Admission of a partner: revaluation, goodwill and the cash the new partner must bring
Amal and Bimal have traded in partnership for nine years, sharing profits 3:2 and preparing accounts to 31 March. At 31 March 2024 their capital accounts were Rs 1,500,000 and Rs 900,000 respectively; the firm has no current accounts. On 1 April 2024 they admitted Chandana for a 1/5 share of profits. The new profit-sharing ratio is Amal 12/25, Bimal 8/25 and Chandana 5/25. Before admission the assets were revalued: land and buildings up by Rs 600,000, inventory down by Rs 80,000, and the provision for doubtful debts increased by Rs 40,000. The three partners agreed that firm goodwill is worth Rs 1,000,000 and that it is not to remain in the books. Chandana is to bring cash for capital so that her capital account equals 1/5 of the total capital of the new firm, and separately in cash for her share of the goodwill, which is credited to the old partners in their old ratio. She has Rs 1,100,000 available in her savings account and is nervous about how much she will be asked for.
1. Prepare the revaluation account and the partners' capital accounts immediately after admission.
Read the worked answer
Revaluation account
| Dr | Rs | Cr | Rs |
|---|---|---|---|
| Inventory | 80,000 | Land and buildings | 600,000 |
| Provision for doubtful debts | 40,000 | ||
| Profit on revaluation: Amal 3/5 | 288,000 | ||
| Bimal 2/5 | 192,000 | ||
| 600,000 | 600,000 |
The revaluation gain of Rs 480,000 belongs to the partners who owned the assets before the change - it must be shared in the old ratio 3:2, not the new one.
Capital accounts
| Amal | Bimal | Chandana | |
|---|---|---|---|
| Opening balance | 1,500,000 | 900,000 | – |
| Revaluation profit | 288,000 | 192,000 | – |
| Goodwill credited (3:2) | 120,000 | 80,000 | – |
| Cash introduced – capital | – | – | 770,000 |
| Balance | 1,908,000 | 1,172,000 | 770,000 |
Goodwill of Rs 1,000,000 is not opened as an asset: Chandana's 1/5 share of Rs 200,000 is paid in cash and credited to the old partners in their old ratio (Rs 120,000 and Rs 80,000).
2. Compute the total cash Chandana must bring, showing clearly the two components.
Read the worked answer
Step 1 – capital required.
Work from the old partners' side first. After revaluation and after goodwill has been credited, their combined capital is:
1,908,000 + 1,172,000 = Rs 3,080,000
This represents the old partners' 4/5 share of the new firm's capital (because Amal 12/25 + Bimal 8/25 = 20/25 = 4/5).
Total capital of the new firm = 3,080,000 x 5/4 = Rs 3,850,000 Chandana's 1/5 = 3,850,000 / 5 = Rs 770,000
Check: 1,908,000 : 1,172,000 : 770,000 = 12 : 8 : 5 approximately, consistent with the profit-sharing ratio.
Step 2 – goodwill.
Her share = 1/5 x 1,000,000 = Rs 200,000, paid in cash and credited to Amal and Bimal 3:2.
Total cash = 770,000 + 200,000 = Rs 970,000, comfortably within her Rs 1,100,000. Note that Rs 200,000 of this is not capital she can ever withdraw as her own - it is a payment for a share of the existing business's earning capacity.
3. Chandana objects that 'goodwill is not something you can put in the bank, so I should not pay cash for it'. Justify the payment and show how the position would be recorded if goodwill were instead raised in the books and written off in the new ratio.
Read the worked answer
Justification. Chandana is buying 1/5 of a business that already has nine years of customers, reputation and trained staff. Future profits will be earned partly from that established base, and she will take 1/5 of them. The old partners have, in effect, given away part of their future income; the Rs 200,000 restores the position. Economically it is a payment for a share of future super-profits.
Alternative treatment: raise and write off
| Entry | Dr | Cr |
|---|---|---|
| Raise goodwill | Goodwill 1,000,000 | Amal 600,000; Bimal 400,000 (3:2) |
| Write off in new ratio 12:8:5 | Amal 480,000; Bimal 320,000; Chandana 200,000 | Goodwill 1,000,000 |
| Net effect | Amal +120,000; Bimal +80,000; Chandana −200,000 |
The net effect on the old partners' capitals is identical to the cash method: +120,000 and +80,000. The difference is that Chandana's capital account is debited with Rs 200,000 rather than her paying cash, so she must bring a larger capital balance to reach the agreed proportion. This route also temporarily breaches the principle that purchased goodwill is only recognised when paid for, which is why most partnerships avoid it. Either way, Chandana bears the cost; the method only changes where it is recorded.