What is Death of a Partner?
A partnership firm is an organization that is formed with two or more individuals with a common objective to earn revenue. The structure of an organization and its capital tend to undergo massive change in the event of the admission of a new partner or the retirement or death of an existing partner. Notably, the accounting treatment in case of a retirement and death of a partner is not entirely different. On that note, let’s read along to find out more about the death of a partner in accounting and its impact on a firm’s capital.
What Happens When a Partner Dies?
In such a situation, the partnership deed after the death of a partner is terminated. Subsequently, the rights of the legal representatives of a deceased partner depend on the provisions of that firm’s partnership deed. In most cases, surviving partners decide to continue the venture and may end up purchasing the shares of their deceased partner once his/her due is computed and subsequently treated as a loan.
The most common death of partner problems and solutions pertaining to the unpredictability of the incident as to when a partner may succumb to death. Typically, legal representatives would receive the deceased’s portion of profits that were accrued between the period when accounts were closed and until the death of the said partner. Now such duration can range anywhere between 1 day and 365 days.
Nonetheless, in the absence of an agreement or arbitrary decision, accounts must be prepared as they were on the date while profit and loss were being ascertained.
How is a Partners’ Capital Adjusted?
In such a situation, these following are credited in the capital account of the deceased partner –
Undistributed earnings or reserves.
Profit generated on revaluation of assets and liabilities.
Sum of money lent by the partner.
Interest in the capital.
Goodwill.
Designated share in Joint Life Policy.
A share in successive earnings.
On the other hand, these following are debited their account as well –
Drawings made by the deceased.
The interest levied on such drawings.
The loss is incurred on the revaluation of assets and liabilities.
A share in successive losses.
Notably, legal representatives of the deceased are entitled to avail a share in successive earnings. They also have the right to decide whether they want a share in profits or wish to avail interest at 6% annually. Once these adjustments are recorded in deceased partners’ capital account, the final amount standing is paid to their legal representatives.
How is the Subsequent Profit of a Deceased Partner Calculated?
Primarily, there are two ways to determine the subsequent profit or earnings of a deceased partner. Notably, such an earning is generated from the date of the latest balance sheet until the date of a partner’s death. These two methods are used to compute the earnings of a deceased partner –
Time Basis
Sales or Turnover Basis
Time Basis
In this method, it is assumed that earnings are steadily generated throughout the year. Typically, the previous year’s profit is taken into account to estimate such earnings. For example - Bobby, Sam, and Dean were partners of a firm and shared profits in the ratio 2:2:1. Bobby died on 01.07.19.
According to their agreement, Bobby’s share in profit until his death is to be calculated based on profits earned during the previous financial year, which is Rs.15,00,000.
Solution: Total profit for 3 months = Rs.15,00,000 x (3/12) =Rs.37,5000
Therefore, Bobby’s share = Rs.37,5000 x (2/5) = Rs.150000
Sales or Turnover Basis
With the help of this particular method, the earnings along with the total sales of the previous year are taken into account. Therefore, based on the sales of last year, one can estimate the earnings until the date of the partner’s death. For example - Crowley, Rowena, and Kevin are partners in a firm and share profits in the ratio 3:2:1. Kevin dies on 01.09.18.
Last year’s sales amounted to Rs.900000. Profit on it stood at Rs.60000. Also, sales up to 31.08.18 accounted for Rs.460000
Solution: The earnings on sale of Rs.460000 = 60000/900000 x 460000 =Rs.30667
Therefore, Kevin’s share = Rs. (30667 x 1/6) =Rs.5111
Partnership Deed Format
A series of journal entries are passed in the books of account immediately after the death of a partner. The following serves as a sample of the partnership deed format after the death of a partner.
Alan, Kara, and Oliver are partners in a firm and share profits as 3:2:1. Oliver died on 1st July 2018. This balance sheet as of 31st March 2018 -
Alan and Kara agree to share future earnings and losses equally. The goodwill stood at Rs.29000, however, it does not appear in the books of account.
Revaluation profit amounted to Rs.14000, and the Joint Life Policy was realised at Rs.50000. John, the legal representative of the deceased partner in a partnership for a share in successive earnings. Oliver’s portion in successive profits amounts to Rs.10000.
Task for you: Find out how to pass necessary journal entries and create a partner’s capital A/C. Refer to Vedantu’s compact study solutions and solve the problem mentioned above. Also, learn in detail what happens after the death of a partner in a limited partnership at our live online classes.
You can also refer to the retirement of partner notes and gain a fair understanding of the procedure for the retirement of a partner in a partnership firm and strengthen your fundamentals of partnership chapter.
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Procedure After the Death of Partner Member
Partnerships in Business has a long history since the 14th century. A merchant of Florence named Francesco di Marco Datini is the one who implemented the first partnership. This new mode of starting an enterprise created a revolution in the commercial scenario of Europe. This system helped individuals to come together with the required capital to start a business. Starting in medieval times, partnerships are still in existence and quite successful too. All administrations and governments have prescribed the necessary rules and regulations for the operation and taxation of such firms. Apart from this all partnerships also come up with their own laws and rules to abide by that are necessary for the smooth running of the firm or organization.
