How the amount is calculated for a partner who is retiring from the firm?

Accounting Procedure Regarding Partnership Accounts on Retirement or Death!

The retirement of a partner extinguishes his interest in the Partnership firm and this leads to dissolution of the firm or reconstitution of the Partnership. A partner, who goes out of a firm, is called retiring partner or outgoing partner. Causes for the retirement may be that a retiring partner may be too old or he may have better opportunity in a different line or he may dislike the co-partners’ attitude or any other reasons.

The following are the ways in which a partner can retire:

1. With the consent of all the other partners,

2. In accordance with an express agreement among the partners,

3. By giving a written notice of intention to retire to all the other partners where partnership is at will.

Various Adjustments on Retirement:

When a partner retires his share in the properties of the firm has to be ascertained and paid off. Certain adjustments have to be made in order to ascertain the amount he is to get from the firm.

These adjustments are very similar to those which we saw in connection with admission of a partner. When a partner retires from the business, it becomes necessary to prepare the accounts so as to ascertain the amount payable to him.

When a partner retires, the following adjustments must be made:

1. Adjustment of accumulated reserves and undistributed profit and losses.

2. Revaluation of assets and liabilities.

3. Adjustment for goodwill of the firm.

4. Calculation of new profit and loss sharing ratio.

5. Calculation of the amount due to retiring partner and the mode of payment.

We shall discuss these points.

1. Adjustment of Accumulated Reserves and Undistributed Profits and Losses:

Any reserves or undistributed profits appearing on the liability side of the Balance Sheet, at the time of retirement, are past profits, which are created to strengthen the financial position of the firm the retiring partner has a right over such profits. Therefore, it is necessary to divide the accumulated reserve or undistributed profit among all the partners in their old profit or loss sharing ratio. When the distribution is over, they do not appear in the Balance Sheet.

The journal entries are:

General Reserve Account Dr.

Profit and Loss Account Dr.

  To All Partners Capital Account

(Being transfer of General Reserve and profit in the old profit sharing ratio)

Alternatively, instead of transferring the entire reserve or profit, only the share of the Retiring Partner may be transferred to the Retiring Partner’s Capital Account. The balance in the reserve or profit account continues to appear on the liability side, at reduced amount.

In case the firm has incurred any losses in the past and the losses were not adjusted so far to the capital accounts, then such losses, which is found in the asset side of balance sheet, be transferred to the Retiring Partner’s Capital Account, to the extent of his share. By doing so, the losses continue to appear on asset side of the Balance Sheet, at a reduced amount.

2. Revaluation of Assets and Liabilities:

Revaluation of assets and liabilities is equally necessary at the time of retirement of a partner, as at admission. The revaluation is done on the same principles as in case of admission. Even if he Partnership Deed is silent, it is better to revalue assets and liabilities. If it is agreed to revalue the assets and liabilities on the retirement of a partner, Profit and Loss Adjustment Account or Revalua­tion Account is prepared.

The profit or loss arising out of this account is transferred to all partners including retiring partner in OLD RATIO. Therefore, the assets and liabilities will then appear in the books at the revised values.

If the continuing partners decide to maintain the assets and liabilities at their original value, then a MEMORANDUM REVALUATION ACCOUNT is prepared by passing reversal entry and the profit or loss of this account is transferred to continuing partner’s capital ac­count in their NEW PROFIT SHARING RATIO.

Illustration 1:

A and B are partners in a business sharing profits and losses as A 3/5ths and B 2/5ths.

Their Balance Sheet as on 1st January 2005 is given below:

B decides to retire from the business owing to illness and A takes it over and the following revaluation are made:

(a) Goodwill of the firm is valued at Rs 15,000.

(b) Depreciate Machinery by 7.5% and Stock by 15%.

(c) A Bad Debts provision is raised against Debtors at 5% and a Discount Reserve against Creditors at 2.5%.

