1. GAINING RATIO

📚 Concept Explanation

Gaining Ratio is the ratio in which the continuing partners acquire the share of the retiring partner. It is calculated by subtracting the old ratio from the new ratio.

Formula: Gaining Ratio = New Ratio - Old Ratio

Purpose: Gaining ratio is used to adjust goodwill among the continuing partners.

📝 Problem 1.1: Basic Gaining Ratio Calculation

Question: A, B, and C are partners sharing profits in the ratio of 5:3:2. C retires from the firm. A and B decide to share future profits in the ratio of 3:2. Calculate the gaining ratio.

Solution:

Step 1: Identify Old Profit Sharing Ratio

Partner Old Ratio Fraction
A 5 5/10
B 3 3/10
C (Retiring) 2 2/10

Step 2: Identify New Profit Sharing Ratio (after retirement)

Partner New Ratio Fraction
A 3 3/5
B 2 2/5

Step 3: Calculate Gaining Ratio

Gaining Ratio = New Ratio - Old Ratio

For Partner A:

= 3/5 - 5/10 = 6/10 - 5/10 = 1/10

For Partner B:

= 2/5 - 3/10 = 4/10 - 3/10 = 1/10

Gaining Ratio of A and B = 1:1

Final Answer: Gaining Ratio = A:B = 1:1

📝 Problem 1.2: Gaining Ratio with Complex Fractions

Question: P, Q, and R are partners sharing profits in the ratio of 4:3:2. R retires and his share is taken by P and Q in the ratio of 2:1. Calculate the gaining ratio and new profit sharing ratio.

Solution:

Step 1: Old Profit Sharing Ratio

P:Q:R = 4:3:2

P = 4/9, Q = 3/9, R = 2/9

Step 2: R's Share Distribution

R's share = 2/9

This is taken by P and Q in the ratio 2:1

P gets = 2/9 × 2/3 = 4/27

Q gets = 2/9 × 1/3 = 2/27

Step 3: New Profit Sharing Ratio

Partner Old Share Gain from R New Share
P 4/9 = 12/27 + 4/27 16/27
Q 3/9 = 9/27 + 2/27 11/27

New Profit Sharing Ratio: P:Q = 16:11

Step 4: Gaining Ratio

Gaining Ratio = Share gained from retiring partner in the ratio they acquire it

P gains = 4/27

Q gains = 2/27

Gaining Ratio: P:Q = 4:2 = 2:1

Final Answer:

New Profit Sharing Ratio = P:Q = 16:11

Gaining Ratio = P:Q = 2:1

2. REVALUATION ACCOUNT

📚 Concept Explanation

Revaluation Account is prepared at the time of retirement to revalue the assets and liabilities of the firm. It records the increase or decrease in the values of assets and liabilities.

Purpose: To determine the profit or loss on revaluation and distribute it among all partners (including retiring partner) in their old profit sharing ratio.

Format:

Revaluation Account
Dr. Side (Decrease in Assets / Increase in Liabilities) Cr. Side (Increase in Assets / Decrease in Liabilities)
To Assets (decreased) By Assets (increased)
To Liabilities (increased) By Liabilities (decreased)
To Partners' Capital A/c (Profit) By Partners' Capital A/c (Loss)

📝 Problem 2.1: Basic Revaluation Account

Question: A, B, and C are partners sharing profits in the ratio of 3:2:1. C retires and following revaluations are agreed upon:

  • Building increased in value by ₹30,000
  • Machinery decreased in value by ₹15,000
  • Stock depreciated by ₹5,000
  • Provision for Doubtful Debts to be created @ 5% on Debtors ₹40,000

Prepare Revaluation Account and pass necessary journal entries.

Solution:

Step 1: Revaluation Account

Revaluation Account
Dr. Side Cr. Side
To Machinery A/c - ₹15,000 By Building A/c - ₹30,000
To Stock A/c - ₹5,000  
To Provision for Doubtful Debts A/c - ₹2,000  
To Profit on Revaluation transferred to:  
   A's Capital A/c - ₹4,000  
   B's Capital A/c - ₹2,667  
   C's Capital A/c - ₹1,333  
Total: ₹30,000 Total: ₹30,000

Calculation of Profit on Revaluation:

Credit Side Total = ₹30,000

Debit Side Total = ₹15,000 + ₹5,000 + ₹2,000 = ₹22,000

Profit on Revaluation = ₹30,000 - ₹22,000 = ₹8,000

Distribution in Old Ratio (3:2:1):

A's Share = ₹8,000 × 3/6 = ₹4,000

B's Share = ₹8,000 × 2/6 = ₹2,667 (rounded)

C's Share = ₹8,000 × 1/6 = ₹1,333 (rounded)

