3-ch. (admission of a partner) (ver.-4)

8/14/2019 3-Ch. (Admission of a Partner) (Ver.-4)

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3

LEARNING O BJ ECTIVES After s tu dy ing this chapter you w ill be able to: Explain the concept and the

w ay s of reconstitution of a partnership firm;

Identify the matters that need adjustm ents in the books of

firm w hen a new partner isadmitted;

Determine the new profit sharing ratio and calculatethe s acrificing ratio;

Define goodw ill an d enumerate the factors that affect it;

E x pla in t h e m e th o d s of valuation of goodw ill;

Describe how goodw ill w illbe treated under different s i t u a t i o n s w h e n a n e w

partner is adm itted; Make necessary adjustments

for revaluation of ass ets and reass ess ment of liabilities;

Make necessary adjustments for accum ulated profits and losses;

Determine the capital of each partner, if required accordingto the new profit sharing ratioa n d m a k e n e c e s s a r yadjustments;

Make necessary adjustmentson change in the profi t sharing ratio among theexisting partners.

P ar tn ersh ip is a n agreement be tween two or m orepers ons (called pa rtn ers) for sh ar ing the profi tsof a bu sines s car r ied on by al l or an y of th em a ct ingf o r a l l . A n y c h a n g e i n t h e e x i s t i n g a g r e e m e n tam oun ts to recons t itu t ion of the pa r tners h ip firm .This resu l ts in a n en d of th e exist ing agreemen t an da n ew agreement comes in to be ing with a ch an gedre la t ions h ip am ong the mem bers of the pa r tnersh ipfirm an d/ or their composi t ion . However, the fi rmcontinu es. The pa rtn ers often res ort to reconstitu tionof the f irm in var ious wa ys su ch a s a dm iss ion of an e w p a r t n e r , c h a n g e i n p r o f i t s h a r i n g r a t i o ,

ret i rement of a partner, death or insolvence of apartner. In this chapter we shal l have a brief ideaabou t a l l these an d in de ta il abou t the accoun t ingimplicat ions of ad miss ion of a n ew partn er or an oncha nge in the profit s ha r ing ra t io.

3 . 1 Mo d e s of Re c o n s t it u t i o n o f a Pa r t n e r s h ipF i rm

Recons t itut ion of a par tners hip f irm us ual ly tak es place in any of the follow ing w ay s:

Adm is sion of a new partner: A new par tn er ma y be

adm it ted when the f irm needs addi t iona l cap i ta l ormanager ia l he lp . Accord ing to the provis ions of Partn ersh ip Act 193 2 u nless i t is otherwise providedi n t h e p a r t n e r s h i p d e e d a n e w p a r t n e r c a n b ea d m i t t e d o n l y w h e n t h e e x i s t i n g p a r t n e r sunanimous ly agree for i t . For example , Har i andHaqque a r e par tn ers sh ar ing profit s in th e ra t io of

R e c o n s t it u t io n o f a Pa r t n e r s h i p F ir m Ad m i s s io n o f a P a r t n e r


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1 1 6 Accountancy Not-for-Profit Organisation and Partnership Accounts

3 :2 . O n Apr il 1 , 2007 t hey admit t ed John a s a new pa r tne r w ith 1 / 6 sh a r e inprofits of th e fi rm. With th is chan ge now ther e are th ree par tn ers of th e firm an dit s tan d recons t itu ted .

Change in the profit sharing ratio among the existing partners: Somet imes thepa rtn ers of a f irm m ay decide to cha n ge th eir exist ing profit sh ar ing rat io. Th isma y happ en a n a ccou nt of a ch an ge in the exist ing partn ers role in th e fi rm. Forexample , Ram, Mohan an d Sohan a re pa r tners in a f irm s ha r ing profit s in thera tio of 3:2:1. With effect from April 1,200 7 th ey decided to sh ar e pr ofits equ allyas Sohan br ings in a ddi t iona l cap i ta l. This resu lt s in a cha nge in th e exis t ingagreem ent leadin g to reconst i tut ion of th e fi rm.

Retirement of an existing partner: I t means wi thdrawal by a par tner f rom thebu s iness of the f irm which m ay be du e to h i s bad h ea l th , o ld a ge or chan ge inbu s iness in te res t s . In fac t a p ar tn er can r e t ire an y t ime i f the pa r tners h ip is a twil l. For examp le, Roy, Ravi an d Rao a re pa rtn ers in t he f irm sh ar ing profi ts inth e ra t io of 2:2:1. On a ccoun t of il lnes s , Ravi ret i red from t he f irm on March 31,200 7. This resu l ts in recon st i tu t ion of th e fi rm now havin g only two pa rtn ers .

Death of a partner: Par tnersh ip may a l so s tand recons t i tu ted on dea th of apar tn er, if the remain ing par tn ers dec ide to cont inu e the bu s iness of the firm asu su a l . For exam ple, X,Y an d Z a re p ar tn ers in a firm sh ar ing profit s in the r a t io3:2:1. X died on March 31, 200 7. Y an d Z decide to carry on th e bu siness s ha ringfuture profi ts equal ly. The continui ty of business by Y and Z sharing futureprofits equ al ly leads to recons t i tut ion of the f irm .

3 .2 Ad m i s s io n o f a Ne w P ar t n e r

When f i rm requi res addi t iona l cap i ta l o r manager ia l he lp or bo th for theexpans ion of i t s bus iness a new par tner may be admi t ted to supplement i t sex is t ing resou rces . Accord ing to the Par tn ersh ip Act 1932 , a new par tner ca nbe a dm it ted into th e firm only with the consent of al l the exist ing partn ers u nlesso therwise agreed up on. With t he a dm iss ion of a n ew par tn er, the pa r tn ersh ipfirm is reconst i tuted an d a new agreemen t is entered into to carry on th e bu sinessof th e firm .