Journalise the above transaction in the books of the firm; prepare ledger accounts and the Balance Sheet of A.  

Illustration 2:

B retires on that date subject to the following adjustments:

1) The goodwill of the firm to be valued at Rs 18.000.

2) Plant to be depreciated by 10% and Motor vans by 15%.

3) Stock to be appreciated by 20% and Buildings by 10%.

4) Provision for doubtful Debts to be increased by Rs 1.950.

5) Liability for workmen’s compensation to the extent of Rs 450 is to be brought into account.

It was agreed that A and C will share profits in future in the ratio of A-3/5th and C-2/5th.

Pass journal entries; prepare Memorandum revaluation Account, capital account and balance Sheet when the assets and liabilities are to continue to appear at their original figures.

3. Adjustment of Goodwill:

The valuation of goodwill may be done according to the provisions of the Partnership Deed and in the manner as in case of admission by any one of the following methods:

A. When Goodwill does not appear in the books:

Illustration 1:

A, B and C were partners in a firm with capitals of Rs 10,000, Rs 8,000 and Rs 6,000 respectively and sharing profits and losses in the ratio of 3 : 2 : 1. On 31st December 2005, B retires. For the purpose of retirement, the goodwill of the firm was valued at Rs 18,000.

Pass necessary journal entries under the following circumstances and also find out the amount pay­able to B:

a) Total goodwill raised and maintained in the books.

b) Total goodwill raised but written off later.

c) Only B’s share of goodwill is raised and maintained in the Books.

d) Only B’s share of goodwill is raised but later on written off.

e) B is given his share of goodwill without raising Goodwill Account.

Illustration 2:

(a) A, B and C are equal partners. Goodwill appears in the books at Rs 10,000. C retires and goodwill is revalued at Rs 15,000. Now A and B decide to share future profits and losses m the ratio of 3. 2

(b) X, Y and Z are partners sharing profits in the ratio of 4: 3: 3. Goodwill does not appear in, the books. Z retires from the firm and his share of goodwill is estimated to be Rs. 6,000, which was purchased by X and Y in equal proportion. X and Y decide not to open Goodwill Account.

(c) Ram, Mohan and Moni were partners sharing profits in the ratio of 2: 2: 1. On 1st January 2005, their goodwill was valued at Rs 30,000 and there is no Goodwill Account appearing m the books. Mohan ordered No goodwill is to appear in the books.

Pass journal entries:

4. Calculation of New Profit and Loss Sharing Ratio:

When a partner of a firm retires, it is for the continuing partners to agree amongst themselves as to in what ratio, they shall share the profit and loss of the firm in future. The ratio so agreed upon is called New Profit Sharing Ratio.

In the absence of any agreement between the partners, the continuing partners will continue to share the profit or loss in between themselves in the same ratio in which they were sharing before retirement.

For instance, A, B and C were partners sharing profits in the ratio of 3 : 2 : 1 and if C retires, nothing is given about the new profit sharing ratio, then the profit sharing ratio of the continuing partners would be 3 : 2. Ratio of their gain will also be 3: 2 which was their old profit sharing ratio.

Sometimes, the continuing partners may agree to have a new profit sharing ratio, by making changes in the existing profit sharing ratio and sometimes, the remaining partners may agree to pur­chase the share of the retired partner in a different ratio.

This is explained below:

Illustration 1:

X, Y and Z were partners sharing profits in the ratio of 2: 2:1. Z retires and his share was taken up by X and Y in the ratio of 3:2. Calculate new profit sharing ratio and gaining ratio of X and Y. 

Solution:

Illustration 2:

A, B and C are in partnership sharing profit or losses in the ratio of 5: 3:2.

Find the new ratio and gaining ratio in the following cases:

(a) A retires, B and C continue.

(b) B retires, A and C continue.

(c) C retires, A and B continue.

Solution:

In the absence of any agreement between the partners as regards the new profit sharing ratio, the continuing partners will continue to share the profit or loss in between themselves, in the same ratio in which they were sharing profits before retirement of partner.