Step 2: Journal Entries

Date Particulars L.F. Debit (₹) Credit (₹)
1 Building A/c      Dr.
    To Revaluation A/c
(Being increase in value of building)		 30,000
30,000
2 Revaluation A/c      Dr.
    To Machinery A/c
(Being decrease in value of machinery)		 15,000
15,000
3 Revaluation A/c      Dr.
    To Stock A/c
(Being depreciation of stock)		 5,000
5,000
4 Revaluation A/c      Dr.
    To Provision for Doubtful Debts A/c
(Being provision created @ 5% on ₹40,000)		 2,000
2,000
5 Revaluation A/c      Dr.
    To A's Capital A/c
    To B's Capital A/c
    To C's Capital A/c
(Being profit on revaluation distributed)		 8,000
4,000
2,667
1,333

Final Answer: Profit on Revaluation = ₹8,000 distributed as A: ₹4,000, B: ₹2,667, C: ₹1,333

📝 Problem 2.2: Revaluation with Loss

Question: X, Y, and Z are partners sharing profits equally. Z retires. The following adjustments are to be made:

  • Land increased by ₹50,000
  • Furniture decreased by ₹10,000
  • Investment depreciated by ₹20,000
  • Creditors to be increased by ₹30,000
  • An unrecorded liability of ₹15,000 is to be recorded

Prepare Revaluation Account.

Solution:

Revaluation Account
Dr. Side Cr. Side
To Furniture A/c - ₹10,000 By Land A/c - ₹50,000
To Investment A/c - ₹20,000  
To Creditors A/c - ₹30,000  
To Outstanding Liability A/c - ₹15,000  
  By Loss on Revaluation transferred to:
     X's Capital A/c - ₹8,333
     Y's Capital A/c - ₹8,333
     Z's Capital A/c - ₹8,334
Total: ₹75,000 Total: ₹75,000

Calculation:

Credit Side (Gains) = ₹50,000

Debit Side (Losses) = ₹10,000 + ₹20,000 + ₹30,000 + ₹15,000 = ₹75,000

Loss on Revaluation = ₹75,000 - ₹50,000 = ₹25,000

Loss distributed equally: Each partner = ₹25,000 ÷ 3 = ₹8,333 (approx)

Final Answer: Loss on Revaluation = ₹25,000 distributed equally among X, Y, and Z

3. GOODWILL TREATMENT

📚 Concept Explanation

Goodwill represents the value of the firm's reputation and customer base. When a partner retires, the continuing partners must compensate the retiring partner for their share of goodwill.

Methods of Goodwill Treatment:

Method 1: When Goodwill is Raised and Written Off

a) Raise goodwill at full value and credit all partners in old ratio
b) Write off goodwill by debiting continuing partners in new ratio

Method 2: When Goodwill is NOT Raised (Hidden Goodwill)

Continuing partners compensate retiring partner by debiting their capital accounts in gaining ratio and crediting retiring partner's capital account.

Formula for Retiring Partner's Share of Goodwill:

Retiring Partner's Goodwill Share = Total Goodwill × Retiring Partner's Share in Profit

📝 Problem 3.1: Goodwill Raised and Written Off

Question: A, B, and C are partners sharing profits in the ratio of 4:3:2. C retires. The goodwill of the firm is valued at ₹81,000. Goodwill is to be raised and then written off. New profit sharing ratio between A and B is 5:3. Pass necessary journal entries.

Solution:

Step 1: Raise Goodwill at Full Value

Particulars Debit (₹) Credit (₹)
Goodwill A/c      Dr.
    To A's Capital A/c (4/9)
    To B's Capital A/c (3/9)
    To C's Capital A/c (2/9)
(Being goodwill raised in old ratio)		 81,000
36,000
27,000
18,000

Calculation:

A's Share = ₹81,000 × 4/9 = ₹36,000

B's Share = ₹81,000 × 3/9 = ₹27,000

C's Share = ₹81,000 × 2/9 = ₹18,000

Step 2: Write Off Goodwill (Continuing Partners in New Ratio)

Particulars Debit (₹) Credit (₹)
A's Capital A/c      Dr.
B's Capital A/c      Dr.
    To Goodwill A/c
(Being goodwill written off in new ratio)		 50,625
30,375

81,000

Calculation:

New Ratio A:B = 5:3

A's Share = ₹81,000 × 5/8 = ₹50,625

B's Share = ₹81,000 × 3/8 = ₹30,375

Net Effect on Capital Accounts:

Partner Credited (Old Ratio) Debited (New Ratio) Net Effect
A +₹36,000 -₹50,625 -₹14,625 (Debited)
B +₹27,000 -₹30,375 -₹3,375 (Debited)
C +₹18,000 - +₹18,000 (Credited)

Final Answer: A and B compensate C for his share of goodwill through the raise and write-off mechanism. C's capital is credited with ₹18,000.

📝 Problem 3.2: Hidden Goodwill (Goodwill NOT Raised)

Question: P, Q, and R are partners sharing profits in 5:3:2. R retires. Goodwill of the firm is valued at ₹1,00,000 but it is decided not to show goodwill in the books. P and Q decide to share future profits in the ratio of 3:2. Pass the adjustment entry for goodwill.

