Q.Discuss the various methods of computing the share in profits in the event of death of a partner.

When a partner dies, the partnership is dissolved by death under Section 42(c) of the Indian Partnership Act, 1932. The surviving partners must settle the deceased partner’s account, which includes their share of profits earned from the last balance sheet date up to the date of death. There are three standard methods to compute this share, each based on the partnership deed or mutual agreement.

1. Time Basis (Proportion of Year)

Profit is assumed to accrue evenly throughout the year. The deceased partner’s share is calculated as:

Share of profit = (Last year’s profit (or average profit) × Period from last B/S to death)/(12 months) × Profit-sharing ratio

Example: If last year’s profit was ₹1,20,000, the partner died after 3 months, and his share is 1/4, then:

(1,20,000 × 3)/12 × 1/4 = ₹7,500

2. Turnover or Sales Basis

Profit is linked to actual sales during the intervening period. The formula is:

Share of profit = (Sales from last B/S to death)/(Last year’s total sales) × Last year’s profit × Profit-sharing ratio

This method is more accurate when sales fluctuate significantly.

3. Average Profit of Past Years

The average profit of a fixed number of previous years (e.g., 3 or 5 years) is used instead of the last year’s profit. The calculation then follows the time basis.

Average profit = (Total profit of past years)/(Number of years)

Then apply the time proportion as in Method 1. …

Concept First: Why Compute Profit Share on Death?

When a partner dies, the partnership deed usually states that the deceased partner's estate is entitled to a share of profits earned from the last balance sheet date up to the date of death. The firm cannot wait until the year-end to calculate actual profits — the settlement must happen quickly. So, we estimate this profit share using one of several accepted methods.

The accounting treatment is straightforward: the estimated profit is credited to the deceased partner's Capital Account (increasing the amount due to their legal heirs). The corresponding debit goes either to a Profit & Loss Suspense Account (a temporary account) or directly to the continuing partners' Capital Accounts in their gaining ratio (the ratio in which they will now share future profits).

The Three Main Methods

Method 1: Time Basis (Most Common)

This method uses the profit of the previous year (or an average of past years) as a base and calculates the deceased partner's share for the exact number of months/days they survived in the current year.

Formula:

Deceased Partner's Share = (Last Year's Profit) × (Deceased Partner's Profit Share Ratio) × (Period from last B/S to death / 12 months)

Variation: Sometimes the deed says "average profits of the last 3 years" instead of just the last year. The principle remains the same — calculate the base profit first.

Example: If last year's profit was ₹1,20,000, partner A (1/3rd share) dies after 4 months:

A's share = ₹1,20,000 × 1/3 × 4/12 = ₹13,333

Method 2: Turnover or Sales Basis

This method is used when profit is directly linked to sales volume. It assumes the profit-to-sales ratio remains constant.

Steps:

1. Calculate the profit-to-sales ratio from the previous year: (Last Year's Profit ÷ Last Year's Sales) × 100
2. Find the actual sales from the last balance sheet date to the date of death.
3. Apply the ratio to get the estimated profit for that period.
4. Multiply by the deceased partner's profit share ratio.

Formula:

Deceased Partner's Share = (Actual Sales up to death) × (Last Year's Profit / Last Year's Sales) × (Deceased Partner's Share)

Example: Last year sales ₹10,00,000, profit ₹2,00,000. Sales up to death ₹3,00,000. Partner B (1/4th share):

Estimated profit = ₹3,00,000 × (2,00,000/10,00,000) = ₹60,000

B's share = ₹60,000 × 1/4 = ₹15,000

Method 3: Average Profit of Past Years

Instead of relying on a single year's profit, this method uses the average profit of a fixed number of past years (commonly the last three or five years) as the base. It is preferred when yearly profits fluctuate, because averaging smooths out an unusually good or bad year.

Steps:

1. Add the profits of the chosen past years and divide by the number of years to get the average profit.
2. Apportion that average profit for the period from the last balance sheet date to the date of death (on a time basis).
3. Multiply by the deceased partner's profit-sharing ratio.

Formula:

Deceased Partner's Share = Average Profit of Past Years × (Period from last B/S to death ÷ 12 months) × Deceased Partner's Share

Example: If the average profit of the last three years is ₹90,000 and partner C (1/5th share) dies after 6 months:

C's share = ₹90,000 × 6/12 × 1/5 = ₹9,000

Journal Entry (Common to All Methods)

The journal entry is the same regardless of which method is used:

Alternative Entry (when the continuing partners' capitals are adjusted directly):

Working Notes (Illustrative Example)

Let's take a concrete case to see all methods in action.

Given:

• Partners: X, Y, Z sharing profits 2:2:1
• Last Balance Sheet: 31st March 2024 …