A newly adm it ted pa r tn er acqu ires two ma in r igh ts in the firm

1 . R igh t t o sha r e t he a s s e t s o f t he pa r t n e r sh ip firm ; and2 . R igh t t o sha r e t h e p ro fit s o f t he pa r t ne r sh ip firm .For the r igh t t o acqui re sha re in th e ass e t s an d profit s o f the pa r tn ersh ip

firm, th e par tn er br ings an agreed amou nt of cap i ta l either in cas h or in k ind .Moreover, in t he ca se of an esta bl ish ed fi rm wh ich m ay be ear nin g more profi tsthan the normal ra te of re turn on i t s cap i ta l the new par tner i s requi red tocontr ibut e some ad dit iona l am oun t kn own a s pr emium or goodwill . This is done


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1 1 7Adm ission of a Par tn er

pr imar i ly to comp ensa te th e ex is t ing par tn ers for loss of the i r sh are in su perpr ofits of the firm .

Following are th e other imp ortan t point s which requ ire at ten t ion a t the t imeof adm iss ion of a n ew par tn er :

1 . New p rofit sh a r i ng r a t io ;2 . Sacr i fic ing ra t io;3 . Valua t ion an d ad jus tm ent of goodwill;4 . Revalua t ion of ass e t s an d Reassessm ent of liab i lit ies ;5 . Dis t r ibu t ion of accu mu la ted profit s (reserves); and6 . Ad jus tmen t o f pa r t ne r s c ap it a ls .

3 . 3 New P ro f i t Sha r ing Ra t i oWhen new partn er is a dmitted he acqu ires h is sh are in profits from th e old pa rtners.In oth er words , on th e adm iss ion of a n ew partn er, the old par tn ers sa crifice ash are of th eir profi t in favour of th e new par tn er. Bu t , what will be th e sha re of new partner and how he wil l acquire i t f rom the exist ing partners is decidedmutual ly among the old partners and the new partner. However, i f nothing isspecified as to how does th e new part ner a cquire his sha re from th e old pa rtn ers;it m ay be as su med th a t h e gets i t from th em in th e ir p rofit sh ar ing ra t io. In an ycase, on admission of a new partner, the profi t sharing rat io among the oldpa rtn ers wil l cha nge keeping in view their res pect ive contr ibu t ion to th e profitsh aring rat io of the incoming part ner. Hence, there is a need to ascertain th e new

profit sh ar ing ra t io am ong a ll the par tn ers . This depends up on h ow does th enew par tn er acqui res h i s sha re from th e old par tners for which th ere a re man yposs ibi lit ies . Let u s u nd ersta nd i t with th e h elp of the fol lowing il lu str at ions.

I ll u s t r a t i o n 1

An il an d Visha l ar e part ner s sh ar ing profi ts in th e rat io of 3:2. Th ey ad mit tedSu mi t as a new par tn er for 1 / 5 sh are in the fu tur e profit s o f the firm. Calcu la ten ew profi t sh ar ing rat io of An il , Visha l and Su m it .

S o l u t i o n

S u m it s s h a re =15

Rem a in in g s h a re =1

15

=4

5

An ils n ew s h ar e =35

of 45

=1 22 5

Vis h a ls n ew s h a r e =25

of 45

=8

2 5New profi t sharing rat io of Anil , Vishal and Sumit wil l be 12:8:5.

Note: It h a s b e e n a s s u m e d t h a t t h e n e w p a r t n e r a c q u i r e d h i s s h a r e fr o m o ld p a r t n e r s inold rat io.


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Aksh ay an d Bh ara t i a re par tn ers sh ar ing profit s in th e ra t io of 3 :2 . They adm itDinesh as a new par tn er for 1 / 5 th s ha re in th e fu tu re profit s o f the firm wh ichh e gets equ al ly from Aksh ay an d Bha ra t i . Calculate n ew profi t sha ring rat io of Aksh ay, Bhara t i an d Dinesh .

S o l u t i o n

Din es h s s h a r e =15

or2

1 0

Ak s h a ys s h a r e =3 1 55 1 0 1 0

=

Bh a r a t is s h a r e =2 1 35 1 0 1 0

=

New profi t sha r ing ra t io be tween , Aksh ay, Bhar a t i an d Dinesh wil l be 5 :3 :2 .


Ans hu an d Nitu a re pa r tn ers sh ar ing profit s in th e ra t io of 3 :2 . They adm it tedJ yo ti a s a new pa r tne r fo r 3 / 10 sha r e wh ich s he acqu ir ed 2 / 10 from Ansh u and1/ 10 from Nitu . Calculate the n ew profit sh aring rat io of Ans hu , Nitu an d J yoti .

S o l u t i o n

J yot is s h a r e =3

1 0

As h u s n ew s h a re =3 2 45 1 0 1 0

=

Nitu s n ew s h a r e = Old s h a r e S h a r e S u r r en d ered

=2 1 35 1 0 1 0

=

The n ew profi t sha r ing ra t io be tweenAns hu , Ni tu an d J yot i wil l be 4 : 3 : 3 .


Ram a nd Shyam are pa r tners in a firm sh ar ing profit s in th e ra t io of 3 :2 . Theyadmi t Ghan shyam as a n ew par tner. Ram sur renders 1 / 4 of h i s share and Sh yam1/ 3 of h i s sh are in favour of Gha ns hyam . Calcu la te n ew profit sh ar ing ra t io of R a m , Sh y a m a n d G h a n s h y a m .