Solution:

Step 1: Calculate R's Share of Goodwill

Total Goodwill = ₹1,00,000

R's Share = ₹1,00,000 × 2/10 = ₹20,000

Step 2: Calculate Gaining Ratio

Partner Old Ratio New Ratio Gain
P 5/10 3/5 = 6/10 1/10
Q 3/10 2/5 = 4/10 1/10

Gaining Ratio = P:Q = 1:1

Step 3: Distribute Goodwill in Gaining Ratio

P compensates = ₹20,000 × 1/2 = ₹10,000

Q compensates = ₹20,000 × 1/2 = ₹10,000

Step 4: Journal Entry

Particulars Debit (₹) Credit (₹)
P's Capital A/c      Dr.
Q's Capital A/c      Dr.
    To R's Capital A/c
(Being R's share of goodwill adjusted through P and Q's capital in gaining ratio)		 10,000
10,000

20,000

Final Answer: P and Q's capitals are debited with ₹10,000 each, and R's capital is credited with ₹20,000 without raising goodwill in books.

📝 Problem 3.3: Partial Goodwill Raised

Question: X, Y, and Z are partners in the ratio 2:2:1. Z retires. Goodwill is valued at ₹50,000. X and Y continue in equal ratio. The continuing partners decide to raise goodwill only to the extent of retiring partner's share. Pass necessary journal entries.

Solution:

Step 1: Calculate Z's Share of Goodwill

Z's Share = ₹50,000 × 1/5 = ₹10,000

Step 2: Calculate Gaining Ratio

Old Ratio X:Y = 2:2 or 1:1

New Ratio X:Y = 1:1 (equal)

Gaining Ratio = 1:1 (since both gain equally from Z's retirement)

Step 3: Pass Journal Entries

Entry 1: Raise Goodwill for Retiring Partner's Share Only

Particulars Debit (₹) Credit (₹)
Goodwill A/c      Dr.
    To Z's Capital A/c
(Being Z's share of goodwill raised)		 10,000
10,000

Entry 2: Write Off Goodwill (Gaining Partners)

Particulars Debit (₹) Credit (₹)
X's Capital A/c      Dr.
Y's Capital A/c      Dr.
    To Goodwill A/c
(Being goodwill written off in gaining ratio)		 5,000
5,000

10,000

Alternative Single Entry Method:

Particulars Debit (₹) Credit (₹)
X's Capital A/c      Dr.
Y's Capital A/c      Dr.
    To Z's Capital A/c
(Being Z's share of goodwill compensated by gaining partners)		 5,000
5,000

10,000

Final Answer: Z's capital is credited with ₹10,000 as goodwill compensation, debited from X and Y equally (₹5,000 each).

4. ACCUMULATED PROFITS & LOSSES

📚 Concept Explanation

Accumulated Profits and Losses are the reserves, undistributed profits, or losses that exist in the books at the time of retirement.

Treatment:

Accumulated Profits (General Reserve, Profit & Loss A/c Cr. Balance):

These should be distributed among ALL partners (including retiring partner) in their OLD profit sharing ratio by transferring to their capital accounts.

Accumulated Losses (Profit & Loss A/c Dr. Balance, Deferred Revenue Expenditure):

These should be written off by debiting ALL partners' capital accounts (including retiring partner) in their OLD profit sharing ratio.

Items to be Transferred:

  • General Reserve
  • Reserve Fund
  • Profit & Loss Account (Credit or Debit Balance)
  • Workmen Compensation Reserve (if not required)
  • Investment Fluctuation Reserve (if investments are revalued)
  • Deferred Revenue Expenditure
  • Advertisement Suspense Account

📝 Problem 4.1: Distribution of Accumulated Profits

Question: A, B, and C are partners sharing profits in the ratio of 3:2:1. C retires. The following items appear in the Balance Sheet:

  • General Reserve: ₹60,000
  • Profit & Loss Account (Cr.): ₹24,000
  • Workmen Compensation Reserve: ₹18,000 (Liability estimated at ₹12,000)

Pass necessary journal entries for the adjustment of accumulated profits and reserves.

Solution:

Step 1: General Reserve Distribution

Total General Reserve = ₹60,000

Distribution in ratio 3:2:1

Partner Ratio Amount (₹)
A 3/6 30,000
B 2/6 20,000
C 1/6 10,000
Total 60,000

Journal Entry:

Particulars Debit (₹) Credit (₹)
General Reserve A/c      Dr.
    To A's Capital A/c
    To B's Capital A/c
    To C's Capital A/c
(Being general reserve distributed)		 60,000
30,000
20,000
10,000

Step 2: Profit & Loss Account Distribution

Partner Amount (₹)
A (3/6) 12,000
B (2/6) 8,000
C (1/6) 4,000
Total 24,000

Journal Entry:

Particulars Debit (₹) Credit (₹)
Profit & Loss A/c      Dr.
    To A's Capital A/c
    To B's Capital A/c
    To C's Capital A/c
(Being credit balance of P&L distributed)		 24,000
12,000
8,000
4,000

Step 3: Workmen Compensation Reserve

Reserve available = ₹18,000

Liability = ₹12,000

Excess Reserve to be distributed = ₹18,000 - ₹12,000 = ₹6,000

Partner Amount (₹)
A (3/6) 3,000
B (2/6) 2,000
C (1/6) 1,000
Total 6,000

Journal Entry:

Particulars Debit (₹) Credit (₹)
Workmen Compensation Reserve A/c      Dr.
    To A's Capital A/c
    To B's Capital A/c
    To C's Capital A/c
    To Workmen Compensation Claim A/c
(Being excess reserve distributed and liability created)		 18,000
3,000
2,000
1,000
12,000

Summary of Capital Account Credits:

Partner Gen. Reserve P&L A/c WC Reserve Total Credit
A ₹30,000 ₹12,000 ₹3,000 ₹45,000
B ₹20,000 ₹8,000 ₹2,000 ₹30,000
C ₹10,000 ₹4,000 ₹1,000 ₹15,000

Final Answer: Total accumulated profits distributed - A: ₹45,000, B: ₹30,000, C: ₹15,000

📝 Problem 4.2: Write-off of Accumulated Losses

Question: X, Y, and Z are partners in the ratio of 4:3:2. Z retires. The Balance Sheet shows:

  • Profit & Loss Account (Dr.): ₹27,000
  • Advertisement Suspense: ₹18,000

Pass journal entries for adjustment of accumulated losses.

Solution:

Step 1: Write-off Profit & Loss Account (Debit Balance)

Total Loss = ₹27,000

Distribution in ratio 4:3:2

Partner Share Amount (₹)
X 4/9 12,000
Y 3/9 9,000
Z 2/9 6,000
Total 27,000

Journal Entry:

Particulars Debit (₹) Credit (₹)
X's Capital A/c      Dr.
Y's Capital A/c      Dr.
Z's Capital A/c      Dr.
    To Profit & Loss A/c
(Being debit balance of P&L written off)		 12,000
9,000
6,000


27,000

Step 2: Write-off Advertisement Suspense

Total = ₹18,000

Partner Amount (₹)
X (4/9) 8,000
Y (3/9) 6,000
Z (2/9) 4,000
Total 18,000

Journal Entry:

Particulars Debit (₹) Credit (₹)
X's Capital A/c      Dr.
Y's Capital A/c      Dr.
Z's Capital A/c      Dr.
    To Advertisement Suspense A/c
(Being deferred revenue expenditure written off)		 8,000
6,000
4,000


18,000

Total Debits to Capital Accounts:

Partner P&L A/c Adv. Suspense Total Debit
X ₹12,000 ₹8,000 ₹20,000
Y ₹9,000 ₹6,000 ₹15,000
Z ₹6,000 ₹4,000 ₹10,000

Final Answer: Accumulated losses written off - X: ₹20,000, Y: ₹15,000, Z: ₹10,000 (debited from their capital accounts)

5. CAPITAL ACCOUNT ADJUSTMENT

📚 Concept Explanation

Capital Account Adjustment involves preparing the Partners' Capital Accounts to show all adjustments at the time of retirement including:

  • Revaluation profit/loss
  • Goodwill adjustment
  • Accumulated profits/losses distribution
  • Share of profit up to date of retirement
  • Drawings and interest on drawings
  • Interest on capital

Format of Partners' Capital Account:

Partners' Capital Account
Dr. Side Cr. Side
To Drawings
To Interest on Drawings
To Revaluation A/c (Loss)
To Goodwill A/c (Written off)
To P&L A/c (Dr. Balance)
To Retiring Partner's Capital A/c (Goodwill)
To Balance c/d		 By Balance b/d
By Interest on Capital
By Revaluation A/c (Profit)
By General Reserve
By P&L A/c (Cr. Balance)
By Goodwill A/c (Raised)
By Gaining Partners' Capital (for retiring partner)

📝 Problem 5.1: Complete Capital Account Preparation

Question: A, B, and C are partners sharing profits in the ratio of 2:2:1. Their capital balances on 1st April 2024 were: A - ₹80,000, B - ₹60,000, C - ₹40,000. C retires on 31st March 2025. The following adjustments are agreed upon:

  • Goodwill valued at ₹50,000 (not to be raised in books)
  • Building to be appreciated by 20% (Current value ₹1,00,000)
  • Machinery to be depreciated by 10% (Current value ₹80,000)
  • General Reserve: ₹25,000
  • Profit for the year up to retirement: ₹60,000
  • Drawings: A - ₹10,000, B - ₹8,000, C - ₹6,000
  • A and B continue in the ratio of 3:2

Prepare Partners' Capital Accounts.

Solution:

Step 1: Calculate Revaluation Profit/Loss

Building appreciation = ₹1,00,000 × 20% = ₹20,000 (Gain)

Machinery depreciation = ₹80,000 × 10% = ₹8,000 (Loss)

Net Profit on Revaluation = ₹20,000 - ₹8,000 = ₹12,000

Distribution (2:2:1): A = ₹4,800, B = ₹4,800, C = ₹2,400

Step 2: Goodwill Adjustment

C's share of goodwill = ₹50,000 × 1/5 = ₹10,000

Gaining Ratio calculation:

Old Ratio - A:B = 2:2 or 1:1

New Ratio - A:B = 3:2

A's gain = 3/5 - 2/5 = 1/5

B's gain = 2/5 - 2/5 = 0/5

Gaining Ratio = 1:0

Wait, this needs recalculation. Let me recalculate properly.

