TREATMENT OF GOODWILL ON ADMISSION OF PARTNER

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TREATMENT OF GOODWILL ON ADMISSION OF PARTNER

Goodwill is an intangible asset which enables a firm to earn higher profit than the normal profit earned by the other firms in the industry. Goodwill is created through the sincere and honest efforts made by the partners in the past. The goodwill so generated is known as internally i.e. Self Generated Goodwill. Treatment of Goodwill on the Admission of Partner is done to compensate the sacrificing partners by the new partner who acquires the share in future profits. Payment of premium for goodwill is mode of compensating the sacrificing partners for the sacrifice they make in favor of the new partner.

There can be following situations relating to the Treatment of Goodwill on Admission of Partner:

CASE 1: GOODWILL IS PAID PRIVATELY BY NEW PARTNER TO OLD PARTNERS

On the admission of a new partner, it may happen, that new partner pays goodwill to the old partners off the record of the firm i.e. privately. The amount paid privately as goodwill will not be recorded in the books of the firm.

EXAMPLE: X and Y are partners in a firm sharing profits and losses in the ratio of 3:2. They admit Z as a partner for 1/4th share. Z paid directly ₹80,000 to X and Y as his share of goodwill. Show the treatment.

SOLUTION: No journal entry will be passed in the books as Z has paid his share of goodwill to X and Y directly, i.e., privately outside the firm.

CASE 2: GOODWILL IS BROUGHT IN CASH BY THE NEW OR INCOMING PARTNER AND IS RETAINED IN THE BUSINESS.

The new partner is required to compensate the old partners by paying amount of his share of goodwill. The amount so paid by the new partner to old partners through the firm is debited to cash account and credited to premium account. Then premium Account is closed by transferring it to old partner’s capital account in sacrificing ratio. Thus premium account is closed and it will not appear in the balance sheet.

When Premium (goodwill) is brought in cash
Cash A/c                        Dr.    
To Premium A/c
(Being premium brought in cash)
Premium is credited to old partners in sacrificing ratio:
Premium A/c                Dr.    
To old partner’s capital A/c
(Being premium credited in sacrificing ratio)

EXAMPLE: A and B are partners sharing profits and losses in the ratio of 3:2. C is admitted for 1/4th share and bring his share of goodwill amounted to ₹20,000 in cash. The journal entries will be:

SOLUTION: TREATMENT OF GOODWILL ON ADMISSION OF PARTNER C IS:

PARTICULARS
Cash/ Bank A/c         Dr.   20,000
   To Premium A/c 20,000
(Being the amount brought by C for his share
of goodwill)
Premium A/c           Dr.   20,000
    To A’s capital A/c   12,000
    To B’s Capital A/c 8,000
(Being goodwill transferred to old partners in
sacrificing ratio.)

CASE 3: GOODWILL IS BROUGHT IN BY NEW PARTNER IN CASH AND SAME IS PARTLY OR FULLY WITHDRAWN BY THE OLD PARTNERS

In this case, the cash introduced by the new partner as goodwill is given to the old partners in sacrifice ratio and subsequently the old partners withdraw the amount from business. The following enteries will be passed in this case:

When Premium (goodwill) is brought in cash
Cash A/c                        Dr.    
To Premium A/c
(Being premium brought in cash)
Premium is credited to old partners in sacrificing ratio:
Premium A/c                Dr.
    To old partner’s capital A/c
(Being premium credited in sacrificing ratio)
Premium is withdrawn by old partners from the business
Old partner’s Capital A/c    Dr.
     To Bank/ Cash A/c
(Being goodwill is withdrawn by the old partners)

EXAMPLE: A, B and C are partners in 3:2:1 ratio. They admitted D for 1/4th share. D brings cash ₹100,000 including ₹30,000 for goodwill. A and B withdrew the full amount of premium credited to their account.

SOLUTION: TREATMENT OF GOODWILL ON ADMISSION OF PARTNER D IS:

PARTICULARS
Cash/ Bank A/c         Dr. 1,00,000
    To D’s Capital A/c 70,000
    To Premium A/c 30,000
(Being the amount brought by C for his
share of goodwill)
Premium A/c           Dr. 30,000
    To A’s capital A/c   15,000
    To B’s Capital A/c 10,000
    To C’s Capital A/c 5,000
(Being premium distributed to the partners)
A’s capital A/c        Dr. 15,000
B’s Capital A/c        Dr. 10,000
C’s Capital A/c        Dr.  5,000
     To Cash A/c 30,000
(Being goodwill is withdrawn by the old
partners)

CASE 4: GOODWILL IS NOT BROUGHT IN CASH BY NEW PARTNER

Accounting Standard 26 (Intangible Assets) specifies that goodwill can be recorded in the books only when some consideration in money or money’s worth has been paid for it. It means that only purchased goodwill can be recorded in the books. At the time of admission, retirement or death of a partner or in case of change in the profit sharing ratio among existing partners, goodwill account cannot be raised in the books of the firm because it will be non- purchased goodwill and no consideration in money or money’s worth has been paid for it.

