Treatment of Goodwill in Admission of a Partner
Goodwill plays a crucial role in the admission of a new partner in a partnership firm. It reflects the intangible value of the business, affecting the distribution of profits among partners. Methods of treating goodwill include recognizing it as an asset only when paid for, adjusting it through partners' capital accounts, and distributing it among old partners based on their sacrifice ratio. Accounting treatments involve bringing in cash for goodwill, revaluing existing goodwill, and adjusting partners' capital accordingly.
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ADMISSION OF A PARTNER Treatment of Goodwill
Goodwill refers to the value attached to the capacity of a business to earn above normal profits. Goodwill which is an intangible asset depends on a number of factors, some of which are: Past profits Present profit earning capacity Future prospects of the business Quality of goods and services Monopoly power enjoyed Employee efficiency Efficiency of management, etc
In case of a partnership firm goodwill is valued and taken into account when there is reconstitution of the firm. When a new partner is admitted he gets a share in the future profits of the business and this will reduce the share of profits available to the existing partners. Thus old partners sacrifice in favour of the new partner and the new partner gets a share in the profits of the business. For enjoying the right to participate in the future profits of the firm, the incoming partner has to pay compensation to the old partners who sacrifice a portion of their own respective share of profit. This compensation is called Premium or Goodwill. The goodwill of the firm is valued according to the agreement between the existing partners and the new partner.
Methods of treatment of Goodwill As per AS 10 goodwill should be recognised in the books only when some consideration in money or money s worth has been paid for it Whenever a business is acquired for a price, which is in excess of the value of the net assets of the business taken over, the excess should be termed as goodwill AS 26 on intangible assets also states that internally generated goodwill should not be recognised as an asset On admission the value of goodwill should not be raised in the books, rather it should be adjusted through concerned partner s capital account
Accounting Treatment For Goodwill A] New partner brings in his share of goodwill in cash and is retained in the business. For bringing goodwill in cash: Cash A/c Dr. To new partner s capital A/c For distribution of goodwill among old partners [in the sacrifice ratio] New partner s Capital A/c Dr. To Old partners Capital A/c
B] Goodwill already appears in the books and it is revalued. To write off the existing goodwill Old partner s Capital A/c Dr. To Goodwill A/c (in the old ratio) Goodwill revalued[to the extent of new partner s share] New partner s capital A/c Dr. To old partner s capital A/c (sacrifice ratio)
C] Goodwill already appears in the books and the new partner brings his share of goodwill in cash. To write off existing goodwill Old partner s capital A/c Dr. To Goodwill A/c (old ratio) For goodwill brought in cash Bank A/c Dr. To new partner s capital A/c For distribution of goodwill among old partners (sacrifice ratio) New partners capital A/c Dr. To old partner s capital A/c
D] Where goodwill is created or raised. New partner s capital A/c Dr. (with his share of goodwill) To old partner s capital A/c
