Treatment of Goodwill in Partnership Accounts. CPT Section A Fundamentals of Accountancy Chapter 8 Unit 2 Part 2 CA. Ajay Lunawat

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1 Treatment of Goodwill in Partnership Accounts CPT Section A Fundamentals of Accountancy Chapter 8 Unit 2 Part 2 CA. Ajay Lunawat

2 Learning objectives Need for valuation of Goodwill Valuation of Goodwill in case of admission of partner Accounting treatment of goodwill in case of admission of a new partner change in profit sharing ratio retirement or death of a partner

3 Need for valuation of Goodwill Whenever there is any change in the existing relationship of the partners inter se, some partners have to sacrifice their future profit and some others would gain Gaining Partner Should compensate Sacrificing Partner

4 Valuation of Goodwill in case of admission of partner When a new partner is admitted into a partnership, certain adjustments in accounts become necessary New partner will acquire a share in the profits The old partners will stand to lose

5 Example of admission A and B are partners sharing profits in the ratio of 3:2 If their profits are Rs. 20,000 A will get Rs. 12,000 B will get Rs. 8,000

6 Example of admission Now C is admitted as a partner for 1/4 th share in profits If their profits are Rs. 20,000 A will get Rs. 9,000 B will get Rs. 6,000 C will get Rs. 5,000

7 An Analysis of Profits Situtation A s Share B s Share C s Share A & B are partners A, B & C are partners Impact in profits 12,000 9,000 3,000 Loss 8,000 6,000 2,000 Loss NIL 5,000 5,000 Gain C will have to compensate A & B for this loss

8 Proper Understanding of Goodwill Goodwill is a compensation to old partners for their sacrifice in connection with admission of a new partner. So it is to be credited to the partners according to their profit sacrificing ratio.

9 Calculation of Gain/Sacrifice Ratio STEP 1 Old Profit Sharing Ratio STEP 2 Less : New Profit Sharing Ratio STEP 3 Equals : Sacrifice / Gain Ratio

10 Example Sacrifice / Gain Ratio Nigam and Dhameja are in partnership sharing profits and losses equally. They agreed to take Ghosh as one-third partner. STEP 1 STEP 2 STEP 3 Nigam s Old Profit Sharing Ratio = 1 / 2 Nigam s New Profit Sharing Ratio = 1 / 3 Nigam s Sacrifice = 1/2 1/3 = 1/6

11 Example Sacrifice / Gain Ratio Nigam and Dhameja are in partnership sharing profits and losses equally. They agreed to take Ghosh as one-third partner. STEP 1 STEP 2 STEP 3 Dhameja s Old Profit Sharing Ratio = 1 / 2 Dhameja s New Profit Sharing Ratio = 1 / 3 Dhameja s Sacrifice = 1/2 1/3 = 1/6

12 Example Sacrifice / Gain Ratio Nigam s Sacrifice Dhaneja s Sacrifice Ghosh Gaining 1/6 1/6 1/3 Sacrifice Ratio = 1 : 1

13 Sharing of Goodwill Goodwill paid by Ghosh Rs. 24,000 Nigam s Share Rs. 24,000 X ½ = Rs. 12,000 Dhaneja s Share Rs. 24,000 X ½ = Rs. 12,000

14 Journal Entry Gaining Partner s Capital A/c To Sacrificing Partner s Capital A/c Dr Gaining Partner is Ghosh Sacrificing Partners are Nigam and Dhaneja Ghosh s Capital A/c Dr 24,000 To Nigam s Capital A/c 12,000 To Dhaneja s Capital A/c 12,000

15 Example Sacrifice / Gain Ratio Nigam and Dhameja are in partnership sharing profits and losses equally. They agreed to take Ghosh as a new partner. The new profit sharing ratio is 4:2:3 STEP 1 STEP 2 STEP 3 Nigam s Old Profit Sharing Ratio = 1 / 2 Nigam s New Profit Sharing Ratio = 4 / 9 Nigam s Sacrifice = 1/2 4/9 = 1/18

