firm.

Working Notes

Gaining ratio (Shyam : Ram): Shyam 5/8 − 2/5 = 25/40 − 16/40 = 9/40; Ram 3/8 − 1/5 = 15/40 − 8/40 = 7/40 → 9 : 7. Gagan's goodwill ₹28,000 is therefore borne ₹15,750 (Shyam) and ₹12,250 (Ram).

Gagan's dues (→ Loan): Opening capital ₹62,500 + revaluation profit ₹3,780 + reserve ₹5,800 + goodwill ₹28,000 = ₹1,00,080.

Continuing partners' capitals:

  • Shyam: 80,000 + 3,780 (reval.) + 5,800 (reserve) − 15,750 (goodwill) = ₹73,830
  • Ram: 75,000 + 1,890 (reval.) + 2,900 (reserve) − 12,250 (goodwill) = ₹67,540

Solution — Journal

DateParticularsL.F.Debit (₹)Credit (₹)
2017 Mar 31Revaluation A/c Dr.20,550
To Machinery A/c7,000
To Stock A/c12,000
To Debtors A/c1,550
(Loss on revaluation of assets recorded on Gagan's retirement)
Building A/c Dr.30,000
To Revaluation A/c30,000
(Appreciation in the value of Building)
Revaluation A/c Dr.9,450
To Shyam's Capital A/c3,780
To Gagan's Capital A/c3,780
To Ram's Capital A/c1,890
(Profit on revaluation transferred in old ratio 2 : 2 : 1)
General Reserve A/c Dr.14,500
To Shyam's Capital A/c5,800
To Gagan's Capital A/c5,800
To Ram's Capital A/c2,900
(Reserve transferred to partners' capital accounts)
Shyam's Capital A/c Dr.15,750
Ram's Capital A/c Dr.12,250
To Gagan's Capital A/c28,000
(Gagan's share of goodwill adjusted to Shyam and Ram in gaining ratio 9 : 7)
Gagan's Capital A/c Dr.1,00,080
To Gagan's Loan A/c1,00,080
(Amount payable to retiring partner transferred to his loan account)

Revaluation Account …

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