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Accountancy

Recommendation of Accounting Standard 10 (AS-10) – Issued by The Institute of Chartered Accountants of India

According to AS-10 goodwill should be recorded in the books only when some consideration in money or money’s worth has been paid for it. Thus, in case of admission or retirement/death of a partner or in case of change in profit sharing ratio among partners, goodwill, following the accounting standard should not be raised in the books of the firm because no consideration in money or money worth is paid for it. If any partner brings any premium over and above his capital contribution at the time of his admission, such premium should be distributed to other existing partners.

If goodwill is evaluated at the time of change in the constitution of the firm (by way of admission/retirement/death/change in profit sharing ratio), goodwill should not be brought in books since it is inherent goodwill. If it is raised then it should be immediately written off.

Treatment of goodwill

Goodwill of a firm is the result of the efforts made by the existing partners in the past. Therefore, at the time of admission, the new partner who acquires right to share future profit should compensate the existing partners by making payment to them. Such payment is called premium (goodwill). Goodwill is a way for compensating exiting partners for the sacrifice they make on the admission of a new partner. Form accounting point of view, there may be different situations related to treatment of goodwill which are given below:

Case 1. The new partner brings his share of premium (goodwill) in cash and the same is paid to old partners privately (i.e. outside the business). In this case, no journal entry is to be made in the books of accounts for premium.

Illustration 1. (When goodwill is paid privately) A, B and C are partners in firm sharing profits in the ratio of 3:2:1. On April 1, 2003 they admit D as a new partner for 1/4th share. D paid Rs. 30,000 privately to A, B and C as his share of premium. Record the accounting treatment, if any, in the books of A, B and C for the same.

Solution: Since D has paid goodwill premium to A, B and C privately outside the business, hence no journal entry will be recorded in the books of the firm.

Case 2. When new partner brings goodwill/premium in cash which is retained in the business.

Journal Entries:

1. Cash/Bank A/c ………………Dr. (Goodwill + Capital amount)
   To Premium/Goodwill A/c (Goodwill Amount)
   To New partner’s capital A/c (Capital amount)
   (Being cash brought by new partners as his share of goodwill and capital)
2. Premium A/c ……………….Dr.
   To Sacrificing Partner’s Capital/Current A/c
   (Being Premium for goodwill is shared by existing partners in their sacrificing ratio)
   Alternatively, entry nos. (i) and (ii) may be combined as under:
   Cash/Bank A/c ……………..Dr.
   To Sacrificing Partners’ Capital/Current A/c

Illustration 2. (When brought in cash and retained in business) Lakshmi and Ganesh are partners in a business and sharing profits and losses in the ratio of 3:2 respectively. Their capitals are Rs. 40,0000 and 20,000 respectively. They admit Shanker and give him 1/6 share of future profits on the following terms. That (a) Shanker has to bring Rs. 25,000 as his capital, and (b) Rs. 5,000 as his share of Goodwill. Give Journal entries these transactions.

Illustration 3. Ram and Shyam are partners sharing profits and losses in the ratio of 4:1. Their capitals are Rs. 50,000 and Rs, 30,000. They agreed to admit Mohan into the partnership on April 1, 2003 for 1/3rd share in profit. It was agreed that Ram, Shyam and Mohan would share profits equally in future. Mohan brought Rs. 50,000 as goodwill (premium) for his 1/3rd share in profits and Rs. 70,000 as his capital. Record the necessary Journal entries in the books of the firm.

Working Notes:
     Calculation of Sacrificing Ratio:
                     Sacrificing Ratio = Old Raito – New Ratio
                     Ram’s Sacrifice =
                     Shyam’s Sacrifice (gain) =
Since Shayam is gaining equal in the profits, therefore, he will also have compensate Ram proportionately.

For   Share Mohan brought Rs. 50,000 as premium. Therefore Shyam compensate Ram by

Illustration 4. On 1st January, 2003, A and B, sharing profits 2/3 and 1/3 respectively, agree to admit C into partnership on condition that he pays Rs. 30,000 as capital and Rs. 9,000 for 1/6 share of goodwill which he acquires equally from A and B.