16 Example Sacrifice / Gain Ratio Nigam and Dhameja are in partnership sharing profits and losses equally. They agreed to take Ghosh as a new partner. The new profit sharing ratio is 4:2:3 STEP 1 STEP 2 STEP 3 Dhameja s Old Profit Sharing Ratio = 1 / 2 Dhameja s New Profit Sharing Ratio = 2 / 9 Dhameja s Sacrifice = 1/2 2/9 = 5/18

17 Sharing of Goodwill Goodwill paid by Ghosh Rs. 24,000 Nigam s Share Rs. 24,000 X 1/6 = Rs 4,000 Dhaneja s Share Rs. 24,000 X 5/6 = Rs. 20,000

18 Example Sacrifice / Gain Ratio Nigam s Sacrifice Dhaneja s Sacrifice Ghosh Gaining 1/18 5/18 1/3 Sacrifice Ratio = 1 : 5

19 Journal Entry Gaining Partner s Capital A/c To Sacrificing Partner s Capital A/c Dr Gaining Partner is Ghosh Sacrificing Partners are Nigam and Dhaneja Ghosh s Capital A/c Dr 24,000 To Nigam s Capital A/c 4,000 To Dhaneja s Capital A/c 20,000

20 Sacrifice / Gain Situations New Profit Sharing Ratio > Old Profit Sharing Ratio New Profit Sharing Ratio < Old Profit Sharing Ratio Partner will Gain Partner will Sacrifice

21 Incoming Partner brings Goodwill in Cash Incoming partner brings any premium for Goodwill It will be distributed to other existing partners. On the basis of profit sacrificing ratio.

22 Example Goodwill brought in Cash A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital and 10,000 as premium for goodwill. Pass necessary Journal Entries

23 Solution Entry for Capital A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital and 10,000 as premium for goodwill. Pass necessary Journal Entries Entry for Capital Bank A/c Dr. 40,000 To D s Capital A/c 40,000 (Being capital and goodwill brought by the new partner)

24 Solution Calculation of Ratios A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital and Rs. 10,000 as premium for goodwill. Pass necessary Journal Entries Balance Share for A, B & C after D s admission= 1 1/5 = 4/5 A s share = 4/5 X 2/5 = 8/25 B s share = 4/5 X 2/5 = 8/25 C s share = 4/5 X 1/5 = 4/25 D s share = 1/5 = 5/25 New Profit Sharing Ratio = 8 : 8 : 4 : 5 A B C Old Ratio 2/5 2/5 1/5

25 Solution Sacrifice Ratio A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital and 10,000 as premium for goodwill. Pass necessary Journal Entries New Profit Sharing Ratio = 8 : 8 : 4 : 5 A B C Old Ratio 2/5 2/5 1/5 New Ratio 8/25 8/25 4/25 Sacrifice Ratio 2/25 2/25 1/25 Sacrifice Ratio = 2:2:1

26 Solution Entry for Goodwill A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital and 10,000 as premium for goodwill. Pass necessary Journal Entries Entry for Goodwill D s Capital A/c Dr. 10,000 To A s Capital A/c 4,000 To B s Capital A/c 4,000 To C s Capital A/c 2,000 (Being goodwill distributed to partners in sacrifice ratio)

27 Goodwill withdrawn by partners In the previous example, if the partners withdraw their share of goodwill, the journal entries will be : Entry for withdrawal of Goodwill A s Capital A/c Dr. 4,000 B s Capital A/c Dr. 4,000 C s Capital A/c Dr. 2,000 To Bank 10,000 (Being goodwill withdrawn by partners)

28 Incoming Partner does not bring Goodwill in Cash Incoming partner does not brings any premium for Goodwill The value of goodwill should not be raised in the books since it is inherent goodwill It is preferable that such value of goodwill should be adjusted through partners capital accounts.

