Admission Of Partner in Partnership Accounting _ Treatment of Goodwill

Introduction of Goodwill

When a new partner is admitted into a partnership firm, he or she acquires a share in the future profits of the business. This share is given by the existing partners, resulting in a reduction of their respective profit shares. To compensate for this sacrifice, the new partner pays an amount known as premium for goodwill either in cash or in kind. The premium represents the new partner’s share in the firm’s goodwill.

Goodwill is an intangible asset that enables a firm to earn profits over and above the normal returns typically earned by other firms in the same industry. The premium paid for goodwill serves as compensation to the existing partners for the share of profit they relinquish in Favor of the new partner. There may be several situations relating to the treatment of goodwill at the time of admission of a partner.

According to Accounting Standard 10 (AS-10), goodwill should be recorded in the books only when monetary consideration has been paid for it. Therefore, if the new partner does not bring the required amount of goodwill in cash, no goodwill account can be created in the firm's books. In such a case, the new partner must still compensate the existing partners for goodwill, in addition to contributing to the capital of the firm.

Meaning of Goodwill

Over time, a business develops a good name, reputation, and customer loyalty. This strong reputation enables the firm to earn extra profits, compared to a newly established business. In accounting, the capitalised value of these extra profits is known as goodwill.

For example:

1. Actual profit earned by the firm = ₹1,200
2. Normal expected profit = ₹700
3. Rate of return = 10%

• Step 1: Calculate Excess Profit
• Excess Profit = Actual Profit - Normal Profit =1200-700=500
• Step 2: Calculate Goodwill
•  Goodwill =(500×100)/10= ₹ 5000

Thus, goodwill represents the value of the firm’s reputation, measured through the firm's ability to earn future profits above the normal level.

Goodwill may also be defined as:

• The present value of a firm’s capacity to earn excess profits in the future.

This means a firm can be said to possess goodwill only if it has the ability to earn more than the normal profits. A business earning merely normal profits similar to other firms in the same industry cannot claim to have any goodwill.

If the new partner does not bring his/her share of goodwill in cash, an amount equal to his/her share of goodwill is deducted from his/her capital account. Whether the new partner brings goodwill in cash or the amount is adjusted through capital, the goodwill amount is distributed among the existing partners in their sacrificing ratio.

At the time of admission, any goodwill already appearing in the books must be written off among the existing partners in their old profit-sharing ratio. There are several situations related to the treatment of goodwill when a new partner is admitted. These are described below:

Different Cases: Treatment of Goodwill on Admission of a Partner

1. Case 1: Goodwill Paid Privately - The premium for goodwill is settled privately between the new partner and the existing partners. No entry is passed in the firm’s books.
2. Case 2: Goodwill Brought in Cash and Retained in Business - The new partner brings his/her share of goodwill in cash. This amount is kept in the business and credited to the sacrificing partners in their sacrificing ratio.
3. Case 3: Goodwill Brought in Kind - Goodwill (premium) is contributed in the form of assets instead of cash. The value of such assets is credited to the sacrificing partners in their sacrificing ratio.
4. Case 4: Goodwill Brought in by New Partner and Withdrawn by Old Partners (Fully or Partly) - The new partner brings goodwill in cash, and the existing partners withdraw their share either fully or partially from the business.
5. Case 5: Only Part of Goodwill Brought in Cash - The new partner brings only a portion of his/her goodwill share in cash. The remaining amount is adjusted through his/her capital account.
6. Case 6: New Partner Unable to Bring Goodwill in Cash - If the new partner is unable to contribute goodwill in cash, the entire amount of his/her goodwill share is adjusted by debiting his/her capital account and crediting the sacrificing partners.

Treatment of Goodwill

Case	Situation	Treatment / Accounting Effect
Case 1	Goodwill paid privately	• Goodwill (premium) is paid privately between the new partner and existing partners. • No journal entry is passed in the firm’s books.
Case 2	Goodwill brought in cash and retained in business	• New partner brings goodwill in cash. • Cash is retained in the business. • Credited to sacrificing partners in sacrificing ratio.
Case 3	Goodwill brought in kind (assets)	• New partner brings goodwill in the form of assets (e.g., property, stock). • Asset is recorded at value contributed. • Credited to sacrificing partners in sacrificing ratio.
Case 4	Goodwill brought in cash and withdrawn by old partners (fully or partly)	• New partner brings goodwill in cash. • Sacrificing partners receive it in sacrificing ratio. • They withdraw full or part of their share.
Case 5	Only part of goodwill brought in cash	• New partner brings partial goodwill in cash. • Remaining amount is debited to new partner’s capital account. • Total goodwill credited to sacrificing partners in sacrificing ratio.
Case 6	New partner unable to bring goodwill in cash	• New partner does not bring any goodwill. • Entire goodwill amount is debited to new partner’s capital account. • Credited to sacrificing partners in sacrificing ratio.
General rule	Goodwill already appearing in books	• Existing goodwill must be written off among existing partners in their old profit-sharing ratio.

