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Treatment of Goodwill

The retiring partner is entitled to his/her share of goodwill at the time of retirement because the goodwill is the result of the efforts of all partners including the retiring one in the past. When a partner retires from the firm, the continuing partners will gain in future profits. The retiring partner is compensated for his/her share of goodwill by the continuing partners who gains, in their gaining ratio.

 

Goodwill is recorded in the books only when some consideration in money is paid for it. Therefore, goodwill is recorded in the books only when it is purchased. In case of reconstitution of a partnership firm, goodwill cannot be raised in the books of accounts as a consideration for the same is not paid.
 

If the goodwill is not bought/recorded in the books, such goodwill should be adjusted through the capital accounts of the partners. The following journal entries are passed in case of retirement of a partner.
 

Case 1: When goodwill is raised with full value

 


After the above entry goodwill will appear in the Balance Sheet with full value. As per As 26 self-generated goodwill cannot be shown in the balance sheet. Hence, the above goodwill will be written off by continuing partner’s in the new profit sharing ratio by passing the following entry.

 

 

Case 2: When goodwill adjustment entry need to be made through partner’s capital accounts without raising goodwill in the book.
 



Illustration – 4

 

X, Y & Z are partners sharing profit and losses in the ratio of 3:2:1. Z retires. The new ratio between X:Y is 1:1. Goodwill value of the firm is Rs 60,000/-. Pass the goodwill adjustment entry in the following situations
 

Solution:

 

a) When goodwill is raised with full value and then written off.
 



After the above entry goodwill will appear in the Balance Sheet at Rs 60,000/-. As it is self-generated it cannot be shown in the balance sheet as per As 26. It will be written off by continuing partners in new ratio by passing the following entry.

 



b) When goodwill adjustment entry need to be made through partner’s capital accounts without raising goodwill.

 

 

Note: In this case as Y is the gainer, he should compensate the retiring partner.


Case 3: When goodwill is already appearing in the Balance Sheet.

 



Illustration - 5

 

X, Y and Z are partners sharing profit in the ratio of 3: 2: 1. Y retires and on the date of Y’s retirement, goodwill is valued at ₹ 75,000. Goodwill already appears in the books at a value of ₹ 48,000. New ratio of X and Y is 3: 2. Pass the necessary journal entries.
 

Solution:

 

Journal entries
 



Working note:

Y’s share of goodwill = ₹ 75,000 × 2/6 = ₹ 25,000

 

Gaining ratio = New ratio – Existing ratio

 

X’s gain = 3/5 – 3/6 = (18 – 15)/30 = 3/30

 

Z’s gain = 2/5 – 1/6 = (12 – 5)/30 = 7/30

 

Gaining ratio between X and Z = 3 : 7
 

Illustration – 6

 

X, Y and Z are partners sharing profits equally. Z retires and the goodwill of the firm is valued at ₹ 48,000. No goodwill appears in the books of the firm. X and Y share future profits in the ratio of 3:2. Pass necessary journal entries.
 

Solution:

 

Journal entries



Working note:

Z’s share of goodwill = ₹ 48,000 × 1/3 = ₹ 16,000

 

Gaining ratio = New ratio – Existing ratio

 

X’s gain = 3/5 – 1/3 = (9 – 5)/15 = 4/15

 

Y’s gain = 2/5 - 1/3 = (6 – 5)/ 15 = 1/15

 

Gaining ratio between X and Y= 4 : 1





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