Friday, August 15, 2014

AHSEC - 12: Reconstitution of Partnership (Admission, Retirement and Death of a Partner) Important Questions for Feb' 2017 Exam

Unit – 3: Reconstitution of Partnership (Admission, Retirement and Death of a Partner)
Q.1. What do you mean by “Reconstitution of a Partnership Firm? Under what situations it takes place?          2012
Ans: Reconstitution of Partnership: Reconstitution of a partnership refers to a situation when there is a change in the existing partnership agreement. A Partnership agreement is an agreement between two or more persons for carrying out various business activities. In case of reconstitution, a new partnership agreement is formed to replace the old partnership agreement. It means the firm continues to exist and the only change will take place in existing partnership agreement.  Thus, reconstitution of a partnership takes place in each of the following cases:
a)      Admission of a partner
b)      Retirement of a partner
c)       Death of a partner
d)      Change on profit sharing ratio
Q.2. When and Why revaluation of Assets and Liabilities are done in Partnership Business?      2013
Ans: When? Revaluation of Assets and Liabilities takes place in each of the following cases:
a)      Admission of a partner
b)      Retirement of a partner
c)       Death of a partner
d)      Change on profit sharing ratio

Why? The actual value of the assets and liabilities may be different from their book value as shown by the balance sheet. So Revaluation account is prepared at the time of reconstitution of partnership to record any increase/decrease in the value of assets and liabilities. The value of some assets may increase with time and some may show a decrease. Similarly some liabilities may also show an increase/decrease in the value. The Revaluation account is credited if there is an increase in the value of assets or decrease in the value of liabilities. On the other hand it is debited if there is any decrease in the value of assets or an increase in the value of liabilities. This account is a nominal account and is sometimes also called Profit and Loss adjustment account. The profit or Loss arising due to revaluation is divided among the old partners in their old ratio.
Q.3. Why a New Partner is admitted into Partnership?
Ans: Sometimes, it becomes difficult to run the partnership business due to lack of sufficient capital or managerial help or both. In this case a firm may decide to admit a new partner into the firm. But according to Indian Partnership Act 1932, no partner can be admitted into the firm without the consent of all the existing partners.
A person who is admitted as a partner into the firm does not thereby becomes liable for any act of the firm done before his admission. A partner is admitted for any one or more of the following reasons:
a)      In order to acquire more capital for the business.
b)      In order to have more managerial skill, a competent and experienced person is needed.
c)       In order to expand and boost up the business.
d)      In order to increase the goodwill by admitting a well-reputed person into the business.
e)      In order to reduce the competition.
Q.4. What is Sacrifice and Gaining Ratio? Distinguish between them.                    2008, 2010, 2012, 2013, 2015
Ans:  Sacrificing Ratio: At the time of admission of an incoming partner, existing partners have to surrender some of their share in favour of the new partner. The ratio in which they surrender their profits is known as sacrifice ratio.
Gaining Ratio: Gaining Ratio is calculated at the time of retirement or death of partner. It is the excess of new ratio over old ratio of old partners except retire or dead partner. Gaining Ratio = New Ratio - Old Ratio.
Distinguish between sacrificing ratio and gaining ratio:
Basis
Sacrifice Ratio
Gaining Ratio
Meaning
Sacrificing Ratio is a ratio in which the old partners have agreed to surrender their share of profit in favour of new partner.
Gaining Ratio is ratios in which remaining partners’ gain the retiring partner’s share.
Objective
The main purpose to calculate the sacrificing ratio is to ascertain the compensation to be paid by incoming partner to the sacrificing partner’s in the form of goodwill.
The main purpose to calculate the gaining ratio is to find out the compensation to be paid by the gaining partner’s to the retiring partner.
When to Calculate
Sacrificing Ratio is calculated at the time of admission of a new partner.
Gaining Ratio is calculated at the time of retirement of a partner.
Method
Sacrificing Ratio = Old Ratio – New Ratio
Gaining Ratio = New Ratio – Old Ratio