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S o l u t i o n

Ra m s old s h a r e =35

S h a re s u r ren d ered b y Ra m = 14

of 3 35 2 0

=

Ra m s n ew s h a re =3 3 95 2 0 2 0

=

S h ya m s old s h a r e =25

S h a re s u rr en dered b y Sh ya m =

1

3 of

2 2

5 1 5=

S h ya m s n ew s h a r e =2 2 45 1 5 1 5

=

Gh an sh ya ms n ew s ha re = Ra ms s a cr ifice + S h ya m s S a cr ifice

=3 2 1 7

2 0 1 5 6 0+ =

N ew p r o fi t s h a r i n g r a t i o a m o n g R a m , S h y a m a n d G h a n s h y a m w ill b e 2 7 : 1 6 : 1 7


Das a nd S inh a a re par tn ers in a firm sh ar ing profit s in 4 :1 ra t io . They adm it tedPal as a new par tner for 1 / 4 sh are in th e profit s , which he a cqui red wholly from

Das . Determine th e new profit sh ar ing ra t io of the p ar tn ers .S o l u t i o n

Pa ls s h a re = 14

Da ss n ew s h are = Old Sh a re Sh a re Su r ren d ered

=4 15 4

=1120

S in h a s n ew s h a re =15

The n ew profi t sha r ing ra t io amon g Das , S inh a a nd Pa l wil l be 11 :4 :5 .

3 . 4 S a c ri fi cin g R a t ioThe rat io in which the old partners agree to sacrif ice their share of profi t infavour of th e incom ing part n er is called sa crificin g ra tio. Th e sacr ifice by a pa rtn eris equa l to :

O l d S h a r e o f P r o fi t Ne w S h a r e o f P r o f it


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As s tated ea rl ier, the n ew partn er is required to comp ens ate th e old pa rtn er sfor th eir loss of sh ar e in t h e su per pr ofi ts of th e fi rm for which h e brings in a nadd it iona l am oun t kn own a s prem iu m or goodwill. This am oun t is sh ared byth e exist ing pa rtn ers in th e rat io in wh ich th ey forego th eir sh ar es in favour of th e new pa rtn er which is cal led sa crificing rat io.

The rat io is n orma lly clearly given as agreed am ong the p artn ers wh ich couldbe t he old r at io, equ al sa crifice, or a specified r at io. The difficul ty ar ises wher ethe ra t io in which th e new par tn er acqui res h i s sh are from th e o ld par tners isn ot specified. Ins tead , the n ew profi t sha ring rat io is given. In su ch a s i tu at ion,th e sacr ificing ra t io is to be worked ou t by dedu cting each pa rtn er s n ew sha re

from h is old sh ar e. Look at th e il lu str at ions 6 to 8 an d see h ow sacrificing ra t iois ca lcu la ted in s u ch a s itu a t ion .


Rohit and Mohit ar e par tn ers in a fi rm sh ar ing profi ts in t he ra t io of 5:3. Th eyadm it Bijoy as a n ew par tner for 1 / 7 sh are in the pr ofit . The n ew profit sh ar ingra t io will be 4:2:1. Calcu late th e sa crificing ra t io of Rohit a n d Mohit .

S o l u t i o n

Roh it s old s h a r e =58

Roh it s n ew s h a r e = 47

Roh it s s a cr ifice =5 4 38 7 5 6

=

Moh it s old s h a r e =38

Moh it s n ew s h a r e = 27

Moh it s s a cr ifice =3 2 58 7 5 6

=

Sacr i fi c ing ra t io amon g Rohi t a nd Mohi t wi ll be 3 :5 .


Ama r an d Bah adu r are pa rtn ers in a firm s ha ring profi ts in th e rat io of 3:2. Theyadm it ted Marry as a new par tn er for 1 / 4 sh are . The n ew profit sh ar ing ra t iobetween Am ar a nd Bah ad u r wil l be 2:1. Calculate th eir sa crificin g rat io.


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S o l u t i o n

Ma rrys s h a re = 14

Rem a in in g s h a r e = 114

= 34

Th i s 3 / 4 s h a r e is t o b e s h a r e d b y Am a r a n d B a h a d u r in t h e r a t io o f 2 : 1 .Therefore,

Am a rs n ew s h a re =23

of 34

= 61 2

or24

Ba h a d u r s n ew s h a r e =1

3of 3

4=

3

1 2or

1

4New profi t sha r ing ra t io o f Ama r, Bah ad u r a nd Marry wil l be 2 :1 :1 .

Am a r s s a cr ifice =3 2 25 4 2 0

=

Ba h a d u r s s a cr ifice =2 1 35 4 2 0

=

Sacr i fi c ing ra t io am ong Ama r an d Bah ad u r wil l be 2 :3 .


Ramesh an d Su resh a re par tn ers in a firm s ha r ing profit s in the ra t io of 4 :3 .They adm it ted Moha n as a n ew par tn er. The p rofit sh ar ing ra t io of Ramesh ,Su resh an d Moha n will be 2:3:1. Calculate th e gain or s acrifice of old pa rtn er.

S o l u t i o n

Ra m es h s old s h a r e = 47

Ra m es h s n ew s h a r e =26

Ra m es h s s a cr ifice =4 2 1 07 6 4 2

=

S u r es h s n ew s h a r e =36

S u r es h s old s h a re = 37

S u r es h s ga in =3 3 36 7 4 2

=

Moh a n s s h a re =16

or7

42


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Ra m es h s s a cr ifice = S u res h s ga in +Moh an s ga in

= 3 7 1 04 2 4 2 4 2

+ =

In th i s ca se , th e whole sacr i fi ce is by Ram esh .