In other words, retiring partner’s share of profit is shared by remaining partners in their old profit sharing ratio. For example, take the case of (a) above.

(a) B’s share of profit = 3/10 + (5/10 x 3/5) = 3/10 + 3/10 = 6/10

C’s share of profit = 2/10 + (5/10 x 2/5) – 2/10 + 2/10 = 4/10

(Or) Ratio is 6: 4 or 3: 2 Gaining Ratio = 3:2

Similarly, it can be proved with case (b) and (c).

Illustration 3:

X, Y and Z are partners, sharing profit and losses in die ratio of 2:3:1. X retires and his share is purchased by Y and Z in the ratio of 3: 2. What is new profit sharing ratio?

Solution:

Old profit faring ratio of X, Y and Z = 2: 3:1

Y and Z purchased X’s share i.e. 2/6 in the ratio of 3: 2.

New Profit Sharing ratio of Y and Z is 7/10 and 3/10 or 7: 3

Gaining Ratio of Y and Z = 3: 2 (given)

(That is the ratio at which they purchased X’s share.)

Illustration 4:

A, B and C are partners in a business, sharing profit and losses in the ratio of 2: 2:1. A retires by selling his share in the business for a sum of Rs 6,000 which is paid by A and B as to Rs. 4,800 and Rs. 1,200 respectively. Find out the new profit sharing ratio of B and C.

Solution:

B and C purchased A’s share in the ratio of 4800: 1200 (or) 4: 1

B’s future share in profits or losses = 2/5 + (2/5 x 4/5) = 2/5 + 8/25 = 18/25

C’s future share in profit or losses = 1/5 + (2/5 x 1/5) = 1/5 + 2/15 = 7/25

The new profit or loss sharing ratio of B and C = 18/25: 7/25 or 18: 7.

5. Calculation of Amount Due to Outgoing Partner:

To find out the amount payable to retiring partner, the following items are considered:

1. Balance to his Capital Account, as per last Balance Sheet.

2. Proportionate profit on revaluation.

3. Share of goodwill.

4. Interest on capital up to the date of retirement.

5. Salary, if any, payable to him.

6. Share of past profit or loss of the firm.

7. Share of profit till his date of retirement.

8. Share of proceeds of Joint Life Policy

Any withdrawals and interest due thereon should be deducted from the amount payable to the outgoing partner. The firm is obliged to make payment to the retiring partners of the firm due to him at the time of retirement. The total amount so calculated will be transferred to retiring partner’s loan account by debiting the retiring partner’s capital account.

If he is paid in full immediately after retire­ment, the account is settled. Sometimes, the agreement may be to settle the share of the retiring partner by paying him a fixed annual sum (annuity).

Illustration 1:

The Balance Sheet of A, B and c who are sharing profits and losses in the proportion of one-half, one-third and one-sixth, respectively, was as follows on 30th June 2002:

A retires from the business on 1st July 2002 and his share in the firm is to be ascertained on a revaluation of the assets as follows:

Stock at Rs 20,000

Furniture Rs 3,000

Plant and Machinery Rs 9,000

Buildings at Rs 20,000

Rs 850 to be provided for Doubtful Debts

The goodwill of the firm is agreed to be valued at Rs 6,000

A is to be paid Rs 11,050 in cash on retirement and the balance in three equal yearly installments together with interest at 5% p.a.

Show the necessary accounts required giving effect to the above, the Balance Sheet of the continuing partners and the Account of A till it is finally closed.  

Illustration 2:

On 31st March, 2006, Hari desired to retire from the firm and the remaining partners decided to carry on the same business.