When the goodwill of the firm is evaluated and the new partner does not bring his share of goodwill in cash, goodwill should be adjusted through partner’s capital accounts. For this purpose new partner’s current account is debited from his share of goodwill and the old partner’s capital accounts are credited in their sacrificing ratio. Following journal entry is passed for this purpose:

New partner’s Current A/c                Dr. 
    To old partner’s capital A/c

EXAMPLE: A and B are partners sharing profits and losses in the ratio of 3:2. C is admitted for 1/4th share and bring his share of goodwill amounted to ₹20,000 which he is unable to bring in cash. The journal entry will be:

SOLUTION: TREATMENT OF GOODWILL ON ADMISSION OF PARTNER C IS:

PARTICULARS
C’ Current  A/c           Dr.  20,000
    To A’s capital A/c 12,000
    To B’s Capital A/c 8,000

CASE 5: TREATMENT OF GOODWILL ALREADY EXISTING IN BOOKS ON ADMISSION

Sometimes, at the time of admission of a new partner, there may appear the goodwill in the books of the firm. The reason for goodwill being appearing in the books could be:

  • That it was brought by the old partners in the past
  • The goodwill might have been raised in the past before the issuance of Accounting Standard 26.

It must be remembered that goodwill which is existing in the books must be written off between old partners in the old ratio. The accounting treatment of such goodwill is as follows:

Old partner’s Capital A/c                Dr.   
    To Goodwill A/c

The entry to write off existing goodwill is always passed whether the goodwill is brought in cash or not. After passing the above entry, goodwill will not appear in the new balance sheet.

EXAMPLE: X and Y are partners sharing profits in the ratio of 4:3. On 1 April 2018, they admitted Z as partner. Z brought in ₹1,00,000 for his capital and ₹21,000 for 1/3rd share of goodwill premium. On Z’s admission, goodwill appeared in the books of the firm at ₹28,000. The journal entries will be:

SOLUTION: TREATMENT OF GOODWILL ON ADMISSION OF PARTNER Z IS:

X’s Capital  A/c         Dr. 16,000
Y’s Capital A/c          Dr. 12,000
    To Goodwill A/c 28,000
(Being the existing goodwill written off prior
to Z’s admission)
Bank A/c           Dr.   1,21,000
    To Z’s capital A/c 1,00,000
    To Premium A/c 21,000
(Being Z brought in cash for his capital and
his share of goodwill)
Premium for Goodwill A/c       Dr.   21,000
    To X’s Capital A/c   12,000
  To Y’s Capital A/c 9,000
(Being the goodwill/ premium for goodwill
brought in by Z is transferred to the Capital
Accounts of X and Y I their sacrificing ratio, i.e. 4:3)

CASE 6: GOODWILL IS PARTLY BROUGHT IN CASH BY NEW PARTNER

New or Incoming partner may not be able to bring the amount of his share of goodwill fully or partly in cash. In this situation:

Premium for Goodwill Account is credited with the amount of premium for goodwill brought by the new or incoming partner.

At the time of recording the transfer entry, New or Incoming partner’s Capital/ Current Account is debited with the amount of premium for the goodwill not brought by him besides debiting Premium for Goodwill Account with the amount of premium paid by him. In case, Capital Accounts are maintained following Fixed Capital Accounts Method, It is debited to his Current Account.

Cash A/c                        Dr.
     To New partner’s Capital A/c   
     To Premium A/c
Premium A/c                Dr.
New Partner’s Current A/c    Dr.
    To Old Partner’s Capital A/c

EXAMPLE: A and B are partners sharing profits equally. They admit C into partnership. C paying only ₹1,000 for premium out of his share of premium of ₹1,800 for 1/4th share of profit. Give the necessary Journal entries.