Te s t y o u r Un d e r s t a n d i n g - I

1 . A a n d B a r e p a r t n e r s s h a r i n g p r ofit s i n t h e r a t io o f 3 : 1 . Th e y a d m i t C fo r 1 / 4sh are in th e fu tu re p rof it s . The n ew profi t sha r ing ra t io wil l be :

(a ) A9

1 6, B

31 6

, C4

1 6

(b ) A8

1 6, B

41 6

, C4

1 6

(c) A1 01 6

, B2

1 6, C

41 6

(d ) A8

1 6, B

91 6

, C1 01 6

2 . X a n d Y s h a r e p r o fit s i n t h e r a t i o o f 3 : 2 . Z w a s a d m it t e d a s a p a r t n e r w h o s e t s1 / 5 s h a r e . Ne w p r o fit s h a r i n g r a t io , if Z a c q u i r es 3 / 2 0 f r om X a n d 1 / 2 0 f r omY would b e:(a ) 9 : 7 : 4 (b ) 8 : 8 : 4 (c) 6 : 1 0 : 4 (d ) 1 0 : 6 : 4

3 . A a n d B s h a r e p r o fit s a n d l os s e s i n t h e r a t i o o f 3 : 1 , C is a d m i tt e d in t opa r tn ersh ip fo r 1 / 4 sh are . The sa cr i fi cing ra t io of A an d B i s :(a ) equ a l (b ) 3 : 1 (c ) 2 : 1 (d ) 3 : 2 .

3 .5 Go od will

Goodwill is a lso one of th e special aspects of pa rtn ersh ip accoun ts wh ich r equiresad jus tm en t (also valua tion if n ot specified) at t h e time of recon st itut ion of a firmviz . , a change in the prof i t shar ing ra t io , the admiss ion of a par tner or there t iremen t or dea th of a pa r tner.

3 . 5 . 1 Me a n i n g o f Go o d w i l l

Over a period of t ime, a well-establ ished business develops an advantage of good nam e, reputa t ion an d wide bu s iness connec t ions . This he lps the bu s inessto earn m ore profit s a s compar ed to a n ewly se t up b u s iness . In a ccou nt ing , them oneta ry valu e of su ch a dvan tage is kn own as goodwil l.

It is regarded as an inta ngible as set. In oth er words, goodwill is the value of th e repu ta tion of a firm in resp ect of th e profits expected in futu re over an d a boveth e norm al profits. It is gener ally observed th at wh en a pers on pa ys for goodwill,


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he/ sh e pays for s omething, which places h im in the posit ion of being able to earnsu per profits as compa red to the profit earn ed by oth er firms in th e sam e ind u stry.

In simp le words , goodwill can be d efined a s the p res ent value of a firmsan ticipa ted excess ear nin gs or as th e capitalised value a tta ched to th e differen tialprofit cap acity of a bu sines s. Thu s, goodwill exists only when th e firm ea rn s s u perprofits. Any firm th at earn s norm al profits or is incu rring loss es h as no goodwill.

3 . 5 . 2 Fa c t o rs Af f e c t in g t h e Va l u e of Go od w i l l

The m ain fact ors a ffectin g the value of goodwill are a s follows:1 . Nature of bus ines s: A firm tha t p rodu ces h igh va lue ad ded produ cts o r

ha ving a s tab le deman d i s ab le to earn more profit s a nd therefore hasm ore goodwill.

2 . Location: If th e bu siness is centra l ly located or is a t a place ha vin g heavycu stom er t r affic, th e goodwil l ten ds to be h igh.

3 . Eff iciency of ma nagem ent: A well-m an aged concern u su al ly enjoys th ead van tage of high produ ctivi ty an d cost efficiency. This lead s to h igh erpr ofits a n d s o th e value of goodwill will also be h igh .

4 . Mark et situa tion: The m onopoly condition or lim ited competition ena blesth e concern to earn h igh pr ofi ts which leads to higher value of goodwil l.

5 . Spe cial ad vantages : The f irm th at enjoys s pecial ad van tages l ike importl icences , low ra te an d as su red s u pply of electr icity, lon g-term contr acts

for su pply of mater ia l s , well-known co llabora tors , pa ten ts , t r adem arks ,etc. en joy higher value of goodwill.

3 . 5 .3 Ne e d f or Va l u a t i on o f Go od w i l l

Norm ally, th e n eed for valua tion of goodwill ar ises a t th e time of sa le of a b u sines s.But , in the context of a partnership f i rm i t may also ar ise in the fol lowingc i rcumstances :

1 . C han ge in t h e p ro fit s h a r ing r a t io amongs t t he ex is t ing pa r t ne r s ;2 . Admis s ion of new pa r tne r ;3 . Re tir e m en t o f a p a r t n e r ;4 . D ea t h o f a p a r t n er ; a n d5 . Disso lu t ion of a firm involving sa le of bu s iness as a going concern .6 . Ama lgam a t ion o f pa r t n e r sh ip firms .

3 . 5 .4 Me t h od s o f Va l u a t ion o f Go od w i l l

Since goodwill is an inta n gible as set it is very difficult to accu ra tely calcu late itsvalu e. Var ious m eth ods h ave been ad vocated for th e valua t ion of goodwil l of apa rtn ersh ip firm. Goodwill calculated by one m ethod m ay differ from th e goodwill


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calculated by another method. Hence, the method by which goodwil l is to becalculated, may be specif ical ly decided between the exist ing partners and theincoming partner.The importa nt m eth ods of valu at ion of goodwil l ar e a s follows:

1 . Average Profit s Method2 . S u p p e r P r ofit s M et h o d3 . C ap it a lis a t i on Method

3 . 5 .4 .1 Av e ra g e Prof it s M e th od

Und er th is m eth od, the goodwill is valued a t agreed n u mb er of years pu rch as eof the a verage profit s o f the pas t few years . I t i s bas ed on th e as su mp t ion th a t an ew bu sines s will not be ab le to earn an y profits d u ring the f irs t few year s of i tsopera t io n s . Hence , t he pe r son who pu rchas e s a r un n ing bus ine s s mu s t pay i nth e form of goodwill a s u m which is equ a l to the p rofits h e is likely to receive forth e f irs t few years . Th e goodwill , therefore, sh ould b e ca lcu lated b y mu lt iplyingthe p as t average profit s b y the n u mb er of years du r ing which th e an t ic ipa tedprofits a re expected to accru e.

