Retirement of a partner implies a situation when a partner leaves a partnership firm for any reason and the remaining partners of the firm decide to continue with the business. There may be various reasons due to which a partner may seek retirement from a partnership firm.
Some of these reasons are old age, illness, change in interests, etc. As in the event of the retirement of a partner, there exists a change in the existing partnership agreement and relationship between the partners, so it can be said that the retirement of the partner leads to the reconstitution of the partnership firm. That is, to put in different words, in case of retirement of a partner, the old partnership deed gets terminated and is replaced by a new partnership deed, which defines a new relationship among the remaining/continuing partners.
Retiring Partner’s Liability
A general rule that applies while determining the liability of the retiring partner is that he cannot and should not be held responsible for a debt or liability once he has left the firm. For example, Rohan, Rahul, and Raj are partners in a firm. Rahul retires from the firm on 5th January 2019. Raj took a loan on behalf of the firm on 25th March 2019 and failed to pay the interest on the debt when due. Then, in this case, only Rohan and Raj will be held liable for the default in payment.
However, this general rule may not apply in the following cases:
Case 1: Holding Out
This occurs when the retiring partner has held himself as a member of the Partnership firm and has acted in that capacity, thereby giving an impression that he is still a partner to the firm. In such a case, the oral or written representation thus made in a personal capacity or by knowledge of such representation through someone acting on his behalf, the retiring partner will be held liable. In the above example if Rahul takes a loan in the name of the firm even after retirement then he shall be held liable for the same.
Case 2: Failure in Reporting about the Retirement through an appropriate notice
This is a case of mistaken identity whereby, a person may be assumed as a Partner to the firm if he has not given proper notice of his retirement to the concerned parties. He might as well be held responsible for a firm’s debt or liability in such a case. To avoid confusion or doubt regarding his status, it is thus, advisable that he informs all the concerned parties about his retirement and gives public notice of the same.
Case 3: Novation
It is a kind of agreement in which three parties are involved, namely:
- The creditor of the Partnership firm
- The Partner representing the firm at the time of contract with the creditor, and
- The new or incoming partner
With the help of this agreement, the creditor may agree that the liability of the outgoing or retiring partner will no longer exist and instead the new partner will be taking it up. For example, Rohan, Rahul, and Raj are partners in a firm. On 20th October 2018, he took debt from a creditor on the firm’s behalf. On 1st December 2018, he decided to retire from the firm and Sohan agrees to join the firm as a partner. The creditor agrees to relieve Rohan of his liabilities and instead agrees to Sohan taking up the liability. Then this is the case of an ovation agreement.
Ways of Retirement of a Partner
A partner may retire from a partnership firm in any of the following ways.
With the Consent of all the Partners: In this way, it becomes compulsory for the retiring partner to obtain the consent of all other partners of the firm before seeking retirement. This implies that the partner can get retirement if and only if all the partners agree on the decision of his/her retirement.
Example: A, B, and C are the partners in a partnership firm sharing profits and losses in the ratio of 4 : 3 : 1. On April 01, 2011, B wants to retire from the firm. To this, both A and C agreed. Thus, as B has obtained consent from all the partners so, now he can take retirement from the firm.
With Express Agreement by All the Partners: In the case of written agreement among the partners, a partner may retire from the firm by expressing his/her intention of leaving the firm through a notice to the other partners of the firm. In other words, if a partner wants to leave the firm, he/she can do so by giving notice to the other co-partners
Example: A, B, and C are the partners in a partnership firm sharing profits and losses in the ratio of 4 : 3 : 1. It was provided in their partnership deed that any partner may retire from the firm by giving notice. On April 01, 2011, B wants to retire from the firm. So, he expresses his intention of retirement to A and C. In this case, B can retire from the firm even without obtaining the consent of all the partners.
By Giving a Written Notice: If partnership among the partners is at will then a partner may retire by giving notice in writing to all the other partners informing them about his/her intention to retire.
Example: A, B, and C are the partners in a partnership firm sharing profits and losses in the ratio of 4 : 3 : 1. The partnership between the partners is at will. B wants to retire from the firm. He can retire by giving written notice to A and C expressing his intention to retire.
Ascertaining the Amount Due to the Retiring Partner
At the time of retirement of a partner, he/she is entitled to receive the following amounts.
- Credit Balance of his Capital / Current Account
- Share of Goodwill
- Share of Accumulated Profits (Reserves)
- Share in the Gain of Revaluation of Assets and Liabilities.
- Share of Profits up to the Date of Retirement.
- Interest on Capital (if any) up to the Date of Retirement
- Salary or Commission (if any) up to the Date of Retirement.
All these amounts are posted on the credit side of the Retiring Partner’s Capital Account.
Deductions
The following are some deductions (if any) that are to be made from his/her amount due (mentioned above).
- Debit Balance of his/her Current Account
- Share of Accumulated Losses
- Share of Loss on Revaluation of Assets and Liabilities
- Share of Loss up to the Date of Retirement
- Drawings up to the Date of Retirement
- Interest in Drawings (if any) up to the Date of Retirement.
All these amounts are posted on the debit side of the Retiring Partner’s Capital Account.
Adjustments Required at the time of Retirement of a Partner
Following are some of the accounting matters that are to be adjusted at the time of retirement of a partner.
- Calculation of New-Profit Sharing Ratio
- Calculation of Gaining Ratio
- Treatment of Goodwill
- Revaluation of Assets and Liabilities
- Distribution of Accumulated Profits and Losses
- Settlement of Amount due to the Retiring Partner
- Treatment of Joint Life Policy (JLP)
- Adjustment of Capital Accounts (if required)
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