Death of a Partner. The deceased partner's share of profit is to be determined either on the basis of time or turnover.

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Quentin Knight
5 years ago
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1 Death of a Partner The accounting treatment at the time of death of a partner is same as at the time of retirement. Main difference between the two is that of closing of the account of business. Deceased partner s capital account is credited with his opening capital, interest on capital up to his death, his share in undistributed profits, revaluation profits, and firm s profits from the date of the last balance sheet up to his death and with his share of goodwill. Drawings, interest on drawings and losses are debited in the deceased partner s Capital Account and the remaining amount is transferred to his legal representative s account. Legal representative can receive either interest at 6 per cent per annum, on the amount due from the date of death to the date of settlement or the profit earned with the help of that amount. Calculation of Deceased Partner's Share of Profit The deceased partner's share of profit is to be determined either on the basis of time or turnover. (a) On the basis of time: In this case, it is assumed that the profit during the previous year has been earned uniformly in all months during the year, provided previous year is taken as the base for calculation of profit. Sometimes average profits of the past three or four years are taken as base rather than the previous year. Whatever base may be taken, it is to be multiplied by the period for which the deceased partner remained in the firm and also his profit sharing ratio at the time of his death. For example A, B, and C are partners in a firm sharing profits and losses in the ratio of 3 : 2 : 1. B dies on 14th March,. The average of the last three years is Rs. 30,000. B's share of profit on the basis of time is calculated as under: Average yearly profit = Rs. 30,000 Profit for 73 days i.e., Jan. 1 to March 14, B s Share = 2/6 x 6000 = Rs On the basis of turnover: In this method, average past profit is divided into two portions i.e., before the death and after the death on the basis of ratio of turnover to the date of death to average turnover and then deceased partner's share is calculated and credited to his capital account. For example, A, B and C are partners in a firm sharing profits and losses in the ratio of 3 : 2 : 1. B dies on 14th March,.

2 Turnover from 1st January, to 14th March, is Rs. 42,000. Average turnover of the last three years is Rs. 60,000 and profit is Rs. 30,000. B's share of profit on this basis will be calculated as under: Average turnover = Rs. 60,000 Sales to the date of death = Rs. 42,000. Profit to the date of death = Rs. 42,000. = Rs. 21,000 B's share of profit = 21,000 / 3 = Rs. 7,000. Treatment of Life Policies To make an arrangement for the payment of amount belonging to deceased partner to his legal representative, the firm can get insured the life of all the partners jointly or individually. Premiums on life policies are paid out of firm s funds and this is debited to firm s Profit and Loss Account. Amount received in the form of claim from the life insurance company is credited to all the partners in their profit/loss sharing ratio. In the case of individual policies also, the deceased partner is entitled to his share in the surrender value of policies of all the partners. Other partners are also entitled to their respective share in the amount of policy of the deceased partner. Example Brown and Smith are partners. The partnership deed provides inter alia: i) That the Account be balanced on 31st December each year. ii) That the profits are divided as follows: Brown 1/2; Smith 1/3 and carried to a Reserve account 1/6. iii) That in the event of the death of a partner, his executors be entitled to be paid : (a) The capital to his credit at the date of death. (b) His proportion of reserve at the date of last balance sheet. (c) His proportion of profit to date of death based on the average profits of the last three completed years. (d) By way of goodwill his proportion of the total profits for the three preceding years.

3 On 31st December, 1989, the Ledger balances were: Particulars Amount Amount Brown s Capital 9,000 Smith s Capital 6,000 Reserve 3,000 Creditors 3,000 Bills Receivable 2,000 Investments 5,000 Cash 14,000 21,000 21,000 The profit for three years was: Rs. 4200, Rs. 3900, Rs Smith died on 1st May, 1990 Show the accounts as between the firm and Smith s died on 1st May, 1990 Solution Effective profit sharing ratio between Brown and Smith is 3:2 Smith s share in the profits to the date of death Particulars Amount Profit for ,200 Profit for ,900 Profit for ,500 Total Profits 12,600 Average = Rs. 12,600/3 = Rs. 4,200 Profit for 4 months up to May 1, 1990 = 4,200 1/3 = Rs. 1,400 Smith s share therein = Rs. 1,400 2/5 = 560 Smith s share in Goodwill: Goodwill = Rs. 12,600 Smith s share = Rs. 12,600 2/5 = Rs. 5,040

