Arun and Bala: Admitting Chandru Without Breaking the Capital Structure
Arun and Bala have shared profits in the ratio 3:2, and on 31 March 2024 their capital accounts stood at ₹3,30,000 and ₹2,20,000 respectively. On 1 April 2024 they admitted Chandru for a 1/5 share, of which 3/25 was surrendered by Arun and 2/25 by Bala. Chandru brought ₹1,20,000 as capital and ₹15,000 as his share of goodwill, both in cash. The firm's goodwill was valued at ₹75,000. Before admission it was discovered that stock was overvalued by ₹8,000, plant was undervalued by ₹18,000, a provision for doubtful debts at 5% was needed on debtors of ₹60,000 (no provision existed), and a supplier's bill for ₹4,000 received in March had not been recorded. The partners agreed to record all of these before admitting Chandru, and Chandru agreed to bring in any further cash needed to make his capital proportionate to his share of the reconstituted firm.
1. Work out the new profit-sharing ratio and the sacrificing ratio, and show how the goodwill brought in cash is dealt with. What entry would be passed if Chandru did not bring the goodwill in cash?
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New ratio: Chandru's 1/5 = 5/25. Arun = 15/25 − 3/25 = 12/25; Bala = 10/25 − 2/25 = 8/25; Chandru = 5/25. New ratio 12:8:5.
Sacrificing ratio: Arun 3/25, Bala 2/25 = 3:2, identical to the old ratio only because the surrender was deliberately made in that proportion.
Goodwill: Chandru's share of the firm's goodwill = 1/5 × 75,000 = ₹15,000, exactly the cash he brings. It is not retained by the firm as income; it compensates the partners who gave up a share of future profits:
Bank A/c Dr 15,000 To Arun's Capital A/c 9,000 To Bala's Capital A/c 6,000
If goodwill is not brought in cash: Chandru's Capital A/c Dr 15,000, To Arun's Capital A/c 9,000, To Bala's Capital A/c 6,000. Chandru then pays for goodwill out of his own capital, which falls to ₹1,05,000, and the firm's bank balance is ₹15,000 lower. The distribution between the old partners is unchanged - that is the test of a correct treatment.
2. Prepare the Revaluation Account and the partners' capital accounts on admission, and determine how much additional cash Chandru must bring in to make his capital proportionate.
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Revaluation Account
| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| To Stock | 8,000 | By Plant | 18,000 |
| To Provision for Doubtful Debts | 3,000 | ||
| To Sundry Creditors (unrecorded bill) | 4,000 | ||
| To Partners' Capital A/cs: Arun 1,800, Bala 1,200 | 3,000 | ||
| 18,000 | 18,000 |
Capital Accounts
| Arun ₹ | Bala ₹ | Chandru ₹ | |
|---|---|---|---|
| Balance b/d | 3,30,000 | 2,20,000 | - |
| Revaluation profit | 1,800 | 1,200 | - |
| Goodwill brought in cash | 9,000 | 6,000 | - |
| Cash brought as capital | - | - | 1,20,000 |
| Closing | 3,40,800 | 2,27,200 | 1,20,000 |
Proportionate capital: the old partners' combined capital of ₹5,68,000 represents 20/25 of the firm, so the firm's total capital = 5,68,000 × 25/20 = ₹7,10,000, and Chandru's 1/5 = ₹1,42,000. He has brought ₹1,20,000, so he must bring ₹22,000 more. Note the sequence: the proportionate figure is computed only after revaluation and goodwill, since those change the old partners' capitals.
3. Chandru suggests that instead of paying ₹15,000 in cash, the firm should simply raise a Goodwill Account of ₹75,000 and credit it to Arun and Bala in the old ratio. Analyse the effect of this alternative and advise the partners.
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The entry proposed is: Goodwill A/c Dr 75,000, To Arun 45,000, To Bala 30,000 (old ratio 3:2). That is not the end of the matter - goodwill created in the books must be written off, and the write-off falls on all partners in the new ratio 12:8:5: Arun 36,000, Bala 24,000, Chandru 15,000.
Net effect on capitals: Arun +45,000 − 36,000 = +9,000; Bala +30,000 − 24,000 = +6,000; Chandru −15,000. That is exactly the same net result as the premium method, so the arithmetic is not wrong - but the route is inferior.
Reasons to advise against it: (a) if the write-off is forgotten, the balance sheet carries an intangible of ₹75,000 that the firm never paid for and cannot sell, overstating assets and partners' capital; (b) self-generated goodwill is not recognised as an asset under AS 26, so the accounts would be non-compliant; (c) it conceals the fact that Chandru actually paid nothing for goodwill, which matters if he later retires before the write-off is complete; (d) it adds two entries where one suffices. The premium method - cash or capital adjustment in the sacrificing ratio - gives the same economic result with a cleaner balance sheet.