Admission of a Partner when Goodwill is Credited to the Wrong Account
Anita and Beena share profits 3:2. On 31 March 2025 their capitals stood at ₹3,00,000 and ₹2,00,000. On 1 April 2025 they admitted Charu for a 1/5 share; she brought ₹2,50,000 as capital and ₹80,000 as goodwill in cash, and the old partners withdrew half of the goodwill money immediately. The new profit-sharing ratio is Anita 12/25, Beena 8/25 and Charu 5/25. Before admission the partners agreed that: stock had been overvalued by ₹20,000; furniture was undervalued by ₹15,000; investments were revalued upward by ₹25,000; a debtor of ₹12,000 was insolvent and nothing was recoverable from him, and a 5% provision for doubtful debts was to be created on the remaining debtors of ₹1,68,000 (the existing provision was ₹6,000); and a supplier's bill for ₹9,000, omitted from the books, was to be recorded. The accountant has credited the entire ₹80,000 goodwill to Charu's capital account.
1. Compute the sacrificing ratio and pass the goodwill entries. Explain why Charu's capital must not be credited with the goodwill.
Read the worked answer
Sacrifice = old share − new share:
- Anita: 3/5 − 12/25 = 15/25 − 12/25 = 3/25
- Beena: 2/5 − 8/25 = 10/25 − 8/25 = 2/25
Sacrificing ratio = 3:2.
Entries
- Bank A/c Dr 80,000 - To Premium for Goodwill A/c 80,000
- Premium for Goodwill A/c Dr 80,000 - To Anita's Capital A/c 48,000 - To Beena's Capital A/c 32,000
- Anita's Capital A/c Dr 24,000; Beena's Capital A/c Dr 16,000 - To Bank A/c 40,000 (half withdrawn)
Goodwill is the price Charu pays to the sacrificing partners for the share of future profits she has acquired. Crediting it to Charu would mean she receives back part of her own premium and Anita and Beena are not compensated at all - their capitals would be understated by ₹48,000 and ₹32,000 respectively, and Charu's capital overstated by ₹80,000. If the firm later writes off goodwill, the wrong credit would also distort the new profit-sharing arrangement.
2. Prepare the revaluation account and the partners' capital accounts, and state the total capital of the new firm.
Read the worked answer
Revaluation Account
| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| Stock | 20,000 | Furniture | 15,000 |
| Bad debts | 12,000 | Investments | 25,000 |
| Provision for doubtful debts (8,400 − 6,000) | 2,400 | Loss transferred: Anita 2,040; Beena 1,360 | 3,400 |
| Creditors (unrecorded) | 9,000 | ||
| Total | 43,400 | Total | 43,400 |
Partners' Capital Accounts
| Particulars | Anita ₹ | Beena ₹ | Charu ₹ |
|---|---|---|---|
| Opening balance | 3,00,000 | 2,00,000 | - |
| Revaluation loss | (2,040) | (1,360) | - |
| Goodwill credited | 48,000 | 32,000 | - |
| Cash brought in | - | - | 2,50,000 |
| Half goodwill withdrawn | (24,000) | (16,000) | - |
| Closing balance | 3,21,960 | 2,14,640 | 2,50,000 |
Total capital of the new firm = ₹3,21,960 + ₹2,14,640 + ₹2,50,000 = ₹7,86,600. The provision is computed on the remaining debtors of ₹1,68,000; the bad debt and the provision are both routed through revaluation so that the loss is borne by the old partners alone, as Charu was not a partner when the losses arose.
3. Charu is unable to bring goodwill in cash. Explain the alternative ways of dealing with goodwill and state which is preferable, with reasons.
Read the worked answer
Three routes are used in practice:
- Premium (bonus) method - the incoming partner brings cash, which is credited to the sacrificing partners in the sacrificing ratio. This is the method already used, and it is preferable because it brings in real resources and leaves no fictitious asset on the balance sheet.
- Revaluation/raising-and-writing-off method - goodwill is raised in the books at an agreed value in the old ratio and immediately written off among all partners in the new ratio. The capital effect on the old partners is similar, but it creates and destroys an intangible within the year and can be confusing; it is used when the partners want the accounts to reflect the firm's value.
- Hidden or inferred goodwill - when no cash is brought, the new partner's capital is fixed and goodwill is inferred as the excess of the total capital implied by the new partner's contribution over the actual combined capitals of all partners after revaluation. That excess is credited to the sacrificing partners, and the new partner's capital is correspondingly reduced, effectively adjusting the capitals so the new partner does not share in the old firm's goodwill.
If Charu brings no cash, the third route is the practical one: her capital is settled at the agreed figure and the old partners are compensated by adjustment of capital accounts. Whichever route is chosen, the goodwill must never be credited to the incoming partner, and the basis must be disclosed so that the capitals of all partners are comparable.