Retirement and Death of a Partner

The full picture

A partnership does not end when one partner leaves — it reconstitutes itself. Retirement means an existing partner steps out while the business continues; death has the same accounting effect, except the firm now deals with the deceased partner's legal heir or executor. Either way, three linked questions must be answered: How much is the departing partner owed? How will the remaining partners re-share profits? And who bears any goodwill adjustment? Everything else in this chapter follows from these three questions.

The first new concept to master is the gaining ratio. When a partner leaves, their profit share does not disappear — it is absorbed by the continuing partners. The gaining ratio tells you how that absorption happens. Formula: Gaining Ratio = New Ratio − Old Ratio for each continuing partner. For example, if Arjun, Bhavna, and Chetan share profits in 3:2:1, and Chetan retires, Arjun and Bhavna must re-divide the full profit between themselves. If their new ratio is 3:2, then Arjun's gain = 3/5 − 3/6 = 18/30 − 15/30 = 3/30, and Bhavna's gain = 2/5 − 2/6 = 12/30 − 10/30 = 2/30. So the gaining ratio is 3:2. This is critical because it controls who pays for goodwill.

Goodwill is an invisible asset — it represents the firm's reputation, loyal customers, and earning power built over years. On retirement, the departing partner is entitled to their share of this goodwill (because they helped build it). The rule is: credit the retiring partner's Capital Account with their old-ratio share of agreed goodwill, and debit the remaining partners' Capital Accounts in their gaining ratio. For example, if the firm's goodwill is agreed at ₹1,20,000 and Chetan held a 1/6 share, his capital is credited ₹20,000. Arjun and Bhavna are debited ₹12,000 and ₹8,000 respectively (in their 3:2 gaining ratio). If goodwill already appears in the books at a different amount, it is first written off in full through all partners' Capital Accounts in the old ratio — this prevents double-counting.

Before settling the retiring partner's final dues, assets and liabilities are revalued at current market prices. A Revaluation Account is opened: assets that have increased in value are credited (gain), assets that have fallen are debited (loss), and the same logic applies to liabilities. The net gain or loss in the Revaluation Account is then transferred to all partners' Capital Accounts in their old profit-sharing ratio — including the retiring partner. Why the old ratio? Because these gains and losses belong to the period before retirement, when all three partners were sharing profits together. For example, if a firm's land was recorded at ₹8 lakh but is now worth ₹10 lakh, that ₹2 lakh gain goes to all three partners in their old ratio, not just the two who stay.

Accumulated reserves — general reserve, profit and loss balance, any undistributed profits sitting on the balance sheet — must also be distributed among all partners in the old ratio before the retirement is finalised. These are profits that were earned collectively but not yet paid out. The retiring partner has a rightful claim on their share. Once this is done, the retiring partner's Capital Account shows their true final balance: original capital + revaluation share + reserve share + goodwill credit.

Finally, the settlement itself. The most straightforward outcome is payment by cheque — debit the retiring partner's Capital Account, credit Bank. But many firms, especially small family businesses, cannot pay a large lump sum immediately. In that case, the unpaid balance is transferred to the retiring partner's Loan Account: the partner becomes a creditor of the firm and earns interest (usually at 6% per annum as per the Partnership Act, unless the deed specifies otherwise) until fully paid. In the event of a partner's death, the same calculations apply, but the executor or legal heir stands in place of the deceased. The firm's obligation is recorded as an Executor's Account until the estate is settled.

An Indian example

Rajan, Suresh, and Kavitha run a textile trading firm in Coimbatore, sharing profits in 3:2:1. After fifteen years, Suresh decides to retire. The partners agree that the firm's goodwill is worth ₹90,000. The books also show a General Reserve of ₹30,000 and a stock of goods currently valued at ₹5,000 below book value. First, the General Reserve of ₹30,000 is distributed among all three in the old ratio — Rajan ₹15,000, Suresh ₹10,000, Kavitha ₹5,000. Next, the stock write-down of ₹5,000 is shared as a loss in the old ratio — Rajan bears ₹2,500, Suresh ₹1,667, and Kavitha ₹833. Then goodwill: Suresh's 2/6 share = ₹30,000 is credited to his Capital Account. Rajan and Kavitha's gaining ratio is 3:1 (Rajan's new share 3/4 minus old 3/6 = 3/12; Kavitha's new 1/4 minus old 1/6 = 1/12 — ratio 3:1), so Rajan is debited ₹22,500 and Kavitha ₹7,500. After all these adjustments Suresh's Capital Account shows his final balance, and the firm pays him by bank transfer. Rajan and Kavitha continue with a clear new profit-sharing ratio of 3:1.

Key concepts covered

• Gaining ratio
• Treatment of goodwill
• Revaluation
• Settlement of executor's account

Common misconceptions to watch for

• Many students credit the retiring partner with the full goodwill of the firm — but the retiring partner only receives their old-ratio fraction of the agreed goodwill, not the whole amount; the firm's goodwill does not 'leave' with them.
• Students often apply the old profit-sharing ratio to debit the remaining partners for goodwill — the correct ratio to use is the gaining ratio, because each continuing partner gains a different slice of the vacated profit share and must pay proportionally to what they gain.
• It is a common belief that revaluation gains and losses go only to the continuing partners since the retiring partner is leaving — in fact, revaluation is distributed among all partners, including the retiring one, in the old ratio, because the change in asset values occurred while all were partners.