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When the New Partner Brings His Share of Goodwill in Cash

When the new partner brings his share of goodwill in cash, the payment may be made to the old partners as an outside/private transaction or it may be retained in the business after recording the same in the books of the firm. The old partners may withdraw the whole amount or some portion only.
 

When the amount of goodwill brought by the new partner is not recorded in the books and the payment is made to the old partners as an outside or private transaction, it does not affect the transactions of the firm and hence, no entry is passed in the books of the firm.
 

When the amount of goodwill brought in by the new partner is retained in the business to increase cash resources, and if no goodwill exists at the time of admission, then the following entries are passed.
 

 

Note: Cash can also be retained in business as working capital. In such case, we do not pass the withdrawal entry.

 

Illustration 4

 

[Treatment of goodwill when an incoming partner brings in his share of the firm’s goodwill in cash]

 

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 1/5th share. Z acquires his share from X and Y in the ratio of 2 : 3. The goodwill of the firm has been valued at ₹ 12,500. Z brings in the necessary amount in cash as his share of the firm’s goodwill and ₹ 50,000 as his capital. Pass the necessary journal entries under each of the following alternative cases:

  1. When no goodwill appears in the books and the amount of goodwill is retained in the firm
  2. When no goodwill appears in the books and the amount of goodwill is withdrawn by the concerned partners to the extent of 30% of what is credited to them
  3. When goodwill appears in the books at ₹ 10,000

Case (a)


 

Case (b)

 

Case (c)

 

When the new partner brings his share of goodwill in kind

The new partner may bring his share of goodwill and capital in kind i.e. in the form of assets instead of in cash. In such a situation, the assets brought in are debited and the incoming partner’s capital account is credited with capital brought in and Premium account is credited with amount of Goodwill brought in.

 

Afterwards, incoming partner’s share of goodwill is transferred by debiting the Premium Account and crediting the capital accounts of the Sacrificing partners in their sacrificing ratio.



Illustration 5 [When the incoming partner brings his share of goodwill in kind]

 

X and Y are partners in a firm sharing profits in the ratio of 3 : 2. On January 1, 2014, they admit Z as a new partner for 3/13th share in the profits. The new ratio will be 5 : 5 : 3. Z contributed the following assets towards his capital and for his share of goodwill.

 

Stock ₹ 40,000, debtors ₹ 35,000, land ₹ 25,000, and plant and machinery ₹ 45,000. On the date of admission of Z, the goodwill of the firm was valued at ₹ 3,25,000. Record the necessary journal entries in the books of the firm on Z’s admission.

 

Solution:

 

Journal X, Y and Z

 


 

Working Note:

 

When the new partner is unable to bring his share of goodwill in cash or kind

Situation 1 – If goodwill is not existing in the Balance Sheet

 

In such case raise the full value of goodwill by crediting the old partner in old profit sharing ratio by passing the following entry.
 

Journal entry for raising goodwill
 



After the above entry goodwill account will appear in the Balance Sheet at full value. As per AS 26 self-generated goodwill will not appear in the Balance Sheet. In order to comply with AS 26 the said goodwill need to be written off by debiting all partner’s capital accounts (including the new partner) in new profit sharing ratio.

 

Journal entry for writing off existing goodwill


 

Note: Instead of the above, two entries we can make the goodwill adjustment entry through partner’s capital accounts.



Situation 2 – If goodwill is already existing in Balance Sheet

 

Sometimes the new partner may not bring his share of goodwill. In this case, we will have to first see if there any goodwill already exists or not. If any goodwill already exists then firstly, it should be written off by debiting old partners’ capital A/c and crediting goodwill A/c. Then the full value of goodwill has to be raised by crediting old partner’s capital.
 

Journal entry for writing off existing goodwill
 


 

After writing off the existing goodwill, the following steps should be followed:

  • Calculate the share of goodwill of incoming partner
  • Debit the new partner’s capital A/c with his share of goodwill and credit old partners’ capital A/c with the amount of in their sacrificing ratio


 

Note: Goodwill account should not be raised in the books complying AS - 26.

 

Illustration 6

 

X and Y are partners sharing profit in the ratio of 3: 2. They agree to admit Z for 1/5th share in future profit. Z brings ₹ 5, 00,000 as capital and is unable to bring his share of goodwill in cash. The goodwill of the firm is to be valued at ₹ 3, 60,000. Pass necessary journal entries if:

 

Solution

 

a) No goodwill exists in the books

 

Journal entries in the books of X, Y and Z

 


 

b) At the time of admission, goodwill existed in the books of the firm at ₹ 1,60,000

 


 

Working Note 1 : Calculation of new profit sharing ratio:

 

Let total profit = 1

 

New partner’s share = 1/5

 

Remaining share = 1 - 1/5 = 4/5

 

X’s new share = 3/5 of 4/5 i.e. 12/25

 

Y’s new share = 2/5 of 4/5 i.e. 8/25

 

Z’s Share = 1/5

 

The new profit sharing ratio of X, Y and Z is:

 

= 12/25: 8/25 : 1/5 = 12 : 8 : 5 = 12 : 8 : 5
 

Working note 2: Calculation of sacrificing ratio

 

As only share of new partner is given, it is presumed that sacrifice ratio is equal to their old ratio i.e., 3 : 2

 

Working note 3: Calculation of goodwill

 

Z’s share of goodwill = ₹ 3,60,000 x 1/5 = ₹ 72,000

Z’s share of goodwill is distributed among X and Y in their sacrificing ratio. Therefore,

X’s share = ₹ 72,000 x 3/5 = ₹ 43,200

When the new partner can bring only a portion of his share of goodwill

When the new partner cannot bring the entire amount of his share of goodwill and he brings only a part of this, it is shared by the old partners in the sacrificing ratio. For the balance amount of goodwill which is not brought in by the new partner will be debited to his capital account and will be credited to old partner’s capital account in sacrifice ratio.
 

But it should be noted that, if there exists any goodwill in the books, first it should be written off by crediting to the old partners in the old ratio. Therefore, the entries are:
 


Illustration 7 [Treatment of goodwill when incoming partner brings in only a part of his share of firm’s goodwill in cash]

 

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 1/5th share. Z acquires his share from X and Y in the ratio of 2 : 3. The goodwill of the firm has been valued at ₹ 50,000. Z brings in only 60% of his requisite share of the firm’s goodwill and ₹ 2,00,000 as his capital in cash. Pass the necessary journal entries under each of the following alternative cases:

  1. When no goodwill appears in the books & the amount of goodwill brought in is retained in the firm
  2. When no goodwill appears in the books and the amount of goodwill brought in cash is withdrawn by the concerned partners to the extent of 30% of what is credited to them
  3. When goodwill appears in the books at ₹ 40,000

Solution:

 

Journal entries in the book of X, Y & Z

 







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