A business may contain two or more partners. In simple words, a partnership is an arrangement between two or more people who share both profits and liabilities in their profit sharing ratio. This partnership may break either due to the retirement or death of one of its partners. 

The retirement of the partner may be either due to his will or due to the completion of the venture for which the partnership came into the act. After the retirement of a partner, the firm rearranges the financial accounts and profit-sharing ratios among the remaining partners. The goodwill treatment of the retired partner is as per the agreement among the partners. The business will continue with remaining partners, and the retired partner shall leave with his share of goodwill. 

Reasons for the Retirement of a Partner

The partner of a firm may retire due to the following reasons:

  • The partner may retire due to old age.
  • The partner may retire due to bad health and being incapable of carrying out his responsibilities.
  • The partner may decide to retire due to a change in the nature of the firm.
  • The partner can also retire on his own will if the partnership was on will too.
  • The partner may retire if he got a better opportunity. He must give notice of retirement to other partners. 

Retiring partner is entitled to receive

  • Share in Goodwill: The partner will get his share of goodwill due to his efforts for the company in the past. The goodwill treatment is in accordance with the agreement of all other partners. This goodwill earned by the firm has the contribution of the retired partner too with other existing partners. Moreover, due to the present goodwill, the firm will also experience success in the future. Thus, the retired partner must get his compensation in the form of his goodwill.
  • Share in Reserves: The retired partner has the shares in the reserves too, as the reserves themselves are the undistributed profits of the previous years. Therefore, the shares in his reserves are credited to his capital account.
  • Shares in Revaluation of Assets and Reassessment of Liabilities: The profit of revaluation of assets and reassessment of liabilities are evaluated on the date of retirement of the partner. The retiring partner will receive the profit as credit and loss as a debit from his capital account.
  • He will receive his shares in reserves, accumulated profits and losses too.

Gaining Ratio

When a partner retires, the profit-sharing ratio of all other partners changes. It simply means the reconstitution of the firm concerning the profit and losses due to the loss of one of its partners. The gaining ratio of any firm is the tool to calculate the ratio in which the profits and losses of the retired partner are distributed among the remaining partners of that firm.

Calculation of Gaining Ratio

There are two methods for its calculation in the given question. These two methods are:

Case 1: If the question does not contain the new profit-sharing ratios of the remaining partners, then we can automatically assume that the partners continue to share their profit in the old profit-sharing ratio. Therefore, the gaining ratio for the existing partners is the same as the old profit-sharing ratios of those partners.

Example: Joshua, Ross and Twinkle are three partners who share their profits in the ratio 1:2:3. Calculate the gaining ratios of Ross and Twinkle when Joshua retires.

Solution: The new profit ratio of Ross and Twinkle after the retirement of Joshua is not given in the question. Therefore, we shall assume that the gaining ratio of the remaining partners i.e. Ross and Twinkle shall be the same as their old profit ratio.

Therefore, the gaining ratio of Ross and Twinkle = 2:3.

Case 2: If the question has the new profit sharing ratio, then we simply subtract the old ratio from the new ratio to calculate the gaining ratio.

Gaining ratio= New Ratio- Old Ratio

Example: Elijah, Finn, and Kol are partners sharing profits and losses in the ratio 4:3:2. Finn retires, therefore Elijah and Kol decide to have a new profit sharing ratio as 5:4. Calculate the gaining ratio of Elijah and Kol by the formula of gaining ratio after the retirement of Finn.

Solution: Gaining ratio of Elijah and Kol = New Ratio- Old Ratio

Gaining ratio of Elijah= 5/9-4/9 =1/9

Gaining ratio of Kol= 4/9-2/9 =2/9

Gaining ratio between Elijah and Kol = 1/9:2/9

= 1:2.

Conclusion

The firm or business may contain two or more partners with their business agreement, that is, a partnership. Sometimes, either due to old age, bad health, insolvency, or personal will, one of the partners decides to retire from the business. Before the retirement, the retiring partner must give notice to all other existing partners. The retiring partner shall receive the goodwill treatment as per the agreement between all other partners. He will receive his shares in revenues and the profits of revaluations of assets and reassessment of liabilities in his capital account. The profit-sharing ratio of other existing partners will change after the retirement of one of the team members. This change in profit sharing ratio is the gaining ratio of existing partners. It is calculated by two methods as stated above.