Disposal of Amount Due to Retiring Partner

Disposal of Amount Due to Retiring Partner

Once all adjustments — revaluation of assets and liabilities, treatment of goodwill, distribution of reserves, and calculation of the retiring partner's share of profits up to the date of retirement — are complete, the final amount due to the retiring partner is known. The next question is: how is this amount actually paid?

The partnership deed usually specifies the mode of payment. The retiring partner may be paid:

• The entire amount in a single lump sum immediately.
• In instalments over an agreed period, with or without interest.
• Partly in cash immediately, with the balance paid in instalments later.

When No Agreement Exists — Section 37 of the Indian Partnership Act, 1932

If the partnership deed is silent on this matter, Section 37 applies. It gives the outgoing partner an important choice. The retiring partner can opt to receive either:

• Interest at 6% per annum on the unpaid amount until the date of payment, or
• A share of the profits earned by the firm using the money that belongs to the retiring partner (this share is based on the proportion of the retiring partner's capital to the total capital employed).

This protects the retiring partner from being unfairly kept out of their money without compensation.

Journal Entries for Settlement

The accounting treatment depends on how the payment is made. There are three standard scenarios.

1. Full Payment in Cash Immediately

When the firm has sufficient funds and pays the entire amount due on the retirement date itself:

2. Entire Amount Treated as a Loan

When the firm cannot pay immediately and the entire amount is to be paid later, it is transferred to a separate liability account:

3. Partly Paid in Cash, Balance as Loan

This is a common practical scenario. The firm pays what it can and treats the rest as a loan:

Treatment of the Loan Account

Once the amount is transferred to the Retiring Partner's Loan Account, it becomes a liability of the firm. The loan is shown on the liabilities side of the Balance Sheet until it is fully paid off.

When the loan is repaid in instalments, each instalment typically includes two components: a part of the principal amount and interest on the outstanding balance. Two journal entries are required for each instalment:

a) For recording the interest due on the loan:

b) For recording the payment of the instalment:

These two entries (a and b) are repeated for each instalment until the loan is fully settled.

Illustration: Three Methods of Instalment Payment

Consider Mahinder who is retiring with ₹60,000 due to him. The firm agrees to pay in instalments. The following three cases show how the loan account is prepared differently depending on the agreement.

Case 1: Four Yearly Instalments of Principal + Interest on Unpaid Balance

Here, the principal is repaid in equal parts (₹60,000 / 4 = ₹15,000 per year). Interest is calculated at 12% p.a. on the balance outstanding at the beginning of each year.

Case 2: Three Yearly Instalments of ₹20,000 (Including Interest) + Balance in Fourth Year

Here, the instalment amount is fixed at ₹20,000. This payment includes both principal repayment and interest on the outstanding balance. The interest is calculated first, and the remainder of the ₹20,000 reduces the principal.

Case 3: Four Equal Yearly Instalments (Including Interest) …