Partnership Admission, Guaranteed Profit and Private Goodwill
A and B shared profits 3:2. On 1 July 2024 C was admitted, with a new profit-sharing ratio of 2:2:1. C paid €12,000 directly to A and B for goodwill; the partnership does not maintain a goodwill account. Capital balances were A €80,000, B €60,000 and C €40,000, the last introduced on admission. Current accounts at 1 January 2024 were A €5,000 Cr and B €2,000 Dr. The agreement provides interest on capital at 5% per annum, salaries of A €12,000 and B €8,000, and C a guaranteed minimum total appropriation of €18,000 for the six months to 31 December 2024. Any deficiency is borne by A and B in the ratio 3:2. Profit before appropriations for 2024 was €120,000, accruing evenly. Drawings were A €18,000, B €12,000 and C €9,000. No interest is charged on drawings.
1. Prepare the profit and loss appropriation account for the year ended 31 December 2024, splitting the profit between the pre-admission and post-admission periods.
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Pre-admission: 1 January to 30 June 2024
| € | |
|---|---|
| Profit for six months | 60,000 |
| Less interest on capital: A €2,000; B €1,500 | (3,500) |
| Less salaries: A €6,000; B €4,000 | (10,000) |
| Residual profit | 46,500 |
Residual shared A:B = 3:2: A €27,900; B €18,600.
Post-admission: 1 July to 31 December 2024
| € | |
|---|---|
| Profit for six months | 60,000 |
| Less interest on capital: A €2,000; B €1,500; C €1,000 | (4,500) |
| Less salaries: A €6,000; B €4,000 | (10,000) |
| Residual profit | 45,500 |
Residual shared A:B:C = 2:2:1: A €18,200; B €18,200; C €9,100.
C's total appropriation is interest €1,000 + residual €9,100 = €10,100. The guaranteed minimum is €18,000, so the deficiency is €7,900. A bears 3/5 = €4,740 and B bears 2/5 = €3,160.
Final shares
| Partner | Pre-admission € | Post-admission € | Total € |
|---|---|---|---|
| A | 35,900 | 21,460 | 57,360 |
| B | 24,100 | 20,540 | 44,640 |
| C | 0 | 18,000 | 18,000 |
| Total | 60,000 | 60,000 | 120,000 |
2. Prepare the partners' current accounts for the year and explain how the guarantee affects the capital accounts.
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| A € | B € | C € | |
|---|---|---|---|
| Opening balance | 5,000 Cr | 2,000 Dr | 0 |
| Share of profit | 57,360 Cr | 44,640 Cr | 18,000 Cr |
| Drawings | (18,000) Dr | (12,000) Dr | (9,000) Dr |
| Closing balance | 44,360 Cr | 30,640 Cr | 9,000 Cr |
The guarantee changes the appropriation of profit, not the capital accounts. C's capital remains €40,000 unless a further capital contribution is agreed. The deficiency is borne by A and B in their agreed ratio, so their current account shares are reduced. The guarantee does not create a liability to an outsider; it is an internal allocation among partners.
3. Explain the accounting treatment of the €12,000 paid directly to A and B for goodwill, and evaluate the suggestion that it should be credited to the partnership bank account.
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Because the partnership does not maintain a goodwill account, the €12,000 is a private transaction between the incoming partner and the existing partners. It compensates A and B for the share of goodwill they have given up. No entry is made in the partnership books: there is no increase in partnership bank and no goodwill asset. If the €12,000 were instead paid into the partnership bank account, it would be a capital contribution and would need to be credited to the partners in the agreed profit-sharing ratio, not treated as revenue. That would change the capital structure and is not the same transaction as a private goodwill payment.