Old total ratio = 2+2+1 = 5

A's old share = 2/5, B's old share = 2/5, C's old share = 1/5

After C retires, new ratio A:B = 3:2

A's new share = 3/5, B's new share = 2/5

A's gain = 3/5 - 2/5 = 1/5

B's gain = 2/5 - 2/5 = 0

So A gains entire share of C = ₹10,000

Step 3: General Reserve Distribution

A = ₹25,000 × 2/5 = ₹10,000

B = ₹25,000 × 2/5 = ₹10,000

C = ₹25,000 × 1/5 = ₹5,000

Step 4: Profit Distribution

A = ₹60,000 × 2/5 = ₹24,000

B = ₹60,000 × 2/5 = ₹24,000

C = ₹60,000 × 1/5 = ₹12,000

Step 5: Partners' Capital Accounts

Particulars A (₹) B (₹) C (₹)
Debit Side
To Drawings 10,000 8,000 6,000
To C's Capital A/c (Goodwill) 10,000 - -
To Balance c/d 1,18,800 98,800 -
To Retiring Partner's Loan A/c - - 63,400
Total 1,38,800 1,06,800 69,400
Credit Side
By Balance b/d 80,000 60,000 40,000
By Revaluation A/c 4,800 4,800 2,400
By General Reserve 10,000 10,000 5,000
By Profit & Loss A/c 24,000 24,000 12,000
By A's Capital A/c (Goodwill) - - 10,000
By Balance b/d (Next year) 20,000 8,000 -
Total 1,38,800 1,06,800 69,400

Working Notes:

A's Capital Account:

Opening Balance: ₹80,000

Add: Revaluation Profit: ₹4,800

Add: General Reserve: ₹10,000

Add: Profit Share: ₹24,000

Less: Drawings: ₹10,000

Less: C's Goodwill: ₹10,000

Closing Balance: ₹98,800

C's Amount Payable:

Opening Balance: ₹40,000

Add: Revaluation Profit: ₹2,400

Add: General Reserve: ₹5,000

Add: Profit Share: ₹12,000

Add: Goodwill: ₹10,000

Less: Drawings: ₹6,000

Amount due to C: ₹63,400 (Transferred to Loan Account)

Final Answer: C's total dues = ₹63,400 (transferred to Retiring Partner's Loan Account). A's closing capital = ₹98,800, B's closing capital = ₹98,800

6. SETTLEMENT OF RETIRING PARTNER

📚 Concept Explanation

Settlement of Retiring Partner refers to the payment of the amount due to the retiring partner. The amount can be settled in the following ways:

Methods of Settlement:

1. Immediate Payment in Cash/Bank

The entire amount is paid immediately.

Entry: Retiring Partner's Capital A/c Dr.
      To Bank/Cash A/c

2. Transfer to Loan Account

Amount due is transferred to a loan account and paid later.

Entry: Retiring Partner's Capital A/c Dr.
      To Retiring Partner's Loan A/c

3. Partial Cash Payment + Loan

Part payment in cash, balance transferred to loan account.

4. Payment in Installments

Amount paid in specified installments with or without interest.

📝 Problem 6.1: Immediate Cash Settlement

Question: M, N, and O are partners sharing profits in 3:2:1. O retires. His capital after all adjustments stands at ₹85,000. He is paid immediately by cheque. Pass the necessary journal entry.

Solution:

Date Particulars L.F. Debit (₹) Credit (₹)
O's Capital A/c      Dr.
    To Bank A/c
(Being amount due to O paid by cheque)		 85,000
85,000

Final Answer: O receives immediate payment of ₹85,000 through bank.

📝 Problem 6.2: Partial Payment + Loan Account

Question: P, Q, and R are partners. R retires with total dues of ₹1,20,000. It is agreed that ₹40,000 will be paid immediately in cash and the balance will be transferred to his loan account bearing interest @ 10% per annum. Pass necessary journal entries.

Solution:

Entry 1: Immediate Cash Payment

Particulars Debit (₹) Credit (₹)
R's Capital A/c      Dr.
    To Cash A/c
(Being partial payment made to R)		 40,000
40,000

Entry 2: Transfer Balance to Loan Account

Balance = ₹1,20,000 - ₹40,000 = ₹80,000

Particulars Debit (₹) Credit (₹)
R's Capital A/c      Dr.
    To R's Loan A/c
(Being balance transferred to loan account @ 10% p.a.)		 80,000
80,000

Combined Entry (Alternative Method):

Particulars Debit (₹) Credit (₹)
R's Capital A/c      Dr.
    To Cash A/c
    To R's Loan A/c
(Being settlement of R's account)		 1,20,000
40,000
80,000

Final Answer: R receives ₹40,000 cash immediately and ₹80,000 is transferred to loan account bearing 10% interest.

📝 Problem 6.3: Settlement in Installments with Interest

Question: S, T, and U are partners. T retires with dues of ₹90,000 transferred to loan account @ 12% p.a. interest. The amount is to be paid in 3 equal annual installments starting from the end of first year. Calculate installment amount and pass journal entries for the first installment payment.