Journal Entries

Case 3. When goodwill is brought in by the new partner and premium money is withdrawn by the old partners fully or partially

Journal Entries:

Sacrificing Partner’s Capital A/c ………….Dr [Amount withdrawn by Sacrificing partners]
To Cash/Bank A/c

Illustration 5. In the illustration 4.

1. If the full amount of goodwill withdrawn by the old partners.
2. If half of the amount is withdrawn by the old partners
   

Solution:

Journal Entries

Case 4. When new partner brings his share of premium/goodwill in kind.

1. Assets A/c …………………….Dr. (Individually)
   To New Partner’s Capital A/c
   To Premium (Goodwill) A/c
   (Being assets contributed by new partner on his admission as his capital and his share of goodwill premium)
2. Premium A/c ………………….Dr.
   To Sacrificing Partners’ Capital A/cs
   (Being Premium for goodwill is shared by existing partners in their sacrificing ratio)

Illustration 6. (Admission of a partner who brings in capital and goodwill in cash and kind) A and B carried in the ratio of 2:1 respectively. They admitted C on 1st April, 2003, for 2/7ths share. The actual value of goodwill, however, on that date was Rs. 21,000. C contributed the following assets towards payment of his capital and goodwill:

Pass necessary entries in the journal to give effect to the above. Also gives the new profit-sharing ratio of the new partners.

Solution:

Journal Entries

Working Note:

1. Calculation of New Profit-Sharing Ratio:
   A’s Share =2/3 of 5/7 = 10/21
   B’s Share =1/3 of 5/7 =5/21
   C’s Share 2/7 of 3/3 = 6/21
   New Ratio 10:5:6
2. C’s share in goodwill = Rs. 21,000 2/7=Rs. 6,000
3. Calculation of sacrificing ratio:
   A’s Sacrificing = 2/3 – 10/21 = 12/23
   B’s Sacrificing = 1/3 – 5/21 =6/23
   Thus, Sacrificing Ratio between A & B = 2:1
   

Illustration 7. (Premium brought in kind) X and Y are partners in a firm sharing profits in the ratio of 3:2. On April 1, 2003 they admit Z as a new partner for 3/13 share in the profits. The new ratio will be 5:5:3. Z contributed the following assets towards his capital and his share for goodwill:

On the Admission of Z, the goodwill of the firm was valued at Rs. 10,40,000. Record necessary Journal entries in the books of the firm on Z’s Admission and prepare Z’s Capital account.

Solution:

Journal Entries

Working Note:

1. Z’s share of goodwill =
2. Calculation of sacrificing Ratio of X and Y
   Sacrifice = old Share- New Share
   X’s Sacrifice =
   Y’s Sacrifice =
   Sacrificing Ratio of X and Y is 14:1 or
3. Amount to be credited towards premium to X’s capital account will be
   
   Amount to be credited to Y’s Capital account will be
   

Z’s Capital Accounts

Case 5. When new partner is unable to bring cash for goodwill partially

1. Cash A/c ………………………Dr. [Amount brought by the new partner in cash as goodwill out of his share of goodwill] To Premium A/c
2. Premium A/c…………………..Dr. [Amount brought by the new partner in cash as goodwill out of his share of goodwill] New Partner’s Capital A/c ……Dr. [Portion of the premium unable to bring by the new partner in cash] To Sacrificing Partner’s Capital A/c [Total share of goodwill of the new Partner in sacrificing ratio]

Illustration 8. A and B are partners sharing profits in the ratio of 5:3. They admit C into the firm fro 3/10th profit which he takes 2/10th from A and 1/10th from B and brings Rs. 1,500 as premium in cash out of his share of Rs. 3,900. Goodwill account does not appear in the books of A and B. Give Journal entries and the new ratio of A, B and C.

Solution: Calculation of new ratio:

1. 
2. 
3. 
   New Profit Sharing Ratio of A, B & C = 17:11:12

Journal Entries

Case 6. When the new partner is not able to bring his share of goodwill/premium in cash entirely.

