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Goodwill Adjustments on Admission – Treatment Methods

Introduction

Goodwill is the reputation of the firm earned by the hard work of Old Partners. When a new partner joins, he gets a share of future profits without doing past hard work. Hence, he must compensate the Old Partners. This compensation is called Premium for Goodwill.

Methods of Treatment

There are primarily two situations based on AS-26 (Accounting Standard 26 - Intangible Assets):

Case 1: Premium Method (Goodwill brought in Cash)

When the new partner brings his share of goodwill in cash. Reference: AS-26 allows recording goodwill only if money is paid for it.

Journal Entries:

  1. For Capital & Goodwill brought in cash:

Bank A/c ...Dr (Total) To New Partner's Capital A/c (Capital Amount) To Premium for Goodwill A/c (Goodwill Amount)


2.  **Distribution to Old Partners**:
```text
Premium for Goodwill A/c ...Dr (Goodwill Amount)
To Old Partners' Capital A/c   (Share in SR)

(In SACRIFICING RATIO)

  1. If Old Partners withdraw the cash (Optional):

Old Partners' Capital A/c ...Dr (Amount Withdrawn) To Bank A/c (Amount Withdrawn)


### Case 2: Revaluation Method (Goodwill NOT brought in Cash)
When the new partner is unable to bring goodwill in cash.
*Adjustment is done through Current Accounts (Modern Approach as per AS-26).*

**Entry**:
```text
New Partner's Current A/c ...Dr (Share of Goodwill)
To Old Partners' Capital A/c    (Share in SR)

(In SACRIFICING RATIO)

Note: Determining Sacrificing Ratio (Old - New) is critical here.

Illustration (Premium Method)

Problem: A and B are partners (3:2). They admit C for 1/5 share. C brings ₹50,000 as Capital and ₹10,000 as Goodwill. A and B sacrifice in 3:2 ratio.

Entries:

  1. Bank A/c Dr 60,000

    To C's Capital A/c              50,000
To Premium for Goodwill A/c     10,000

  2. Premium for Goodwill A/c Dr 10,000

    To A's Capital A/c (3/5)        6,000
To B's Capital A/c (2/5)        4,000

    (Distributed in Sacrificing Ratio)

Hidden Goodwill

Sometimes, the value of goodwill is not given but implied by the capital brought by the new partner.

Steps:

  1. Calculate Total Capital of firm based on New Partner's Capital.
    • (e.g., C brings 1 Lakh for 1/4th share => Total Capital = 4 Lakhs).
  2. Calculate Actual Combined Capital (A + B + C's Capital + Reserves).
  3. Hidden Goodwill = Step 1 - Step 2.

Exam Notes: Writing the Answer

Question: "Give Journal entries for Goodwill when new partner brings it in cash." (5 Marks)

Checklist:

  • Mention Premium for Goodwill A/c.
  • Crucial Point: Must mention "Distributed in Sacrificing Ratio". Usage of Old Ratio here is a fatal error.
  • If question mentions "Goodwill already appears in books", first WRITE IT OF (Debit Old Partners, Credit Goodwill) in Old Ratio, then pass the new entries. AS-26 prohibits showing self-generated goodwill in Balance Sheet.

Summary

  • Purpose: Compensation for sacrifice.
  • Ratio: Sacrificing Ratio (SR).
  • Cash Brought: Credit "Premium for Goodwill".
  • Cash NOT Brought: Debit New Partner's Current A/c.
  • Existing Goodwill: Write off immediately in Old Ratio.

Quiz Time! 🎯

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