It was agreed to revalue the assets and liabilities on that date on the following basis:

1. Land and Buildings be appreciated by 30%.

2. Machinery be depreciated by 20%

3. Closing stock to be valued at Rs. 4,50,000

4. Provision for bad debts be made at 5%

5. Old credit balances of sundry creditors Rs. 50,000 be written back.

6. Joint Life Policy of the partners surrendered and cash obtained Rs. 3,50,000

7. Goodwill of the entire firm be revalued at Rs. 6, 30,000 and Hari’s share of the goodwill be adjusted in the accounts of Ram and Mohan who share the future profits and losses in the ratio of 3: 2. No goodwill account be raised.

8. The total capital of the firm is to be the same as before retirement. Individual capital be in their profit sharing ratio.

9. Amount due to Hari is to be settled on the following basis: 50% on retirement and the balance 50% within one year.

Prepare revaluation account, capital accounts of partners, cash account and balance sheet as on 1-4-2006 of M/s Ram and Mohan.

Illustration 3:

A had been suffering from ill-health and gave notice that he wished to retire.

An agreement was, therefore, entered into as on 31st March, 2006, the terms of which were as follows:

(i) The Profit and Loss Account for the year ended 31st March, 2006, which showed a net profit of Rs. 48 000 was to be reopened. B was to be credited with Rs. 4,000 as bonus, in consideration of the extra work which had developed upon him during the year. The profit sharing ratio was to be revised as from 1st April 2005 to 3: 4: 4.

(ii) Goodwill was to be valued at two years’ purchase of the average profits of the preceding five years. The Fixtures were to be valued by an independent value. A provision of 2% was to be made for doubtful debts and the remaining assets were to be taken at their book values.

The valuations arising out of the above agreement were Goodwill Rs. 56,800 and Fixtures Rs. 10,980.

B and C agreed, as between themselves, to continue the business, sharing profits in the ratio of 3:2 and decided to eliminate goodwill from the Balance Sheet, to retain the Fixtures on the books at the revised value and to increase the provision for doubtful debts to 6%.

You are required to submit the journal entries necessary to give effect to the above arrangements and to draw up the capital account of the partners after carrying out all adjusting entries as stated above.

Adjustment of Capitals to be Proportionate to the Profit Sharing Ratio:

On the retirement of a partner, sometimes the continuing partners wish to keep the Capital Ac­counts to be proportionate to new profit sharing ratio. This implies determination of overall capital after making all adjustments. Then find out the total amount of capital and the amount of each partner’s share, on the basis of profit sharing ratio.

Then continuing partners will meet their deficiency, if any, by introducing cash into the firm of the surplus, if any, may be withdrawn or transferred to Current Accounts, if the Capital Accounts are fixed.

Illustration 1:

The Balance Sheet of A. B and C who were sharing profits in the ratio of 3: 2: 1 respectively stood as follows on 31st December 2005:

B having given notice to retire from the firm, the following adjustments in the books of the firm were agreed upon:

a) That investment be reduced to 90%.

b) That land and building be appreciated by 10%.

c) That the stock be appreciated by Rs 1,250.

d) That the goodwill of the firm be fixed at Rs 12,000 and B’s share of the same be adjusted through the Capital Accounts of A and B.

e) That the entire capital of the newly constituted firm be fixed at Rs 60,000 and be readjusted between A and B in their profit sharing ratio i.e. 3 : 1, by bringing in or paying out cash.

From the above particulars, prepare Revaluation Account, Partners’ Capital Accounts and the Balance Sheet of the new firm showing B’s balance as loan:

Admission and Retirement:

When a partner retires from a firm, there arise the needs for finance. The retiring partner is to be paid off. If cash is paid, then the working capital is affected. Therefore, when a partner retires from the firm, the continuing partners feel the urgency of admitting an outsider as a partner to their firm.

The retiring partner can easily be paid off with the amount contributed by the incoming partner. But the simultaneous retirement and admission do not introduce any new principles of accounting. The principles studied under admission and retirement are combined-the combination of the two sets of transactions.