For exam ple, if the p as t average profi ts of a b u siness works out a t Rs. 20,000an d i t is expected tha t su ch p rofits a re l ikely to continu e for an other th ree years ,th e valu e of goodwill will be Rs. 6 0,0 00 (Rs. 2 0,0 00 3),


The pr ofit for th e last five years of a firm were a s follows year 20 02 Rs . 4,00 ,00 0;year 20 03 Rs . 3 ,98 ,000; year 200 4 Rs . 4 ,50 ,000; year 200 5 Rs . 4 ,45 ,000 an dyear 20 06 Rs . 5,00,0 00. Ca lcu late goodwil l of th e fi rm on th e ba sis of 4 yearspu rch as e of 5 years a vera ge profi ts .

S o l u t i o n

Year Profit (Rs.)

2002 4 ,00 ,0002003 3 ,98 ,0002004 4 ,50 ,000

2005 4 ,45 ,0002006 5 ,00 ,000Tot a l 2 1 ,9 3 ,0 0 0

Ave ra ge Pr ofit =Tota lProfi t o f Las t 5 Years

No.of years= Rs.

2 1 , 9 3 , 0 0 05

= Rs . 4 ,38 ,6 00

G ood will = Ave ra ge Pr ofit s No. of yea rs p u rch a s ed= Rs . 4 ,38 ,6 00 4 = Rs . 17 ,54 ,400


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The a bove calculat ion of goodwill is ba sed on th e ass u mp tion t ha t n o chan gein th e overal l s itu at ion of profi ts is expected in t he futu re.

The above il lu stra t ion is b as ed on simple average. Sometimes , i f th ere existsan increas ing on d ecreas ing trend, i t is cons idered to be bet ter to give a h igherweightage to the pr ofits t o the recent years tha n those of the earl ier years . Hence,i t is a ad visable to work ou t weighted a vera ge based on s pecified weight s l ike 1,2, 3 , 4 for res pect ive year s profit . However, weighted average sh ould b e u sedonly if sp ecified. (See illus tra tions 1 0 a n d 11 ).

I ll u s t r a t i o n 1 0

The Profits of firm for th e las t five year s wer e a s follows:Year Profit

(Rs.)

200203 20,000200304 24,000200405 30,000200506 25,000200607 18,000

Calculate th e valu e of goodwill on th e ba sis of th ree years pu rch as e of weighted a verage profits ba sed on weight s 1 ,2,3,4 a nd 5 r espectively to the p rofits

fo r 2002 , 2003 ,2004 ,2005 a nd 2006 .

S o l u t i o n

Year Ended 3 1 st March Profit Weight Prod u c t (Rs.)

200203 20,000 1 2 0 ,0 0 0200304 24,000 2 4 8 ,0 0 0200405 30,000 3 9 0 ,0 0 0200506 25,000 4 1 ,00 ,00 0200607 18,000 5 9 0 ,0 0 0

15 3 ,48 ,00 0

Weighted Average Profi t = Rs.3 , 4 8 , 0 0 0

1 5= Rs . 23 ,2 00

G ood will = Rs . 2 3 ,2 0 0 3 = Rs . 6 9 ,6 0 0


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Calculate goodwil l of a fi rm on th e ba sis of th ree year pu rch as e of th e weightedavera ge profits of th e las t four yea rs . Th e profit of th e las t four yea rs were: 200 3Rs. 20,200; 2004 Rs. 24,800; 2005 Rs. 20,000 an d 200 6 Rs. 30,000. The weightsas s igned to each year a re : 2003 1 ; 2004 2 ; 2005 3 an d 2006 4 .You ar e s u pplied t h e fol lowin g informa tion :

1 . On September 1 , 2005 a m ajor p lan t repa i r was u nder taken for Rs . 6 ,000 ,which was charged to revenue . The sa id sum is to be cap i ta l i sed forgoodwil l calculat ion s u bject to adju stm ent of depr eciat ion of 10% p .a.on redu c ing ba lance meth od .

2 . The Clos ing S tock for the year 2004 was overva lued by Rs . 2 ,400 .3 . To cove r man agemen t co s t an an nu a l cha rge of Rs . 4 ,800 sh ou ld be

m ad e for p u rpose of goodwil l valu at ion.

S o l u t i o n

Ca lcu la tion of Ad ju s ted Profit 2003 2004 2005 2006 Rs . Rs . Rs . Rs .

Given Pr ofit s Les s 20,200 24,800 20,000 30,000Ma n a gem en t Cos t 4 ,8 0 0 4,800 4 ,8 0 0 4,800

Add: Ca p it a l E xp en d it u r e 15,400 20,000 15,200 25,200Ch a r ged to Reven u e - - 6 ,0 0 0 -

15,400 20,000 21,200 25,200

Less: Un p rovid ed Dep recia t ion - - 200 580

15,400 20,000 21,000 24,620

Less; over va lu a t ion of Clos in g S tock - 2,400 - -

15,400 17,600 21,000 24,620

Add: over va lu e of op en in g s t ock - - 2,400 -

Ad ju s t e d P r o fi t s 1 5 ,4 0 0 1 7 ,6 0 0 2 3 ,4 0 0 2 4 ,6 2 0

Calculat ion of weighted average profi ts :

(Rs.)

Year Profit Weight Prod u ct

2003 15,400 1 15,4002004 17,600 2 35,2002005 23,400 3 70,2002006 24,620 4 98,480

Tot a l 1 0 2 ,1 9 ,2 8 0


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Weigh t Avera ge Profit = Rs.2 ,19 ,280

1 0= Rs . 21 ,92 8

G oo d will = R s . 2 1 , 9 2 8 3 = R s . 6 5 , 7 8 4

Notes to Solution

(i) Dep recia tion of 2 00 5 = 1 0% of Rs . 6 00 0 for 4 m on th s= Rs . 6000 1 0/ 1 00 4 / 1 2 = Rs . 2 0 0

(ii) De pr ecia t ion of 2 00 6 = 1 0 % of Rs . 6 00 0 Rs . 2 00 for on e yea r= Rs . 580 0 1 0 / 1 0 0 + R s . 5 8 0

(i ii ) Closin g Stock of 20 04 will becom e open ing st ock for the year 20 05 .