Solution:

Step 1: Calculate Installment

Principal = ₹90,000

Interest Rate = 12% p.a.

Time = 3 years

Year 1:

Interest = ₹90,000 × 12% = ₹10,800

Equal installment principle: Installment = ₹30,000 + Interest due

First Installment = ₹30,000 + ₹10,800 = ₹40,800

Step 2: Journal Entry for First Installment

Particulars Debit (₹) Credit (₹)
Interest on Loan A/c      Dr.
    To T's Loan A/c
(Being interest due on loan)		 10,800
10,800
T's Loan A/c      Dr.
    To Bank A/c
(Being first installment paid including interest)		 40,800
40,800

T's Loan Account (After First Year)

Particulars Amount (₹) Particulars Amount (₹)
To Bank A/c 40,800 By Balance b/d 90,000
To Balance c/d 60,000 By Interest on Loan 10,800
Total 1,00,800 Total 1,00,800

Calculation for Subsequent Years:

Year 2:

Opening Balance = ₹60,000

Interest = ₹60,000 × 12% = ₹7,200

Second Installment = ₹30,000 + ₹7,200 = ₹37,200

Year 3:

Opening Balance = ₹30,000

Interest = ₹30,000 × 12% = ₹3,600

Third Installment = ₹30,000 + ₹3,600 = ₹33,600

Summary of Installments:

Year Opening Balance Interest @ 12% Principal Paid Total Installment Closing Balance
1 ₹90,000 ₹10,800 ₹30,000 ₹40,800 ₹60,000
2 ₹60,000 ₹7,200 ₹30,000 ₹37,200 ₹30,000
3 ₹30,000 ₹3,600 ₹30,000 ₹33,600 ₹0

Final Answer: Three annual installments of ₹40,800, ₹37,200, and ₹33,600 respectively (including 12% interest).

7. COMPREHENSIVE PROBLEM

(Revaluation A/c, Partners' Capital A/c, Retiring Partner's Loan A/c)

📝 Problem 7.1: Complete Retirement Process

Question: Ram, Shyam, and Mohan are partners in a firm sharing profits and losses in the ratio of 5:3:2. The Balance Sheet of the firm as on 31st March 2025 is as follows:

Balance Sheet as on 31st March 2025
Liabilities Amount (₹) Assets Amount (₹)
Creditors 40,000 Cash 20,000
Bills Payable 30,000 Debtors 60,000
General Reserve 30,000 Stock 50,000
Capital Accounts: Furniture 40,000
  Ram 1,00,000 Machinery 80,000
  Shyam 60,000 Building 1,50,000
  Mohan 40,000
Total 3,00,000 Total 4,00,000

Mohan retires on 31st March 2025. The following adjustments are agreed upon:

  • Goodwill of the firm is valued at ₹60,000 (not to be raised in books)
  • Building to be appreciated by 20%
  • Machinery to be depreciated by 10%
  • Provision for Doubtful Debts @ 5% to be created on Debtors
  • An unrecorded investment of ₹10,000 is to be recorded
  • ₹50,000 to be paid to Mohan immediately and balance to be transferred to his loan account
  • Ram and Shyam will continue in the ratio of 3:2

Prepare:

(a) Revaluation Account

(b) Partners' Capital Accounts

(c) Mohan's Loan Account

Solution:

(a) Revaluation Account

Revaluation Account
Dr. Side Cr. Side
To Machinery A/c (10% of ₹80,000) - ₹8,000 By Building A/c (20% of ₹1,50,000) - ₹30,000
To Provision for Doubtful Debts (5% of ₹60,000) - ₹3,000 By Investment A/c (Unrecorded) - ₹10,000
To Profit on Revaluation transferred to:  
   Ram's Capital A/c (5/10) - ₹14,500  
   Shyam's Capital A/c (3/10) - ₹8,700  
   Mohan's Capital A/c (2/10) - ₹5,800  
Total: ₹40,000 Total: ₹40,000

Working:

Credit Side = ₹30,000 + ₹10,000 = ₹40,000

Debit Side = ₹8,000 + ₹3,000 = ₹11,000

Profit = ₹40,000 - ₹11,000 = ₹29,000

Ram = ₹29,000 × 5/10 = ₹14,500

Shyam = ₹29,000 × 3/10 = ₹8,700

Mohan = ₹29,000 × 2/10 = ₹5,800

Goodwill Adjustment Calculation:

Mohan's Share of Goodwill = ₹60,000 × 2/10 = ₹12,000

Gaining Ratio:

Old Ratio - Ram:Shyam = 5:3

New Ratio - Ram:Shyam = 3:2

Ram's old share = 5/10 = 1/2 = 5/10

Ram's new share = 3/5 = 6/10

Ram's gain = 6/10 - 5/10 = 1/10

Shyam's old share = 3/10

Shyam's new share = 2/5 = 4/10

Shyam's gain = 4/10 - 3/10 = 1/10

Gaining Ratio = 1:1

Ram compensates = ₹12,000 × 1/2 = ₹6,000

Shyam compensates = ₹12,000 × 1/2 = ₹6,000

General Reserve Distribution:

Ram = ₹30,000 × 5/10 = ₹15,000

Shyam = ₹30,000 × 3/10 = ₹9,000

Mohan = ₹30,000 × 2/10 = ₹6,000

(b) Partners' Capital Accounts

Particulars Ram (₹) Shyam (₹) Mohan (₹)
Debit Side
To Mohan's Capital A/c (Goodwill) 6,000 6,000 -
To Cash A/c - - 50,000
To Mohan's Loan A/c - - 13,800
To Balance c/d 1,23,500 77,700 -
Total 1,29,500 83,700 63,800
Credit Side
By Balance b/d 1,00,000 60,000 40,000
By Revaluation A/c 14,500 8,700 5,800
By General Reserve 15,000 9,000 6,000
By Ram's Capital A/c (Goodwill) - - 6,000
By Shyam's Capital A/c (Goodwill) - - 6,000
Total 1,29,500 83,700 63,800

(c) Mohan's Loan Account

Dr. Side Amount (₹) Cr. Side Amount (₹)
To Balance c/d 13,800 By Mohan's Capital A/c 13,800
Total 13,800 Total 13,800

Verification of Mohan's Total Dues:

Opening Capital: ₹40,000

Add: Revaluation Profit: ₹5,800

Add: General Reserve: ₹6,000

Add: Goodwill from Ram: ₹6,000

Add: Goodwill from Shyam: ₹6,000

Total Dues: ₹63,800

Less: Cash Paid: ₹50,000

Balance (Loan): ₹13,800

Final Answer:

Mohan's total dues = ₹63,800

Cash paid = ₹50,000

Loan Account balance = ₹13,800

Ram's new capital = ₹1,23,500

Shyam's new capital = ₹77,700

8. COMPENSATION FOR FUTURE PROFITS

📚 Concept Explanation

Compensation for Loss of Future Profits (Super Profit Method): Sometimes, a retiring partner may be entitled to compensation for loss of their share in future profits. This is particularly relevant when the firm is earning super profits.

Formula:

Compensation = Retiring Partner's Share × Average/Super Profit × Number of Years' Purchase

This compensation is paid by the continuing partners in their gaining ratio.

Journal Entry:

Gaining Partners' Capital A/c Dr. (In Gaining Ratio)
    To Retiring Partner's Capital A/c

📝 Problem 8.1: Compensation Based on Average Profit

Question: A, B, and C are partners sharing profits in the ratio of 4:3:2. C retires. The average profit of the firm for the last 3 years is ₹1,80,000. It is agreed that C will be compensated for loss of his share of future profits for 2 years. A and B will share future profits in the ratio of 5:3. Calculate the compensation and pass the necessary journal entry.

Solution:

Step 1: Calculate C's Share of Average Profit

Average Profit = ₹1,80,000

C's Share = 2/9

C's Annual Profit Share = ₹1,80,000 × 2/9 = ₹40,000

Step 2: Calculate Compensation

Compensation for 2 years = ₹40,000 × 2 = ₹80,000

Step 3: Calculate Gaining Ratio

Old Ratio: A:B:C = 4:3:2

A's old share = 4/9, B's old share = 3/9

New Ratio: A:B = 5:3

A's new share = 5/8, B's new share = 3/8

Partner Old Share New Share Gain
A 4/9 = 32/72 5/8 = 45/72 13/72
B 3/9 = 24/72 3/8 = 27/72 3/72

Gaining Ratio = 13:3

Step 4: Distribute Compensation

A's share = ₹80,000 × 13/16 = ₹65,000

B's share = ₹80,000 × 3/16 = ₹15,000

Step 5: Journal Entry

Particulars Debit (₹) Credit (₹)
A's Capital A/c      Dr.
B's Capital A/c      Dr.
    To C's Capital A/c
(Being compensation for loss of future profits paid to C in gaining ratio)		 65,000
15,000

80,000

Final Answer: C receives compensation of ₹80,000, contributed by A (₹65,000) and B (₹15,000) in gaining ratio 13:3.

📝 Problem 8.2: Compensation Based on Super Profit

Question: P, Q, and R are partners sharing profits in the ratio of 3:2:1. R retires. The average profit for the last 4 years is ₹2,40,000. Normal profit is ₹1,80,000. R is to be compensated for 3 years' purchase of his share of super profit. P and Q continue in equal ratio. Calculate compensation and pass journal entry.