Illustration 1: (Retirement-cum-Admission)

A and B were working in partnership sharing profits equally. On 31st December 2004, A decided to retire and in his place, it was decided that C would be admitted as partner from 1st January 2005 and his share in the profits will be one-third.

Balance Sheet of the firm as on 31st December 2004 was as follows:

It was further decided as follows:

1. The goodwill should be raised to Rs 40,000.

2. The motor car would be taken over by A at its book value.

3. The value of land and buildings would be increased by Rs 16,560.

4. B and C would introduce sufficient capital to pay off A to leave thereafter a sum of Rs 14,700 as working capital in a manner that the capitals of the new partners will be proportional to their profit sharing ratio.

5. The new partners decide to show the goodwill as an asset.

The partners introduced the capital on 10th January 2005. Show the accounts of the partners and Bank Account with necessary Journal entries. Also prepare the Balance Sheet of the new firm.  

Illustration 2:

On that date, C decides to retire. The value of goodwill to be Rs 15,000 and sundry assets are taken to have increased in value by Rs 25,000. On C’s retirement, D is admitted as a partner. He pays no premium for goodwill but brings in Rs 15,000 as capital. Profits and losses are to be shared in the ratio of 4: 3: 3.

Show Capital Accounts and draw up two Balance Sheets, one after C’s retirement and the other after D’s admission. The goodwill account is to be wiped off from the books and restore the sundry assets at its original value after D’s admission. 

Illustration 3:

The following adjustments and arrangements have been agreed upon for the purposes of retirement and admission of partners:

(i) Goodwill to be written up to Rs 30,000 and Plant to Rs 50,000.

(ii) Sufficient money to be introduced so as to leave Rs 11,000 cash after payment of amount due to Raman.

(iii) Deshpande and Pritam to provide such fund as would make their capitals proportionate to their share of profit.

Show the journal entries to record the above transactions assuming that Deshpande and Pritam have paid in cash due on 2nd July 2005 and the amount due to Raman was paid on the same day.  

Illustration 4:

Y retired on 30th September 2005 and X and Y continued in partnership sharing profits and losses in the ratio of 3: 2. It was agreed that Rs 16,000 of the balance remaining to him including his earlier loan should remain as loan to the firm and balance amount will be paid to him on 1st October 2005.

The following adjustments were agreed upon:

(1) The lease was acquired on 1st October 2003 for 15 years. This was to be written off over the period of lease. Depreciation not provided from the beginning.

(2) The plant was to be revalued at Rs 11,600.

(3) The provision for bad debts was to be increased by Rs 240.

(4) Creditors for expenses amounting to Rs 1,000 had been omitted from the books.

(5) Rs 800 were to be written off the stock in respect of obsolete items included therein.

(6) Provision of Rs 240 was to be made for professional charges in connection with the revaluation.

The partnership agreement provided that on the retirement of a partner goodwill was to be valued at an amount equal to the average profit of the three years expiring on the date of retirement and that in arriving at the profit, a notional amount of Rs. 16,000 should be charged for partner’s salaries and that for the purpose of valuing goodwill, revaluation of the plant and the professional charges should not be regarded as affecting the profits.

The profits for the years ended on 30th Sept. 2003, 2004 and 2005 were Rs 28,800; Rs 33,600 and Rs 37,640, as shown by the draft accounts, respectively.

No Accounts for goodwill was to be maintained in the books, adjusting entries of transaction between the partners being made in their Capital Accounts. 

Death of a Partner:

The problems arising on the death of a partner are similar to those arising on retirement. Retire­ment can be anticipated and planned. Thus the date of retirement coincides with the date of closing of the firm’s books of accounts.