New Partner’s Capital A/c …………..Dr. [For his share of goodwill)

To Sacrificing Partner’s Capital A/c [in sacrificing ratio]

Illustration 9. (The new partner is unable to bring cash for goodwill) A and B who share profits in proportion of 3 and 2 had capitals of Rs. 2,00,000 and Rs. 1,50,000 respectively. They agree to admit C into partnership as from 1st Jan. 2003, on the following terms in return for one third share in future profits:

1. That C should bring in Rs. 2,00,000 as capital.
2. That as C is unable to bring his share of goodwill in cash, the goodwill of the firm be valued at Rs. 1,50,000. Record necessary Journal entries in the books of the firm.

Solution:

Journal Entries

Note: Since the new profit sharing ratio in not given here, A and B will sacrifice their profit in favour of C in their old profit sharing ratio, i.e. 3:2. Therefore, the sacrificing ratio will be 3:2.

Total Goodwill = Rs. 1,50,000

C’s share in profit =

C’s share of goodwill =

Case 7. (When goodwill account already appeared in the books) Generally, the goodwill, being of intangible nature and is separable from the business, is not shown in the books of a going concern. However, sometimes existing partners of a firm may decide to revalue assets along with goodwill in the event of the reconstitution of the firm. If in any case, goodwill appears in the balance sheet of a before the admission of a new partner it should be closed by passing the following entry:
Old Partner’s Capital A/cs …………….Dr. [Old Profit-sharing ratio]
To Goodwill A/c [Goodwill existing in the Balance Sheet]

Illustration 10. (Goodwill exiting in the books at the time admission). X and Y are partners in affirm sharing profits in the ratio of 4:3. On April, 2003 they admitted Z as a new partner. Z brought Rs. 1,00,000 for his capital and RS. 21,000 for 1/3rd share of goodwill premium. On Z’s admission goodwill appeared in the books of the firm at Rs. 28,000. Record necessary Journal entries on Z’s admission.

Solution:

Journal Entries

Illustration 11. (Incapable to bring premium in cash and Goodwill account existing at the time of admission) A and B are partners sharing profit in the ratio of 3:2. On Jan. 1 2003, they admit C as new partner. The new profit sharing ratio of 4:3:2. C brought Rs. 2,00,000 for his capital but could not bring any share of goodwill. The firm’s goodwill on C’s admission was valued at Rs. 2,70,000. AT the time of C’s admission goodwill existed in the books of the firm at Rs. 1,60,000. Record necessary Journal entries on C’s admission.

Solution:

Journal Entries

Working Note:
     A’s Sacrifice =
     B’ Sacrifice =
Sacrificing Ratio = 7:3
     C’s share of goodwill=
     A’s Capital Account will be credited by
                    
     B’s Capital account will be credited by
                    

Case 8. Hidden or Inferred Goodwill: Sometimes amount of goodwill is not given clearly but it is calculated on the basis of an inferred method of profit-sharing ratio or capitalization.
How to calculate Hidden Goodwill:

Step 1. Calculation of total capital of the firm on the basis of new partner’s capital:
                Total Capital =
Step 2. Calculation of actual capital of the firm.
                Actual capital = Sum of the capital of all partner including new
   partner’s capital
                                Step 3. Calculation of Goodwill:
                                                Goodwill = Total Capital – Actual Capital

Illustration 12. (Hidden Goodwill). A and B are partners with capitals of Rs. 1,60,000 and Rs. 1,20,000 respectively. They admit C as a partner on Jan. 1, 2003, for 1/4th share in the profits of the firm. C brings Rs. 1,60,000 as his share of capital. Give Journal entries on C’s admission.

Solution:

Journal Entries

Working Notes:

1. In the absence of any agreement profits and divided equally.
2. Calculation of Hidden Goodwill
   C’s Capital = Rs. 1,60,000
   C’s Share = ¼
   (i) Total Capital of new Firm = Rs. 1,60,000 4
   = Rs. 6,40,000
   (ii) A, B and C’s Capital = Rs. 1,60,000+Rs. 1,20,000_Rs. 1,60,000
   = Rs. 4,40,000
   Goodwill of the firm. = 6,40,000-4,40,000 = 1,00,000.