3 . 5 .4 . 2 S u p p e r Prof it s Me t h od

The b a s i c a s su mp t ion i n t h e ave r age p ro fit s ( s imp le or we igh t ed ) me th od o f c a l cu l a t i ng goodwil l i s t h a t if a n ew bu s ine s s i s s e t u p , i t w il l no t b e ab l e t oearn an y profi t s du r ing the f ir s t few years of it s opera t ions . Hence , the p ersonwho pu r c ha se s a n ex i s t ing bu s ine s s ha s t o pa y in t he form o f goodwill a su mequ al to th e tota l profits h e is l ikely to receive for th e fi rs t few years . Bu t i t iscont en ded t ha t th e bu yer s rea l ben efi t does not l ie in t otal profits ; it is limitedto su c h a mou n t s o f p ro fit s wh ich a r e i n exce s s o f t he n o rma l r e t u rn on cap i t a lem ployed in s imi la r bu s in ess . Th erefore , i t is d es i ra b le to va lu e , goodwil l onthe b a s i s o f t he exce s s p r o fit s a nd no t t h e ac tu a l p ro fi t s . The exces s o f a c tu a lp r o fi t s o ve r t h e no rm a l p ro fit s i s t e rm ed a s su pe r p r o fi t s .

Norma l Profi t =Capital Em ployed Normal Rate of Return

1 0 0

Su ppose a n ex is t ing firm earn s Rs . 18 ,000 on th e cap i ta l of Rs . 1 ,50 ,000and the normal rate of return is 10%. The Normal profi ts wil l work out atRs. 15,000 (1.50,000 10/ 100 ). The s u per profits in th is case wil l be Rs. 3,000(Rs. 18,000 15,000). The goodwill un der t he su per p rofit m ethod is as certainedby mu lt iplying the su per pr ofits b y certa in nu mb er of years pu rch as e. If, in t heabove example, i t is expected that the benefi t of super profi ts is l ikely to beava i lab le for 5 years in fu ture , the goodwi l l wi l l be va lued a t Rs . 15 ,000(3 ,000 5). Thu s , th e s teps involved u nd er the m ethod a r e :

1 . C a lcu l a t e t he aver age p rofit ,

2 . Calcu la te th e norma l profit on the cap i ta l employed on the ba s i s o f thenorm al ra te of re tur n ,3 . Calcu la te th e su per profit s by deduct ing norma l profit from th e average

profits , an d4 . Calcu la te goodwill by mu lt ip lying th e su per profit s b y the g iven n u mb er

of years pu rch as e.


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Th e b o o k s o f a b u s i n e s s s h o w e d t h a t t h e c a p i t a l e m p l oy ed o n D e c e m b e r3 1 , 2 0 0 6 , R s . 5 , 0 0 , 0 0 0 a n d t h e p r o fi t s fo r t h e l a s t five y ea r s w e r e : 1 9 9 7 R s . 4 0 , 0 0 0 : 1 9 9 8 - R s . 5 0 , 0 0 0 ; 1 9 9 9 - R s . 5 5 , 0 0 0 ; 2 0 0 0 - R s . 7 0 , 0 0 0 a n d2 0 0 1 - R s . 8 5 , 0 0 0 . Yo u a r e r e q u i r e d t o fi n d o u t t h e v a lu e o f g oo d w il l b a s e do n 3 ye a r s p u r c h a s e o f t h e s u p e r p r o fit s o f t h e b u s i n e s s , g ive n t h a t t h en o r m a l r a t e o f r e t u r n is 1 0 % .

S o l u t i o n

Norma l Profi ts = Capi ta l Emp loyed Norm al Rate of Return1 0 0

= Rs.5,0 0,0 0 0 1 0

1 0 0

= Rs . 50 ,00 0

Average Profits:

Year Profit (Rs.)

2002 40,0002003 50,0002004 55,0002005 70,000

2006 85,000To t a l 3 ,0 0 ,0 0 0

Av er a g e P r o fit s = R s . 3 , 0 0 , 0 0 0 / 5 = R s . 6 0 , 0 0 0S u p e r P ro fit = R s . 6 0 ,0 0 0 Rs . 5 0 ,0 0 0 = R s . 1 0 ,0 0 0G ood will = Rs . 1 0 ,0 0 0 3 = Rs . 30 ,0 00


The cap ita l o f the f irm of Anu an d Benu is Rs . 1 ,00 ,000 a nd the m ark e t ra te of interest is 15%. Ann u al salary to partn ers is Rs. 6,000 each . The profits for thelast 3 year s were Rs. 30,000 ; Rs. 36,000 a nd Rs. 42,00 0. Goodwil l is to be

va lued a t 2 years pu rcha se of the las t 3 years average su per profit s . Ca lcu la teth e goodwill of th e firm .

S o l u t i o n

In te r es t on ca p it a l = 1 ,00 ,00 0 1 5

1 0 0= Rs. 15,000(i)

Add: p ar t n er s s a la ry = Rs . 6 ,0 00 2 = Rs. 12,000(ii)


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Nor m a l Pr ofit (i+ii) = Rs . 2 7 ,0 00

Aver a ge Profit = Rs . 3 0 ,0 0 0 +Rs .3 6 ,0 0 0 +Rs .4 2 ,0 0 0 = Rs .1 ,08 ,000

3= Rs . 3 6,0 00

S u per Pr ofit = Avera ge Pr ofit Nor m a l Pr ofit= Rs . 3 6 , 0 0 0R s. 27 , 0 0 0= Rs . 9 ,0 00

G ood will = S u p er Pr ofit No of yea rs p u rch a s e= Rs . 9 ,0 00 2= Rs . 1 8,0 00

3 . 5 . 4 .3 C a p it a lis a t io n Me t h od sUnd er th is meth od th e goodwill can be ca lculated in two ways: (a) by cap italizin gth e a vera ge profi ts , or (b) by capi tal izin g the su per profi ts .

