A partnership firm is an organisation that is formed with two or more individuals with a common objective to earn revenue. The structure of an organisation 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 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 pertain 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 on capital.
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 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 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 –
1. 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)
Therefore, Bobby’s share = Rs.37,5000 x (2/5)
2. 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
Therefore, Kevin’s share = Rs. (30667 x 1/6)
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 partnership deed format after 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 on 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 retirement of a partner in a partnership firm and strengthen your fundamentals of partnership chapter.
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1. What is a Deceased Partner?
Ans. When one of the active partners of a partnership firm dies, their partnership is dissolved. Regardless, the firm may or may not opt to continue the venture after the incident.
2. What Happens when a Partner Dies in a Partnership?
Ans. In case of death of a partner in a partnership agreement, the said agreement ceases to exist. However, the rights of a representative of the deceased partner would rely upon the provisions of their functional partnership deed.
3. Will the Death of a Partner Terminate the Partnership?
Ans. When a partner dies, the partnership is terminated. However, the firm does not cease to exist mainly because the other partner or partners often opt to continue the business venture.