The death may occur at any time during the course of trading period In the event of death of a partner, the Legal Representatives of the Deceased Partner will be entitled to receive from the firm the amount due on account of the following:

1. Capital Account of the deceased partner as per the last Balance Sheet of the firm.

2. Interest on capital, if any, to the date of death of the partner.

3. Share in the goodwill of the firm.

4. Share in the revaluation of assets and liabilities.

5. Share in the accumulated reserves.

6. Share in the undistributed profits.

7. Share in the profit of the firm from the last Balance Sheet to the date of his death.

8. Share in the Joint Life Policy.

9. Salary, if any, due to him till the date of his death.

Further the amount due to the deceased partner as reduced by:

(a) Drawings,

(b) Interest on Drawings and

(c) Undistributed losses, if any, should be transferred to the loan account in the name of his Executor’s Account.

Then the amount may be paid immediately or by installments. If payment is made by installments, it will carry interest @ 6% p.a.

Illustration 1:

A and B were carrying on a business in partnership sharing profits and losses in the ratio of 3: 2 respectively. They closed their books of account on 31st December, 2005.

Their balance Sheet was as follows:

B died on 1st May. 2006.

Partnership Deed provided that in the event of death of a partner his heirs would be entitled to be paid out:

(a) Capital to his credit at the date of death.

(b) His share of reserve at the date of the last balance sheet.

(c) His share of profits at the date of his death based on the average profits of the last three accounting years.

(d) By way of goodwill his share of total profits for the preceding three accounting years.

The profits for the three preceding accounting years were:

2003 Rs. 41,800, 2004 Rs. 39,200, and 2005 Rs. 45,000

Prepare B’s capital account transferring the amount due to B’s heirs loan account. Clearly show your calculations.

Illustration 2:

Ram, Rahim and Robert carry on business sharing the profits in the ratio of 1/2: 1/3: 1/6 respectively.

Capitals as on 31 -3-2006 are Ram Rs. 20,000, Rahim Rs. 15,000 and Robert Rs. 10,000. On 30-6-2006 Robert died and his executors claim the following as per Partnership Deed:

(i) The joint and several life policies against which premiums are charged to the Profit and Loss Account are valued at 40% of the sum assured.

The policies of the partners are: Ram Rs. 10,000, Rahim Rs. 7,500 and Robert Rs. 17,000.

(ii) Allow interest on capital at 6% p.a.

(iii) Calculate Robert’s share of profits till the date of death on the basis of average profits of the preceding 3 years.

(iv) Calculate the goodwill of the firm at 2 years’ purchase of the average profits of the preceding 5 years.

The annual profit or loss figures of preceding five years were:

Prepare an account for presentation to the executors of Robert. Drawing till the date of death of Robert was Rs. 5,000.  

Illustration 3:

The following arrangements were agreed upon:

(a) Assets be valued at Rs. 29,000; Investments at Rs. 2,350; Stock Rs. 4,700

(b) Goodwill is valued at two years’ purchase of the average profits of the past five years.

(c) Sekhar’s profit to the date of death is calculated on the basis of the average profits of the past three years.

(d) The profits of the last five years were:

Prepare continuing partners’ capital accounts and Sekhar’s account and show the new Balance Sheet.  

Illustration 4:

C died on 31st March 2005.

Under the terms of the Partnership Deed, the Executors of a deceased Partner were entitled to:

(a) Amount standing to the credit of the Partner’s Capital Account.

(b) Interest on Capital @ 5% p.a.

(c) Share of goodwill on the basis of twice the average of the past three years’ profits.

(d) Share of profits from the closing of the last financial year to the death on the basis of last year’s profits.

Profits for 2002 Rs. 9,000; for 2003 Rs. 12,000 and for 2004 Rs. 10,500. Profits were shared in the ratio of capitals.

Pass the necessary journal entries and find out the amount payable to the heir of C.  

Goodwill = 9,000 + 12,000 + 10,500 x 2/3 = Rs. 21,000

C’s Share = 21,000 x 1 /4 = Rs. 5,250

Profit = Rs. 10,500 x 1/4 x 3/12 = Rs. 656.25

Illustration 5:

It was provided under the Partnership Deed among A, B and C that in the event of the death of a partner, the survivors would have to purchase his share in the firm on the following terms:

(a) Deceased’s share of goodwill to be taken at three years’ purchase of his share of profits on average of previous four years.