SOLUTION:

PARTICULARS
Cash A/c                        Dr.  1,000
    To Premium A/c 1,000
Premium A/c      Dr. 1,000
C’s Current A/c    Dr. 800
    To A’s Capital A/c 1,000
    To B’s Capital A/c 800

CASE 7: GOODWILL IS BROUGHT IN KIND BY NEW PARTNER

New or Incoming partner may bring his share of Premium for Goodwill in the form of the assets. In this situation, the assets brought in debited individually with their values and Premium for Goodwill Account is credited with his share of goodwill and also new Partner’s capital Account with his capital. Thereafter, Premium for Goodwill is transferred to the capital Accounts of the sacrificing partners in their sacrificing ratio. The Accounting entries in this case will be:

Assets A/c                        Dr.
     To New partner’s Capital A/c   
     To Premium for Goodwill A/c
Premium A/c                Dr.
    To Old Partner’s Capital A/c

EXAMPLE: Ravi and Amit are partners in 3:2 ratio. They admitted Ajay. Ravi gave 1/5 from his share to Ajay and Amit gave 1/5 of his share to Ajay. Ajay contributed stock ₹6,000; Machinery ₹27,000 and Computer ₹16,000 for his share in goodwill. He paid ₹1,60,000 on account of his capital. Pass journal entries.

SOLUTION:

PARTICULARS
Cash A/c           Dr.  1,60,000
    To Ajay Capital A/c 1,60,000
(Being capital contributed by Ajay)
Stock A/c                 Dr. 6,000
Machinery A/c       Dr. 27,000
Computer A/c         Dr. 16,000
      To Premium A/c 49,000
(Being goodwill brought in kind)
Premium A/c          Dr.  49,000 
    To Amit Capital A/c   35,000
    To Ravi Capital A/c 14,000
(Being goodwill credited to Amit and
Ravi in sacrificing ratio 5:2)

 CASE 8: OLD PARTNERS DO NOTHAVE GOODWILL BUT NEW PARTNER HAS GOODWILL

A situation may arise when old partners are running their business in losses, hence they do not have any kind of goodwill. On the other hand, the new partner having similar nature of trade is earning profits ad has goodwill. In this case, the old partners will compensate the new partners with their share in the goodwill of the new partner, which means the old partner’s capital/current account will be debited with their share in sacrifice ratio and new partner’s capital/ current account will be credited.

Old Partner’s Capital A/c              Dr.  
     To New Partner’s Capital A/c
(With the share of old partners)

EXAMPLE: A and B are partners in 3:2 ratio doing Auto Parts business. They are suffering losses from the last many years. C is also doing the same type of business. A and B persuaded C to join them for 2/5th share because C is having a profitable business. C agreed. His goodwill was valued at ₹40,000 whereas A and B do not have any goodwill. C brings ₹50,000 as his capital. Pass necessary journal entries.

SOLUTION:

PARTICULARS
Cash A/c         Dr.  50,000
    To C’s Capital A/c 50,000
(Being C brings Capital)
A’s Capital A/c         Dr. 14,400
B’s Capital A/c         Dr.  9,600
      To C’s capital A/c 24,000

CASE 9: HIDDEN GOODWILL

Sometimes, the value of the goodwill of the business is not given, it has to be inferred on the basis of the net worth of the firm.

Calculation of Hidden Goodwill

Step 1: Find put the total capital of the new firm on the basis of new partner’s capital and his share of profit.

Total capital of the new firm= New Partner’s Capital * Reverse of new partner’s share.

Step 2: Calculate combined capitals of all the partners (old partners as well as new partner).

Step 3: Find out the difference between the old capital calculated as per Step 1 and Step 2. It will be the goodwill of the firm.

EXAMPLE: A and B are partners with the capitals of ₹1,60,000 and ₹1,20,000 respectively. They admit C as a partner on 1st April, 2018 for 1/4th share in the profits of the firm. C brings in 1,60,000 as his share of capital. Pass journal entries.

SOLUTION: Calculation of hidden goodwill:

  1. Total Capital of new firm= 1,60,000 * 4/1= ₹6,40,000
  2. A, B and C’s combined Capital= ₹1,60,000+ ₹1,20,000+ ₹1,60,000= ₹4,40,000
  3. Goodwill of the firm will be= 6,40,000-4,40,000= ₹2,00,000
  4. C’s share of goodwill= ₹2,00,000*1/4=₹50,000
PARTICULARS
Cash/ Bank A/c         Dr. 1,60,000
    To C’s Capital A/c 1,60,000
(Being the amount brought by C for
his capital)
C’s Capital A/c           Dr.   50,000
   To A’s capital A/c    25,000
   To B’s Capital A/c 25,000

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