Question

Explain various methods for the treatment of goodwill on the admission of a new partner?

Answer 1

The methods for the treatment of goodwill on the admission of a new partner are given below.
1. Premium Method
2. Revaluation Method
It should be noted that before following any of the below mentioned methods of goodwill, if goodwill already appears in the old books (old Balance Sheet) of the firm, then first of all, this goodwill should be written off among all the old partners in their old profit sharing ratio. The following Journal entry is passed to distribute the goodwill.
Old Partners’ Capital A/c                                        Dr.
               To Goodwill A/c
(Goodwill written off among the old partners in their old profit sharing ratio)
 1. Premium Method- This method is used when a new partner pays his/her share of goodwill in cash. The following are the different situations under this method.
i) When the new partner privately pays his/her share of goodwill to the old partners.
In this case, there is no need to pass any Journal entry in the books of accounts as the goodwill is privately paid.

ii) When the new partner brings his/her share of goodwill in cash and the goodwill is retained in the business.
Accounting Entries

a) For premium or goodwill brought in cash by the new partner
Cash/Bank A/c                                                       Dr.
          To Premium for Goodwill A/c
(Amount of goodwill brought in by the new partner)

b) For transferring of new partner’s goodwill among the old partners, i.e. if goodwill is retained in the business.
Premium for Goodwill A/c                                     Dr.
          To Sacrificing Partners’ Capital A/c
(Goodwill brought in by the new partner is distributed among the old partners in their sacrificing ratio)

c)  If the new partner’s share of goodwill is withdrawn by the old partner, then
Sacrificing Partner’s Capital A/c                           Dr.
               To Cash A/c
(Amount of goodwill withdrawn by the old partners)

iii) If the new partner partly brings his/her share of goodwill
a) For bringing goodwill in cash
Cash A/c                                                             Dr.
        To Premium for Goodwill A/c
(Amount of goodwill brought in cash by the new partner)

b) For transferring of goodwill to the old partners
Goodwill A/c                                                     Dr.
(With the amount of goodwill brought in by the new partner)
New Partner’s Capital A/c                                Dr.
(With the amount of goodwill not brought in by the new partner)
              To Sacrificing Partners’ Capital A/c
              (Goodwill amount of the new partner distributed among the old partners in their sacrificing ratio)

2. Revaluation Method- When the new partner is not able to bring goodwill in cash at all.
New Partner’s Capital A/c                                          Dr.
(With the whole amount of goodwill that is not brought in by the new partner)
                To Old Partners’ Capital A/c
                (Goodwill amount of the new partner distributed among the old partners in their sacrificing ratio)

NOTE: As per the Para 16 of Accounting Standard 10, goodwill is recorded in the books only when some consideration in money or money’s worth has been paid for it. This practice is mandatory to follow. In  case of admission, retirement, death or change in profit sharing ratio among existing partners, Goodwill Account cannot be raised as no consideration is paid for it.