(a) Capitalisation of Average Profits: Und er th is meth od, th e valu e of goodwil lis a scer ta ined by dedu ct ing th e ac tu a l cap i ta l emp loyed (ne t ass e t s ) in thebusiness from the capi tal ized value of the average profi ts on the basis of norm al rate of retu rn . This involves th e following step s:(i) Ascer ta in t he average profit s bas ed on the pas t few years per forman ce .

(ii) Capital ize th e average profi ts on the ba sis of th e norm al rate of retu rn toas certain th e cap i tal ised valu e of average pr ofi ts a s follows:

Av e r a g e P r o fi t s 1 0 0 / No r m a l R a t e o f R e t u r n

(iii) Ascer ta in the ac tu a l cap i ta l employed (ne t as se t s ) by deduct ing outs ideliab ilities from th e tota l as set s (exclu din g goodwill).

C a p i t a l E m p l o y e d = To t a l As s e t s (e x c l u d i n g g o o d w i l l ) O u t s i d e L i a b i li t i e s

(iv) C ompu te t he va lue o f goodwil l by dedu c t i ng ne t a s s e t s fr om th eca pita lise d va lu e of avera ge pr ofits , i.e. (ii) (iii).


A bu s iness ha s ea rn ed average profit s o f Rs . 1 ,00 ,000 du r ing the las t few yearsan d th e norma l ra te of re tur n in a s imi la r bu s iness i s 10%. Ascer ta in th e va lueof goodwil l by cap i tal isa t ion average pr ofits m eth od, given th at th e value of netas se t s o f the bu s iness i s Rs . 8 ,20 ,000 .

S o l u t i o n

Cap ital ised Valu e of Average Profits

Rs .1,0 0,0 00 1 0 0

1 0

= Rs . 10 ,00 ,000


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G ood will = Ca p it alis ed va lu e Net As se ts= R s . 1 0 , 0 0 ,0 0 0 R s . 8 , 2 0 ,0 0 0= Rs .1 ,8 0,0 00

(b ) Capitalisa tion of S upe r Profits: Goodwi ll can a l so be a scer ta ined by cap i ta l is ing th esu per p rofit d i rec t ly. Und er th i s m ethod th ere i s no n eed to work ou t th e cap i ta l isedvalue of avera ge profits . I t in volves th e fol lowin g step s.

(i ) Ca lcu la te cap i ta l employed of the f irm, which i s equa l to tota l asse t s m inus ou ts idel iabi l i t ies .

(i i) C a lc u l a t e n o r m a l p r o fit s o n c a p i t a l em p l o ye d .

(i i i) Ca lcu la te average profi t fo r pas t years , a s sp ec ified .(i i ) Ca lcu la te su per p rofi t s by deduc t ing norm al p rofi t s from a verage profi t s .

(i ii ) Mult iply the s u per profi ts by the required rate of retu rn m u lt ipl ier, that is ,

G o o d w il l = S u p e r P r o f it s 1 0 0 No r m a l R a t e o f R e t u r n

In other words, goodwil l is th e cap ital ised value of su per p rofi ts . Th e am oun t of goodwil lworked ou t by th i s method wi l l be exac t ly the same as ca lcu la ted by cap i ta l i s ing theavera ge profi ts .

For example , us ing the da ta g iven in i llus t r a t ion 14 wh ere the a verage profi t s a re Rs .1 ,00 ,000 and the normal p rof i t s a re Rs . 82 ,000 (10% of Rs . 8 ,20 ,000) , the super p rof i t sworked ou t as Rs . 18 ,000 (Rs . 1 ,00 ,000 Rs . 82 ,00 0), the goodwil l wil l be Rs . 18 ,00 0

1 0 01 0

= Rs . 1 ,80 ,000 .


1. The goodwill of a f irm is to be worked out a t t h ree years pu rcha se of theavera ge profits of th e las t five years wh ich ar e as follows:

Years Profits (Los s )

(Rs.)

2002 10,000

2003 15,000

2004 4,000

2005 (5 ,0 0 0 )

2006 6,000

2. The capi tal emp loyed of the f irm is Rs. 1,00,000 an d n ormal rate of retur nis 8%, the a vera ge profi ts for las t 5 year s a re Rs. 12,0 00 a n d goodwill isto be worked out a t 3 years pu rcha se of su per pr ofit s ,

3 . Rama Brothers earn a n a verage profit o f Rs . 30 ,000 with a ca p i ta l o f Rs . 2 ,00 ,000 . The n ormal ra te of re tur n in th e bu s iness i s 10%. Us ingcap ital isa t ion of su per p rofi ts m eth od work out th e valu e th e goodwil l of th e firm.


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S o l u t i o n

1 . Tota l Profi t s = Rs . 10 ,000 + Rs . 15 ,000 + Rs . 4 ,000 + Rs . 6 ,000 Rs . 5 ,000= Rs . 30 ,0 00

Ave r a ge Pr ofit s = Rs . 3 0 ,0 0 0 / 5 = R s . 6 , 0 0 0G o od w ill = Av er a g e Pr o fit s 3 = R s . 6 , 0 0 0 3 = Rs .18 ,0 00

2 . Avera ge Profit = Rs . 1 2 ,0 0 0

Norm a l Profit = Rs .1 ,0 0 ,0 0 0 8

1 0 0= Rs . 8 ,000

Su per Profit=Average Profi t Norma l profit = Rs. 12,0 00 Rs. 8,00 0= Rs . 4 ,000

Good will=S u per Pr ofit 3 = Rs . 4 ,0 00

3 = Rs . 12 ,00 03 . N or m a l P r ofit = R s . 2 , 0 0 , 0 0 0 1 0 / 1 0 0 = R s . 2 0 , 0 0 0Su per Profit = Average Profi t Norma l Profi t = Rs. 30,0 00 Rs. 20,00 0

= Rs . 10 ,00 0Goodwill=Super Profit 1 0 0 / No r m a l R a t e o f R e tu r n= 10 ,000 1 0 0 / 1 0 = R s . 1 , 0 0 , 0 0 0 .