Any partner who exits out of the partnership is a great change for the body he was a part of. It can be due to many reasons starting with a change in the interest of the partner to the death of any partner. In such situations, the partnership deed dictates all the legal procedures to be followed. The legal representatives as per the deed are entitled to the portion of the profit in the entity until the death of the partner in question. If there are no such provisions then it can be prepared with the general consensus of all the remaining partners. The most crucial part is the adjustment of the capital that is done according to the predetermined agreement or is decided following the mishap. All other policies and benefits that the deceased partner enjoyed are revised and adjusted.
FAQs on Death of a Partner: Accounting and Legal Implications
1. What happens to a partnership firm when one of the partners dies?
Upon the death of a partner, the existing partnership agreement dissolves, but the firm itself does not necessarily dissolve. The surviving partners can decide to continue the business after settling the account of the deceased partner. If they choose to continue, a new partnership deed is typically drafted to reflect the new profit-sharing ratio and other terms among the remaining partners.
2. How is the total amount payable to a deceased partner's executor calculated?
The total amount is calculated by preparing the deceased partner's Capital Account. The final balance is determined by crediting certain items and debiting others.
Items Credited:
- Opening balance of their capital and current account.
- Share of goodwill of the firm.
- Share in profits from the revaluation of assets and liabilities.
- Share in accumulated profits and reserves.
- Interest on capital, if provided in the deed, up to the date of death.
- Share of profit earned by the firm from the last balance sheet date to the date of death.
- Share in the proceeds of any Joint Life Policy (JLP).
Items Debited:
- Drawings made by the partner up to the date of death.
- Interest on drawings.
- Share in any loss from the revaluation of assets and liabilities.
- Share in any accumulated losses.
3. What methods are used to calculate a deceased partner's share of profit up to the date of death?
Since it's impractical to prepare a full set of accounts mid-year, the deceased partner's share of profit is estimated using one of two primary methods:
- Time Basis: Profit is estimated based on the previous year's profit. It is assumed that the profit accrues evenly throughout the year, so the profit for the period is calculated proportionately. For example, if a partner dies 3 months into the financial year, 3/12th of the previous year's profit is taken as the estimated profit for that period.
- Turnover or Sales Basis: Profit is estimated based on the sales of the current period. The gross profit ratio of the previous year is applied to the sales figure from the last balance sheet date up to the date of death to estimate the profit.
4. How is the treatment of goodwill handled on the death of a partner?
The deceased partner is entitled to their share of the firm's goodwill. As per Accounting Standard 26, the adjustment for goodwill is made through the partners' capital accounts. The gaining partners (the remaining partners who gain a share of the deceased partner's profit) compensate the deceased partner's estate for their share of goodwill. The entry passed is: Gaining Partners' Capital A/c (Dr.) to Deceased Partner's Capital A/c (Cr.), with the amount being distributed in the gaining ratio.
5. What is the role of the Partnership Deed in the event of a partner's death?
The Partnership Deed is the most important document that governs the entire settlement process. It specifies the procedures for:
- Valuing goodwill.
- Calculating the deceased partner's share of profit up to the date of death.
- Determining interest on capital and drawings.
- The method and timeline for settling the final amount due to the deceased partner's legal representatives or executors.
If the deed is silent on any matter, the provisions of the Indian Partnership Act, 1932, are applied.
6. Why are assets and liabilities revalued upon a partner's death?
Assets are revalued and liabilities are reassessed to determine their true and fair value on the date of the partner's death. This ensures that any appreciation or depreciation in the value of assets that occurred during the deceased partner's tenure is accounted for. The resulting profit or loss on revaluation is shared by all partners, including the deceased partner, in their old profit-sharing ratio. This step is crucial for an equitable settlement and to reflect the firm's correct financial position before the new partnership begins.
7. How does the accounting treatment for a deceased partner differ from that of a retiring partner?
While the overall accounting treatment is very similar, key differences arise from the circumstances:
- Timing: Retirement is usually planned and takes place at the end of an accounting period. Death is unforeseen and can occur at any time, necessitating the calculation of profit and interest up to the exact date of death.
- Settlement: In retirement, the amount due is paid to the retiring partner. In case of death, the amount is transferred and paid to their legal executor's account.
- Profit Calculation: For a deceased partner, profit calculation for the interim period is almost always an estimation, whereas for a retiring partner, accounts can often be fully closed.
8. What rights do a deceased partner's legal representatives have if the firm fails to settle their account promptly?
According to Section 37 of the Indian Partnership Act, 1932, if the surviving partners continue the business without a final settlement of the deceased partner's account, the legal executor has a choice. They can opt to receive either:
- Interest at 6% per annum on the outstanding amount.
- A share of the profits that the firm has earned using the deceased partner's unsettled capital.
This choice remains available until the final payment is made.
9. What is a Joint Life Policy (JLP) and how does it help in the case of a partner's death?
A Joint Life Policy (JLP) is a single insurance policy taken out by a firm on the lives of all its partners. The firm pays the premium, and the policy amount is payable upon the death of any one of the insured partners. The key benefit is that the policy proceeds provide the firm with immediate liquid funds. This money can be used to settle the claim of the deceased partner's executor without straining the firm's working capital or requiring the surviving partners to contribute large sums from their personal resources.