Solution:

Step 1: Calculate Super Profit

Average Profit = ₹2,40,000

Normal Profit = ₹1,80,000

Super Profit = ₹2,40,000 - ₹1,80,000 = ₹60,000

Step 2: Calculate R's Share of Super Profit

R's Share = 1/6 of total profit

R's Share of Super Profit = ₹60,000 × 1/6 = ₹10,000

Step 3: Calculate Compensation (3 Years' Purchase)

Compensation = ₹10,000 × 3 = ₹30,000

Step 4: Calculate Gaining Ratio

Old Ratio: P:Q = 3:2

New Ratio: P:Q = 1:1

P's old share = 3/6 = 1/2

P's new share = 1/2

P's gain = 1/2 - 1/2 = 0

Q's old share = 2/6 = 1/3

Q's new share = 1/2 = 3/6

Q's gain = 3/6 - 2/6 = 1/6

Actually, let's recalculate: R's share was 1/6

Old total = 3+2+1 = 6

P's old = 3/6, Q's old = 2/6, R's old = 1/6

After R retires, P:Q = 1:1 (equal)

P's new = 1/2, Q's new = 1/2

P's gain = 1/2 - 3/6 = 3/6 - 3/6 = 0/6 = 0

Q's gain = 1/2 - 2/6 = 3/6 - 2/6 = 1/6

Wait, this doesn't seem right. Let me reconsider.

Actually, P gets 3/6 = 1/2 and Q gets 2/6 = 1/3 originally out of total 6 parts.

After R (who had 1/6) retires, if P and Q share equally:

P now gets 1/2 of the whole, Q gets 1/2 of the whole.

P's gain = 1/2 - 3/6 = 0

Q's gain = 1/2 - 2/6 = 3/6 - 2/6 = 1/6

So Q gains the entire share of R.

Gaining Ratio = P:Q = 0:1 (Q gains all)

Actually since only Q gains, Q compensates R entirely.

Step 5: Journal Entry

Particulars Debit (₹) Credit (₹)
Q's Capital A/c      Dr.
    To R's Capital A/c
(Being compensation for super profit for 3 years)		 30,000
30,000

Final Answer: R receives compensation of ₹30,000 for super profits (3 years' purchase), paid entirely by Q who gains R's entire share.

📊 FLOWCHART: RETIREMENT OF PARTNER PROCESS

START Step 1: Determine Date of Retirement and Prepare Balance Sheet Step 2: Calculate Gaining Ratio (New Ratio - Old Ratio) Step 3: Prepare Revaluation Account (Revalue Assets & Liabilities) Step 4: Distribute Accumulated Profits/Losses (Reserves, P&L A/c in Old Ratio) Step 5: Adjust Goodwill Method 1: Raise & Write Off Method 2: Hidden Goodwill Step 6: Adjust Capital Accounts for all adjustments made Step 7: Calculate Amount Due to Retiring Partner (From Capital Account Balance) Step 8: Settlement Cash Payment / Transfer to Loan / Installments Step 9: Prepare New Balance Sheet (Without Retiring Partner) END

🧠 MIND MAP: RETIREMENT OF PARTNER

RETIREMENT OF PARTNER Gaining Ratio (New - Old) Revaluation Account Assets ↑↓ Liabilities ↑↓ Goodwill Raised & Written Hidden Goodwill Accumulated Profits/Losses Gen. Reserve P&L A/c Capital Adjustment Settlement Cash Loan A/c Installments Compensation Future Profits

🗺️ ROADMAP: RETIREMENT OF PARTNER ACCOUNTING TREATMENT

1

Calculate Gaining Ratio

Determine how continuing partners will share the retiring partner's profit share

Gaining Ratio = New Ratio - Old Ratio

↓
2

Revalue Assets and Liabilities

Prepare Revaluation Account to record changes in asset and liability values

Profit/Loss distributed in OLD RATIO to all partners

↓
3

Distribute Accumulated Profits/Losses

Transfer General Reserve, P&L Account balance, and other reserves

Distributed in OLD RATIO to all partners including retiring partner

↓
4

Adjust Goodwill

Method 1: Raise goodwill in old ratio, write off in new ratio

Method 2: Hidden goodwill - continuing partners compensate retiring partner in GAINING RATIO

↓
5

Prepare Partners' Capital Accounts

Record all adjustments in capital accounts of all partners

Determine amount due to retiring partner

↓
6

Calculate Compensation (if applicable)

Compensate retiring partner for loss of future profits

Paid by continuing partners in GAINING RATIO

↓
7

Settle Retiring Partner's Account

Pay amount due through:

  • Immediate cash payment
  • Transfer to Loan Account
  • Payment in installments
↓
8

Prepare New Balance Sheet

Show reconstituted firm without retiring partner

Continuing partners with adjusted capitals in new ratio

📌 KEY POINTS TO REMEMBER

Important Ratios:

  • Old Ratio: Used for revaluation profit/loss and accumulated profits/losses distribution
  • New Ratio: Continuing partners' profit sharing ratio after retirement
  • Gaining Ratio: Used for goodwill adjustment (New Ratio - Old Ratio)

Goodwill Treatment:

  • If Raised: Credit all partners in old ratio, then debit continuing partners in new ratio
  • If Hidden: Debit continuing partners in gaining ratio, credit retiring partner

Settlement Options:

  • Immediate cash payment
  • Transfer to loan account (with or without interest)
  • Payment in installments
  • Combination of above methods

Journal Entry Sequence:

  1. Revaluation adjustments
  2. Transfer of reserves and accumulated items
  3. Goodwill adjustment
  4. Capital account adjustments
  5. Settlement entries