Accounting Treatment

1. When the new partner brings premium for goodwill in cash:

Journal Entry:

Cash A/c ........................................ Dr.

      To Premium for Goodwill A/c

2. When premium for goodwill is distributed to the sacrificing partners:

Journal Entry:

Premium for Goodwill A/c .................. Dr.

      To Sacrificing Partners’ Capital A/c

(Credit is given in the sacrificing ratio.)

Important Note: Existing Goodwill in the Books

If goodwill already appears in the firm’s books at the time of admission of a new partner, it must first be written off among the old partners in their old profit-sharing ratio.

Journal Entry:

Old Partners’ Capital A/c .................. Dr.

      To Goodwill A/c

Illustration : A and B are partners in the firm sharing profit in the ratio of 3: 2. A and B surrender 1/2 of their respective shares in favour of C. C is to bring his share of premium for goodwill in cash. Goodwill of the firm is estimated at ₹40,000. Pass necessary Journal Entries for recording goodwill in the above case.

Solution:

JOURNAL

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
	Cash/Bank A/c Dr.		20,000
	To Premium for Goodwill A/c			20,000
	(Being the share of premium brought in cash by C)

Premium for Goodwill A/c Dr.   20,000  

          To A’s Capital A/c                                12,000  

          To B’s Capital A/c                                  8,000  

(Being distribution of premium among old partners in their sacrificing ratio, i.e., 3: 2) 

Working Notes

1. A’s Sacrifice = 3/5 × 1/2 = 3/10
2. B’s Sacrifice = 2/5 × 1/2 = 2/10
3. Sacrificing Ratio between A and B = 3: 2

1. C’s Share
2. C’s share = 3/10 + 2/10 = 5/10 = 1/2
3. C’s share in Goodwill = 40,000 × 1/2 = ₹20,000

Case 3: Premium for goodwill or goodwill brought in kind(assets):

For assets brought in by new partner

Assets A/c …. Dr.

     To New partner’s capital A/c (with amount of capital)

     To Premium for goodwill A/c (with share of goodwill brought in)

For giving credit of incoming partner’s share of goodwill to sacrificing partners in sacrificing ratio.

Premium for goodwill A/c … Dr.

  To Sacrificing partner’s Capital A/c (in Sacrificing ratio)

Illustration: (Premium brought in Kind) X and Y are partners in a firm sharing profits in the ratio of 3: 2. On 1st April, 2016, they admit Z as a new partner for 3/13th share in the profits. New ratio will be 5: 5: 3. Z contributed the following assets towards his capital and his share of goodwill:

• Stock – ₹80,000
• Debtors – ₹1,20,000
• Land – ₹2,00,000
• Plant & Machinery – ₹1,20,000

On the date of admission, goodwill of the firm was valued at ₹10,40,000. Record necessary Journal Entries in the books of the firm on Z’s admission.

Solution:

JOURNAL

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
2016 April 1	Stock A/c Dr.		80,000
	Debtors A/c Dr.		1,20,000
	Land A/c Dr.		2,00,000
	Plant & Machinery A/c Dr.		1,20,000
	To Z’s Capital A/c			2,80,000
	To Premium for Goodwill A/c (WN 1)			2,40,000
	(Being assets contributed by Z on his admission as capital and goodwill premium)

April 1 Premium for Goodwill A/c Dr. 2,40,000 

         To X’s Capital A/c (₹ 2,40,000 × 14/15)           2,24,000 

         To Y’s Capital A/c (₹ 2,40,000 × 1/15)                16,000 

(Being goodwill premium transferred to old partners in sacrificing ratio) 

Working Notes

• Z’s Share of Goodwill

Goodwill of the firm = ₹10,40,000

Z’s share = Goodwill × Z’s share = 10,40,000 × 3/13 = ₹2,40,000

• Calculation of Sacrificing Ratio

Partners	Old Share	New Share	Sacrifice (Old – New)
X	3/5	5/13	3/5 – 5/13 = 14/65
Y	2/5	5/13	2/5 – 5/13 = 1/65

Sacrificing Ratio = X: Y = 14: 1

Case 4: Goodwill/Premium of Goodwill is brought by New Partner and is withdrawn by old Partners fully or partly.

For Premium for Goodwill brought in cash by new Partner:

Cash/Bank A/c Dr.

  To Premium for Goodwill A/c

For Sharing of Premium of Goodwill:

Premium for Goodwill A/c Dr.

  To Sacrificing Partner’s Capital A/c

For withdrawal of Premium money fully/partially:

Sacrificing Partner’s Capital A/c Dr.

  To Cash/Bank A/c

Case 5: Only a part of Goodwill / Premium of Goodwill is brought by new/incoming partner in cash.

Write off Goodwill already appearing in Balance Sheet:

Old Partner’s Capital A/c Dr.