4 Joint Life Policy Accounting treatment of Joint Life Policy may be done by any of following methods: 1. First Method: When payment of premium is considered as business expenditure Under this method, the amount of premium is charged to Profit and Loss Account of each year and the amount received from insurance company on the death of any partner is treated as income. Bank Account will be debited and Joint Life Policy Account will be credited with the amount received from the insurance company on the death of a partner. Then Joint Life Policy Account is closed by transferring it to all the partners Capital Accounts (including the deceased partner) in their profit sharing ratio. The main problem in this method is that no surrender value of policy is shown in the books. 2. Second Method : When surrender value is treated as an asset In this method at the time of payment of premium, the Joint Life Policy Account is debited and Bank Account is credited. That amount of premium which is more than surrender value at the end of year, it is assumed as loss with which Profit and Loss Account is debited and Joint Life Policy Account is credited. Joint Life Policy Account (Surrender Value) is shown as asset in the Balance Sheet. At the time of death of any partner, Bank Account is debited and Joint Life Policy Account is credited with the amount received. Credit balance of Joint Life Policy Account is considered as profit and transferred to all partners capital accounts in their profit-loss sharing ratio. The main advantage of this method is that surrender value is considered as an asset and disadvantage is that the premium is not shown fully as an expense in Profit and Loss Account. 3. Third Method: When premium is considered as an asset With the amount of premium paid, Joint Life Policy Account is debited and Bank Account is credited. Joint Life Policy Account is shown as an asset in the Balance Sheet. At the time of death of any partner, Bank Account is debited and Joint Life Policy Account is credited. After his, if there is any credit balance in Joint Life Policy Account, it is distributed among all partners in their profit sharing ratio. 4. Fourth Method: When payment of premium is treated as an investment and a Reserve Account is opened: i. Premium is debited to Joint Life Policy Account. ii. Every year amount equal to the premium is debited to Profit and Loss Appropriation Account and credited to Joint Life Policy Reserve Account. iii. 3. Joint Life Policy Account and Joint Life Policy Reserve Account are adjusted in such a way that the balance in each account is equal to surrender value of the policy.

5 iv. At the death of a partner Joint Policy Account is credited with the amount received. Credit balance of Joint Policy Reserve Account is transferred to Joint Life Policy Account and Joint Life Policy Account is closed by transferring to Capital Accounts of all the partners in their profit sharing ratio. Under this method, surrender value is shown on the assets side and Joint Life Policy Reserve Account on liabilities side of Balance Sheet. Main advantage of this method is that surrender value is shown in Balance Sheet and all premiums is charged from Profit and Loss Appropriation Account. Example A and B are partners in a firm. On April 1, they took out a Joint Life Policy without profits for Rs. 30,000 upon which an annual premium of Rs. 1,400 is payable. A and B share profits in the ratio of 2 : 1. On March 31, B died and Rs. 30,000 is received from the Insurance Company. Journalise the above transactions. Premium is to be adjusted through Profit and Loss Account. (b) A and B who shared profits in the ratio of 3 : 2 took a joint life policy on May 1, for Rs. 30,000. The annual premium was Rs. 1,300. The surrender value of the policy was: Nil; - Rs. 400; - Rs. 900; - Rs. 1,450 B died on September 15, and the amount of the policy was received on Dec. 31,. The books are closed on Dec. 31, each year. Show Joint Life Policy Account and Joint Life Policy Reserve Account assuming that premiums were written off through Joint life Policy Reserve Account. Solution Date Particulars Amount Amount 1-Apr Joint Life Policy Premium A/c 1,400 To Bank A/c 1,400 (Being the payment of annual premium) Mar. 31 Profit and Loss Account 1,400 To Joint Life Policy Premium A/c 1,400 (Being Premium charged to P & L A/c) Mar. 31 Insurance Company A/c 30,000 To Joint Life Policy A/c 30,000 (Being the amount of J.L.P. due for receipt)

6 Mar. 31 Bank Account 30,000 To Insurance Company A/c 30,000 (Being the receipt of claim from Insurance Company) Mar. 31 Joint Life Policy A/c 30,000 To A s Capital A/c 20,000 To B s Capital A/c 10,000 (Being the amount of policy distributed between partners in the ratio of 2 : 1) Joint Life Policy Date Particulars Amount Date Particulars Amount May 1 To Bank A/c 1,300 May 1 To Bank A/c 1,300 Jan 1 To Balance b/d 400 Dec 31 By J.L.P. Reserve A/c 1,300 Dec 31 By J.L.P. Reserve A/c 900 By Balance c/d 400 1,300 1,300 Dec 31 By J.L.P. Reserve A/c 800 May 1 To Bank A/c 1,300 By Balance c/d Jan 1 To Balance b/d 900 Sept 15 By Bank a/c May To Bank A/c 1300 By J.L.P. Reserve A/c Dec To Capital A: B:

7 Joint Life Policy Reserve Account Date Particulars Amount Date Particulars Amount Dec 31 To Joint Life Policy a/c 1300 Dec 31 To Joint Life Policy a/c 900 To Balance c/d 400 Dec 31 By P&L App A/c 1300 Dec 31 By P&L App A/c Dec 31 To Joint Life Policy a/c 800 Dec 31 By P&L App A/c 1300 To Balance c/d 900 By Balance b/d 400 Sept 15 To Joint Life Policy a/c Sept 15 By Balance b/d 900

Test Series No 4-60 Marks

Test Series No 4-60 Marks 1. In the absence of a partnership deed, the allowable rate of interest on partners loan account will be (a) 4% (b) 7% (c) 6% (d) 12% 2. In-------- method, depreciation is charged