29 Example Goodwill not brought in Cash A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital. He does not bring Rs. 10,000 as premium for goodwill. Pass necessary Journal Entries

30 Solution Entry for Capital A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital. He does not bring Rs. 10,000 as premium for goodwill. Pass necessary Journal Entries Entry for Capital Bank A/c Dr. 30,000 To D s Capital A/c 30,000 (Being capital brought by the new partner)

31 Solution Entry for Goodwill A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit D into partnership with one-fifth share. D brings in Rs. 30,000 as capital. He does not bring Rs. 10,000 as premium for goodwill. Pass necessary Journal Entries Entry for Goodwill D s Capital A/c Dr. 10,000 To A s Capital A/c 4,000 To B s Capital A/c 4,000 To C s Capital A/c 2,000 (Being goodwill distributed to partners in sacrifice ratio)

32 Incoming Partner pays privately to Partners Incoming partner pays any premium for goodwill privately to the existing partners No entry is required in the books of the firm Amount to be paid to each partner should be calculated as per the profit sacrificing ratio

33 Example : Change in PSR A, B & C are equal partners. They wanted to change the profit sharing ratio into 4:3:2. The goodwill of the firm is Rs. 90,000. Make the necessary journal entries A B C Old Ratio 1/3 1/3 1/3 New Ratio 4/9 3/9 2/9 Change in Ratio 1/9 (Gain) No change 1/9 (Sacrifice) Entry for Goodwill A s Capital A/c Dr. 10,000 To C s Capital A/c 10,000 (Being 1/9 of Rs. 90,000 = Rs. 10,000 being compensated by A to C)

34 Example : Retirement A, B & C are equal partners. C wanted to retire for which value of goodwill is considered as Rs 90,000. Retiring Partner C s share of Goodwill = Rs.90,000 X 1/3 = Rs. 30,000 Continuing Partner s i.e. A & B will gain after C s retirement equally Hence, they share compensate C for his share of goodwill in their gain ratio i.e. 1 : 1 Entry for Goodwill A s Capital A/c Dr. 15,000 B s Capital A/c Dr. 15,000 To C s Capital A/c 30,000 (Being 1/9 of Rs. 90,000 = Rs. 10,000 being compensated by A to C)

35 Question 1 Goodwill brought in by incoming partner in cash for joining in a partnership firm is taken away by the old partners in their ratio. (a) Capital. (b) New Profit Sharing. (c) Sacrificing. (d) Old Profit Sharing. Ans (c)

Question 2 The capital of B and D are Rs 90,000 and Rs 30,000 respectively with the profit sharing ratio 3:1. The new ratio, admissible after 01.04.2011 is 5:3. The goodwill is valued Rs.

36 Question 2 The capital of B and D are Rs 90,000 and Rs 30,000 respectively with the profit sharing ratio 3:1. The new ratio, admissible after is 5:3. The goodwill is valued Rs. 80,000 as on that date. Amount payable by a gaining partner to a sacrificing partner is: (a) B will pay to D Rs. 10,000. (b) D will pay to B Rs. 10,000. (c) B will pay to D Rs. 80,000. (d) D will pay to B Rs. 80,000. Ans (b)

37 Question 3 X and Y share profits and losses in the ratio of 2 : 1. They take Z as a partner and the new profit sharing ratio becomes 3 : 2 : 1. Z brings Rs. 4,500 as premium for goodwill. The full value of goodwill will be (a) Rs. 4,500 (b) Rs. 18,000 (c) Rs. 27,000 (d) Rs. 24,000 Ans (c)

38 THANK YOU!!!

Necessity for valuation of goodwill

Necessity for valuation of goodwill PARTNERSHIP ACCOUNTS 8.27 UNIT2 : TREATMENT OF GOODWILL IN PARTNERSHIP ACCOUNTS LEARNING OUTCOMES After studying this unit, you will be able to: Understand when does the need for valuation of goodwill