  To Goodwill A/c

For Amount brought in by the incoming partner:

Bank A/c Dr.

  To Incoming Partner’s Capital A/c (with Capital)

  To Premium for Goodwill A/c (with Share of Goodwill brought in)

For Credit given to Sacrificing Partners by incoming partner’s full share of Goodwill:

Premium for Goodwill A/c Dr. (with Share of Goodwill brought in)

New Partner’s Capital A/c Dr. (with unpaid share of Goodwill)

  To Sacrificing Partner’s Capital A/c (in Sacrificing Ratio)

Illustration (New or Incoming Partner brings in only a part of his share of Goodwill).

A and B are partners sharing profits and losses in the ratio of 3 : 2. They admit C into the firm for 1/4th share in profits, which he takes 1/6th from A and 1/12th from B. C brings ₹18,000 as goodwill out of his total share of ₹30,000. No Goodwill Account appears in the books of the firm. Pass necessary Journal entries to record this arrangement.

Solution: 

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
	Cash A/c Dr.		18,000
	To Premium for Goodwill A/c			18,000
	(Being the amount brought in by C as his share of goodwill)

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
	Premium for Goodwill A/c Dr.		18,000
	C’s Capital A/c Dr. (₹30,000 – ₹18,000)		12,000
	To A’s Capital A/c			20,000
	To B’s Capital A/c			10,000
	(Being the goodwill credited to the sacrificing partners in their sacrificing ratio, i.e., 2: 1)

Case 6: When New Partner is not able to bring his share of Goodwill / Premium of Goodwill in Cash

Journal Entry:

New Partner’s Capital A/c Dr. (For his share of Goodwill)

  To Sacrificing Partner’s Capital A/c's (In Sacrificing Ratio)

Illustration (New Partner is unable to bring Cash for Goodwill). A and B, who share profits in the ratio of 3: 2, had capitals of ₹2,00,000 and ₹1,50,000 respectively. They agree to admit C into partnership from 1st April, 2016 on the following terms in return for 1/3rd share in future profits:

• C should bring in ₹2,00,000 as capital.
• C is unable to bring in his share of goodwill; goodwill of the firm is valued at ₹1,50,000.

Record necessary Journal entries in the books of the firm.

Solution: 

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
2016 April	Bank A/c Dr.		2,00,000
	To C’s Capital A/c			2,00,000
	(Being the amount of capital brought in by C in the firm)

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
April 1	C’s Capital A/c Dr. (₹1,50,000 × 1/3)		50,000
	To A’s Capital A/c			30,000
	To B’s Capital A/c			20,000
	(Being the capital accounts of A and B credited in their sacrificing ratio, i.e., 3: 2, for C’s share of goodwill on his admission)

Hidden / Inferred Goodwill

Sometimes, the value of goodwill of the firm is not given; it has to be inferred on the basis of Net Worth (Capital) of the firm.

Example: A & B are two partners whose capital in the firm is ₹50,000 and ₹1,00,000 respectively. They share profits equally.

• They admit C for 1/4 share of profits.
• C brings in ₹60,000 as his share of capital.
• In this case, the total capital of the firm should be: ₹60,000 × 4 = ₹2,40,000
• But the joint capital of all three partners is: ₹2,10,000 (i.e., ₹50,000 + ₹1,00,000 + ₹60,000)
• So, the inferred goodwill is: ₹30,000 (i.e., ₹2,40,000 – ₹2,10,000)
• It will be shared equally by A and B. Value of Goodwill inferred on the basis of net worth of the firm.

Illustration (Hidden Goodwill) A and B are partners with capitals of ₹1,60,000 and ₹1,20,000 respectively. They admit C as a partner on 1st April, 2016 for 1/4th share in the profits of the firm. C brings in ₹1,60,000 as his share of capital. Give Journal entries on C’s admission.

Solution: 

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
2016 April 1	Bank A/c Dr.		1,60,000
	To C’s Capital A/c			1,60,000
	(Being the cash brought in by C for his capital)

Date	Particulars	L.F.	Dr. (₹)	Cr. (₹)
April 1	C’s Capital A/c Dr.		50,000
	To A’s Capital A/c			25,000
	To B’s Capital A/c			25,000
	(Being the credit given for goodwill to A and B on C’s admission)

Working Notes

1. In the absence of any agreement, profits are divided equally.
2. Calculation of Hidden Goodwill: C’s Capital = ₹1,60,000 for 1/4th share
• Total Capital of the New Firm = ₹1,60,000 × 4 = ₹6,40,000
• A, B and C’s actual capitals = ₹1,60,000 + ₹1,20,000 + ₹1,60,000 = ₹4,40,000

∴ Goodwill of the Firm = ₹6,40,000 – ₹4,40,000 = ₹2,00,000

Thus, C’s share of Goodwill = 1/4 × ₹2,00,000 = ₹50,000

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