When a new partner is admitted in the firm, the existing/old partners have to sacrifice, what is given to the new partner, from their future profits, the reputation they have gained in their past efforts and the side of capital they have taken before. The new partner when admitted, has to compensate for all these sacrifices made by the old ones. The compensation for such sacrifice can be termed as 'goodwill'. Hence, at the time of admission of the new partner, it is necessary to account the valuation of goodwill in the firm.
If the new partner brings in cash for his share of goodwill, in addition to his capital, it is known as premium method. When the new partner brings nothing but only the capital, and the value of goodwill is erected or raised, this method of treatment is called Revaluation Method. However, once creating the value of goodwill and writing of the same after admission is done, it can be said to be Memorandum Revaluation Method. Thus, keeping in mind, all these methods, the various ways of treating goodwill in the books of the firm at the time of admission of the new partner, are as follows:
1. Share of goodwill brought by the new partner in cash.
2. Share of goodwill brought by the new partner in kind.
3. Nothing is brought by the new partner as his share of goodwill.
4. Share of goodwill brought by the new partner in cash only a portion not as a whole.
5. Hidden goodwill
1. When the new partner brings his share of goodwill in cash
When the new partner brings his share of goodwill in cash, the payment ma be made to the old partners, as if outside/private transaction. It may be retained in the business or after recording the same in the firm, the old partners may withdraw the whole amount or some portion only,
a. When the amount of goodwill brought by the new partner is not recorded in the books and the payment is made to the old partners as outside or private transaction, it does not affect in the transaction of the firm and hence no entry is passed in the books of the firm.
b. When the amount of goodwill brought in by the new partner is retained in the business to increase cash resources, and if there exists already no-goodwill:
i) Cash/Bank A/C.......................Dr.
To Goodwill A/c
(Being goodwill brought in by the new partner)
ii) Goodwill A/C...........................Dr.
To old partners' capital A/C
(Being goodwill credited to old partners in the sacrificing ratio)
c. When there is no-goodwill already appeared in the books and the amount of goodwill brought in by the new partner, is fully or partially withdrawn by the old partners:
i) Cash A/C.......................Dr.
To Goodwill A/C
(Being goodwill brought by the new partner)
ii) Goodwill A/C................Dr.
To old partners' capital A/C
(Being goodwill divided among old partners)
iii) Old partners' capital A/C...............Dr.
To Cash/Bank A/C
(Being the amount withdrawn)
d. When there is goodwill already appeared in the books and even then if the new partner brings his share of goodwill in cash, the amount may be retained or withdrawn by the old partners. If the amount of goodwill brought in by the new partner is retained in the business:
i) Old partners' capital A/C..............................Dr.
To Goodwill A/C
( Being goodwill appearing in the book written off in the old ratio)
ii) Cash/Bank A/C.......................Dr.
To Goodwill A/C
(Being goodwill brought in by the new partner)
iii) Goodwill A/C.......................Dr.
To old partners' capital A/C
(Being goodwill brought in by new partner shared by the old partners)
If the goodwill amount brought by the new partner is withdrawn by the old partners, the following extra entry should also be passed:
Old partners' capital A/C.............Dr.
To Cash/Bank
(Being amount withdrawn)
If they agree to show the original value of goodwill in the books, it is raised by passing the entry:
Goodwill A/C ......................Dr.
To All partners capital A/C
(Being goodwill raised)
2. When the new partner brings his share of goodwill in kind
The new partner may bring his share of goodwill and capital in kind i.e. the form of assets instead of cash. Again, new partner may have an established name in the market among the customers. In such case, he may be recognized for his goodwill. As a result he will bring a lesser amount of assets than the amount of credited to him. This requires two journal entries:
i) All assets A/C............................Dr.
Goodwill A/C/New partner's capital A/C
(Being goodwill brought in kind by the new partner)
ii) Goodwill A/C/New partner's capital A/C................Dr.
To old partners' capital A/C
(Being goodwill shared by the old partners)
3. When the new partner is unable to bring his share of goodwill in cash or kind
When the new partner cannot bring anything for his share of goodwill, first of all we have to see if there exists goodwill already or not. If there is no-goodwill already appearing in the books of the firm, goodwill is raised at its full value. If goodwill already appears in the books, it is compared to the full value of goodwill raised or created and the adjustment is done accordingly.
a. When the new partner is unable to bring his share of goodwill and if there is no-goodwill already appearing in the books, goodwill is raised at its full value:
i) Goodwill A/C.................Dr.
To old partners' capital A/C
(Being goodwill is created at its full value and credited to the old partners in old ratio)
* By this entry, goodwill A/C then appears as an asset in the balance sheet of the firm.
b.If the new partner cannot bring his share of goodwill and there appears goodwill already in the books, even then goodwill is raised at its full value. If the raised value of goodwill is equal to the existing value of goodwill, no entry what so ever is needed. If the raised goodwill is more than the existing goodwill, then goodwill will be credited to the old partner's capital A/C by the excess amount only:
Goodwill A/C......................Dr. (excess value)
To old partners' capital A/C
( Being the value of goodwill increased to..../increased by......)
* Goodwill then appears at its full value in the balance sheet of the firm
c. If the raised value of goodwill is less than the existing value of goodwill, then excess over raised value of goodwill is written off:
Old partners' capital A/C................Dr.
To Goodwill A/C
(Being the goodwill written off by the reduction in value)
d. Whatever the case may be stated in a,b,c, the partners may not wish goodwill in the books for an indefinite period after the admission of new one, as the value of goodwill changes constantly. They may write off the whole or some portion of the value of goodwill. For writing off the goodwill:
All partners' capital A/C.............Dr.
To Goodwill A/C
(Being goodwill written off)
4. When the new partner can bring only a portion of his share of goodwill
When the new partner cannot bring the entire amount of his share of goodwill and he brings only a part of this, it is shared by the old partners in sacrificing ratio. Then goodwill A/C is raised in the books for the portion not brought by the new partner which is also credited to the old partners in their sacrificing ratio. Goodwill raised for the part of goodwill not brought in by the new partner is calculated as under:
= (Full value of goodwill/share of goodwill of new partner) X goodwill not brought in
But it should be remembered that , if there exists any goodwill in the books, first it should be written off by crediting to the old partners in old ratio. Therefore, the entries are:
i) Old partners' capital A/C..................Dr.
To Goodwill A/C
(Being goodwill written off)
ii Cash/Bank A/C........................Dr.
To Goodwill A/C
(Being the portion of goodwill brought in by new partner)
iii) Goodwill A/C.......................Dr.
To old partners' capital A/C
(Being the goodwill brought in by new partner credited to old partners)
iv) When the goodwill is raised for the part of goodwill not brought in by the new partner, the amount of goodwill is calculated as said above. The entry would be the same as in iii), only the amount being different, which is shared by the old partners in their old profit sharing ratio.
5. Hidden Goodwill
When the value of goodwill is not given in the question, the value of goodwill has to be calculated on the basis of total capital/net worth of the firm and profit sharing ratio.
A. New partner's capital X Reciprocal of the share of new partner....XXX
B. Less net worth(excluding goodwill) of new firm...............................XXX
C. A-B = Value of goodwill........................................................................XXX