Admission of a Partner: Who Really Sacrificed Goodwill?
Kabir and Riya share profits 2:1 and have capitals of ₹5,00,000 and ₹2,50,000. On 1 April 2024 they admit Sara for 1/4 share. Sara takes 3/4 of her share from Kabir and 1/4 from Riya. Goodwill of the firm is agreed at ₹6,40,000. Sara brings ₹3,00,000 as capital but no cash for goodwill. Before admission, the firm had a General Reserve of ₹90,000. On revaluation, the building is found undervalued by ₹80,000, stock is overvalued by ₹30,000, and a creditor of ₹20,000 is unrecorded. Riya argues that goodwill should be credited in the old profit-sharing ratio 2:1 because 'we built the firm together', and that Sara's capital is too low for a 1/4 share. Kabir wants the revaluation gain, if any, to be shared by all three since Sara will enjoy the revalued assets.
1. Compute the sacrifice ratio and show the journal entry for goodwill, explaining why the old ratio is inappropriate.
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Sara's 1/4 share is acquired 3/4 from Kabir and 1/4 from Riya. Kabir sacrifices 3/4 × 1/4 = 3/16; Riya sacrifices 1/4 × 1/4 = 1/16. Sacrifice ratio = 3:1.
Goodwill = ₹6,40,000; Sara's share = 1/4 × ₹6,40,000 = ₹1,60,000.
Journal entry: Sara's Capital A/c Dr 1,60,000 To Kabir's Capital A/c 1,20,000 To Riya's Capital A/c 40,000
Since Sara brings no cash for goodwill, her capital is debited and the sacrificing partners are credited. The old ratio 2:1 is wrong because Riya gave up only 1/16 while Kabir gave up 3/16. Compensating in 2:1 would over-reward Riya and under-reward Kabir; the compensation must follow the actual sacrifice. New ratio: Kabir 2/3 − 3/16 = 23/48; Riya 1/3 − 1/16 = 13/48; Sara 12/48.
2. Pass entries for revaluation and General Reserve, and compute capital balances after admission.
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Revaluation: building +₹80,000; stock −₹30,000; unrecorded creditor −₹20,000; net gain ₹30,000, shared in the old ratio 2:1: Kabir ₹20,000; Riya ₹10,000. General Reserve ₹90,000 shared 2:1: Kabir ₹60,000; Riya ₹30,000.
Capital balances:
- Kabir: 5,00,000 + 20,000 + 60,000 + 1,20,000 = ₹7,00,000
- Riya: 2,50,000 + 10,000 + 30,000 + 40,000 = ₹3,30,000
- Sara: 3,00,000 − 1,60,000 = ₹1,40,000
The revaluation gain and the reserve belong to the old partners because they arose before Sara became a partner. Sharing them with Sara would give her a windfall and contradict the sacrifice principle.
3. Evaluate Riya's claim that Sara's capital is too low. Does the firm need to revalue goodwill or raise it in the books? Explain.
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Riya's claim has substance but is not a legal rule. Sara's capital account shows ₹1,40,000 because the ₹1,60,000 goodwill debited to her has reduced the ₹3,00,000 she brought. If the agreement was that ₹3,00,000 would be her capital for a 1/4 share, she should have brought goodwill in cash as well; alternatively, the firm may ask her to bring ₹1,52,500 more so that her capital equals 1/4 of total capital of ₹11,70,000. There is no statutory minimum capital for a partner; it is a contractual matter.
Goodwill should not be raised in the books. Accounting Standard 26 prohibits recognising self-generated goodwill. The premium method used above is correct. If the firm wants proportionate capital, the admission agreement must say so expressly; otherwise Sara's lower capital is simply the consequence of adjusting hidden goodwill against her account.