(b) Total amount due to his representatives to be paid by survivors in four equal and half yearly installments commencing at 6 months after the date of death with 5% interest on outstanding dues.

They shared profits and losses in the proportion of 9:4:3 and accounts were drawn up each year at 30th June.

A died on 31st December 2003 and their capital Accounts on that date were:

A Rs. 10,800

B Rs. 6,400

C Rs. 3,600

A’s Current Account on 31st December 2003 after crediting his share of profit to that date, however, showed a debit of Rs 960.

Firm’s profit for the year ended 30th June 2000 Rs. 35,200; 30th June 2001 Rs. 28,160; 30th June 2002 Rs. 24,080 and 30th June 2003 Rs. 8,704.

Show the relevant ledger accounts in the books of the firm recording half-yearly payments to A’s estate by surviving partners:  

Joint Life Policy:

When a partner dies, the continuing partners are to make payment to the Executors of the de­ceased partner. They may desire to settle it without disturbing the working capital. The relationship among the partners is based on mutual trust, faith and confidence and as such there is a mutual belief among themselves. But the relationship with the Executor of deceased partner is entirely a new one and there exists no relation.

Thus, the entire amount may be payable to the Executor in one lump sum. If so the working capital of the firm will be depleted and the business will be affected. In such a similar position, precautionary measures are to be taken to safeguard the firm from the financial breakdowns.

The step to overcome this is to take a Joint Life Policy on the partners, by paying a small amount known as premium and in the event of death of any one of the partners the amount of the policy is payable.

The firm gets the full amount of the policy either on its maturity or on the death of a partner, whichever is earlier. Thus the deceased partner’s account can be settled with the policy amount, without disturbing the business activities.

The Policy may be on individual life or may be on the lives of all the partners-Joint Life Policy.

The accounts relating to the Joint Life Policy can be maintained in any one of the following methods:

Method I:

When premium is paid on the Joint Life Policy, it is treated as an expense and is debited to the Profit and Loss Appropriation Account. On happening of death or maturity or surrender, the amount received from the Insurance Company is treated as an income and is credited in the partners’ capital accounts in their profit sharing ratio. There is no Joint Life Policy Account separately maintained.

The journal entries are:

Method II:

Here, the surrender value of the policy is taken into account. The premium paid is treated as an asset and is debited to Policy Account. At the end of the year, the amount of premium in excess of the surrender value is treated as a loss and is debited to the Profit and Loss Account.

The surrender value is shown on the asset side of the Balance Sheet every year at its computed value. On the death or maturity, the excess amount received from the Insurance Company over the accumulated surrender value is credited to the partner’s capital accounts in profit sharing ratio.

The journal entries are:

Method III:

Here, a Joint Life Policy and also a Joint Life Policy Reserve or Fund Account is maintained at surrender value. The Policy Account will then appear at its surrender value on the asset side of the Balance Sheet and Policy Reserve Account will appear on the liability side of the Balance Sheet.

The excess of the amount of policy received over the surrender value of the policy is treated as a profit and credited to partners’ capital accounts in profit sharing ratio. This method is similar to that of Depre­ciation Fund method

The journal entries are:

Illustration 1:

A and B sharing profits and losses in the ratio of 5 : 3 took out a Joint Life Policy for Rs. 40,000 in January 2002 for 20 years paying an annual premium of Rs. 2,200. The surrender values were: 2002 Rs Nil; 2003 Rs. 500; 2004 Rs. 1.200 and 2005 Rs. 2,050; B died on April 20, 2005 and the claim was received on 25th May.

Show the necessary accounts in all the methods.

Solution:

First Method:

Note: In the case of policies on the lives of individual partners, the deceased partner has also a right to share the amount of surrender value, which the other partners’ policies acquired at the time of death.