Q.5. Define Hidden Goodwill and Joint Life Policy.                         2007, 2009, 2013, 2014
Ans: Hidden goodwill means that amount of goodwill which is not known at the time of admission of a new partner but which is calculated on the basis of new partner’s capital.
A Joint Life Policy is an assurance policy taken on the joint lives of the partners. On the death of a partner, the firm becomes liable to pay the executors of deceased partner his capital, interest on capital, his share of profit from the closing of the previous year to the date of death and his share of reserves, goodwill etc. The total amount thus becoming due to the executors is usually significant and immediate payment of such heavy amount out of firm’s resources is likely to affect firm’s finances very adversely.
Q.6. What do you mean by retirement of partner? Mention the causes of retirement of partner. How the amount due to retiring Partner is calculated?    2013, 2016
Ans: A partner may withdraw himself from the partnership. This means that the old partnership comes to an end and new firm is constituted. The exit or withdrawal of a partner is called retirement. As a result of retirement of a partner his relations with the firm are severed.
A partner may retire from the firm for various reasons such as old age, bad health, strain relationship with other partners, financial problems, residence shifting or any other reasons. A partner may quit the firm with the consent of all the partners or when there is an express agreement to this effect.
Calculation of amount due to the retiring partner: The amount due to the retiring partner is paid according to the terms of partnership agreement. The retiring partners’ claim consists of:
(a) The credit balance of Capital Account;
(b) His/her share in the Goodwill of the firm;
(c) His/her share in the Revaluation Profit:
(d) His/her share in General Reserve and Accumulated Profit;
(f) Interest on Capital
But, the following deductions are made from his/her Capital Account on account of:
(a) His/her share in the Revaluation loss;
(b) His/her Drawings and Interest on Drawings up to the date of retirement
(c) His/her share of any accumulated losses
(d) Loan taken from the firm.
The total amount so calculated is the claim of the retiring partner. He/she is interested in receiving the amount at the earliest. Total payment may be made immediately after his/her retirement. However, the resources of the firm may not be adequate to make the payment to the retiring partner in lump sum, then firm makes payment to retiring partner in installments.
Q.7. How the amount due to the executor’s of Deceased Partner is calculated? Explain the provisions of Sec.37 of the Partnership Act regarding payment of the amount due to the executor’s of the deceased partner? 2014, 2016
Ans: The death may come at any time. On the death of a partner, the legal heirs of the deceased partners are entitled to get the amount due to the deceased partner as per the provisions of partnership deed. On the death of a partner, the legal heirs or representatives are entitled to get the following:
a)      The amount standing to the credit to the capital account of the deceased partner
b)      Interest on capital, if provided in the partnership deed upto the date of death:
c)       Share of goodwill of the firm;
d)      Share of undistributed profit or reserves;
e)      Share of profit on the revaluation of assets and liabilities;
f)       Share of profit upto the date of death;
g)      Share of Joint Life Policy.
The following specimen of deceased partner’s capital will help to find out the amount due to the deceased partner.
Particulars
Amount
Particulars
Amount
To Balance B/d (If there is a debit balance)
To Share in Revaluation loss
To Accumulated losses
To Drawings
To Interest on Drawings
To Profit and Loss Suspense A/c (Share in loss upto death)
To Assets taken over
To Executors Account (Balancing figure)

By Balance B/d (If there is a credit balance)
By Share in Revaluation Profit
By Accumulated Profits and Reserves
By Interest on Capital
By Profit and Loss Suspense A/c (Share In profits upto death)
By Liabilities taken over by legal heirs


Amount Due to Deceased Partner (Sec. 37 of the partnership act)
The amount due to the deceased partner is transferred to a loan account opened in the name of executor of the deceased partner and payable by the existing partners. The agreement normally provides for the interest payable on the loan and the conditions for the repayment of such loan. In the absence of any agreement, it is provided in sec. 37 of partnership act that the estate of deceased partner has the option either to claim interest on the amount due @6% p.a. or to such a share of the subsequent profits as may be attributable to the use of his share of the property of the firm.
Q.8. How deceased partner’s share of profit upto the date of death is calculated?                          2014
Ans: Calculation of profit upto the date of death of a partner
If the death of a partner occurs during the year, the representatives of the deceased partner are entitled to his/her share of profits earned till the date of his/her death. Such profit is ascertained by any of the following methods:
(i) Time Basis:
(ii) Turnover or Sales Basis
(i) Time Basis: In this case, it is assumed that profit has been earned uniformly throughout the year. Profit taken here is either Last year’s profit Or Average profits of last few years. For example:
The total profit of Last year is Rs. 2, 25,000 and a partner dies three months after the close of previous year, the profit of three months is Rs. 31,250 i.e. 1, 25,000 × 3/12, if the deceased partner took 2/10 share of profit, his/her share of profit till the date of death is Rs. 6,250 i.e. Rs. 31,250 × 2/10.
Again, the profits of last three years is Rs. 100000, Rs. 75000 and Rs. 125000 and partner dies three months after the close of previous year, the his share of profit upto date of death is calculated as follows:
1.       Average profit of last three years = (100000+75000+125000)/3 = 100000
2.       Profit of last three years = 100000x3/12 = 25000
3.       Deceased partner’s share of profit = 25000 x 2/10 = 5000, if the deceased partner took 2/10 share of profit.
(ii) Turnover or Sales Basis: In this method, we have to take into consideration the profit and the total sales of the last year. Thereafter the profit upto the date of death is estimated on the basis of the following formula:
(Sales upto date of death/Sales of last year) x profit of previous year
 Profit is assumed to be earned uniformly at the same rate. For example: 
A, B and C were partners in a firm sharing profits in the ratio of 2:2:1. C dies on 31st July, 2007. Sales during the previous year upto 31st march, 2007 were Rs. 6, 00,000 and profits were Rs. 150000. Sales for the current year upto 31st July were Rs. 250000. Calculate C’s share of profits upto the date of his death and pass necessary journal entry.
Here, Profit upto date of death (upto 31st July, 2007) = (250000/600000) x 150000 = 62500 And C’s Share of profit = 62500x1/5 = 12500.
Journal entry for Crediting Deceased Partner’s share of profit upto date of death is:
Profit and Loss Suspense A/c                      Dr.
To Deceased Partner’s Capital A/c

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