3 .5 .5 T re a t m e n t o f Good w i ll

As s ta ted ea r l ie r, the incoming par tn er who acqu ires h is s ha re in th e profit s o f t he f i r m f rom the ex i s t i ng pa r t ne r s b r i ngs i n some add i t i ona l amoun t t ocompens ate th em for loss of their sh are in su per profi ts . It is termed as his sh areof goodwill (also called premium). Alternatively he may agree that goodwill

accou nt b e raised in th e books of th e firm by giving the neces sa ry credit to theo ld pa r tners . Thu s , when a n ew par tn er is a dm it ted , goodwill can be t rea ted intwo ways : (1) By Premium Method , an d (2) By Revalua t ion Method .

3 . 5 .5 . 1 Pre m i u m M e th o d

This method is fol lowed when the new partner pays his share of goodwil l inca s h . The am oun t o f p r emium b roug h t in by t he new pa r tne r is sh a r ed by t heexist ing par tn ers in th eir rat io of sa crifice. If th is am oun t is pa id to th e oldpa rtn ers direct ly (privately) by the n ew partn er, no entr y is m ade in th e books of th e firm . But , when th e am oun t is paid throu gh the fi rm, which is genera lly thecas e, the followin g jou rn al entr ies ar e pas sed:

(i) Ca s h A/ c Dr.To Goodwill A/ c

(Am o u n t b r o u g h t b y n e w p a r t n e r a s p r e m iu m )

(ii) Good will A/ c Dr.To Exis t ing Par tn ers Capi ta l A/ c ( Ind ividua l ly )

(Goodwil l d is t r ibu ted am ong th e ex i s t ingpa r tn ers in th e i r sac r i fi cing ra t io )


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Alterna t ively, i t is credi ted to th e new pa rtn er s ca pi tal accoun t an d th enad just ed in favour of th e exist ing par tn ers in th eir sa crificing rat io. In th at ca seth e jou rn al en tr ies will be as follows:

(i) Ca s h A/ c Dr.To New Par tn er s Cap ital A/ c

(Amou nt b rough t by new par t ner for h i ssh ar e of goodwil l)

(ii) New Pa r t n er s Ca p ita l A/ c Dr.To Existin g Partn er s Ca pital A/ cs (Ind ividu ally)

(Goodwil l b rou ght by n ew par tn ers d i s t r ibu teda m o n g t h e e x is t i n g p a r t n e r s i n t h e irsacrif icing rat io)

If the pa r tners dec ide th a t th e am oun t of p remium cred ited to the i r cap ita laccoun ts sh ould be re ta ined in b us iness , th ere is n o need to pass a ny addi t iona lent ry. If, however, they decide to withdra w their am oun ts , (in fu l l or in pa rt) th efollowin g ad ditiona l en try will be pa ss ed:

E xis t in g Pa r tn e rs C a p it a l A/ c (In d ivid u a lly) Dr.To C a s h A/ c

(The am oun t o f goodwil l with dra wn b y theex is t ing par tners )


Su ni l an d Dal ip a re par t ners in a firm sh ar ing profit s a nd losses in th e ra t io of 5:3. Sach in is adm it ted in the fi rm for 1/ 5 sh ar e of profi ts . He is to bring inRs. 20,000 a s cap ital an d Rs. 4,000 as his sh are of goodwil l. Give the n ecessa ry

jou rn al entr ies ,(a ) When the a mou nt of goodwill is re ta ined in the bu s iness .(b) When th e am oun t of goodwil l is fu l ly with dra wn.(c) When 50% of th e am oun t of goodwil l is fu l ly withdr awn .

S o l u t i o n

(a ) Wh en t h e am oun t o f goodwill cr ed i t ed t o exis t i ng pa r t n e r s i s r e t a i ned i nb u s i n e s s


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B o o k s o f S u n i l a n d D a l i pJ o u r n a l

Date Particulars L.F. Debit Cred it (Rs .) (Rs .)

(i) Ca s h A/ c Dr. 24,000To Sa ch in s Ca p it a l A/ c 20,000To Good will A/ c 4,000

(Th e a m o u n t b r o u g h t i n b y S a c h i n a sCapi ta l a nd Goodwil l)

(ii) Good will A/ c Dr. 4,000To S u n ils Ca p ita l A/ c 2,500To Da lip s Ca p ita l A/ c 1,500

(Goodwil l t r an s fer red to Su ni l an d Dal ipin th e ra t io o f 5 :3)

Note: It a s su med tha t th e sacr i fi c ing ra t io is th e sam e as o ld p rofi t shar ing ra t io.

(b) Wh en th e am oun t of goodwill c red i ted to ex is t ing par tn ers i s fu l lywi thdrawn.

J o u r n a l


1 . S a m e a s in (a ) a b ove

2 . S a m e a s in (a ) a b ove ,3 . S u n ils Ca p ita l A/ c Dr. 2,500

Da lip s Ca p ita l A/ c Dr. 1,500To Ca s h A/ c 4,000

(C a s h w it h d r a w n b y S u n i l a n d D a l ipequal to their share of goodwil l)

(c) When 5 0% of th e am oun t of goodwil l credi ted to exist ing partn ers iswi thdrawn.

J o u r n a l


1 . S a m e a s in (a ) a b ove ,

2 . S a m e a s in (a ) a b ove3 . S u n ils Ca p ita l A/ c Dr. 1,250

Da lip s Ca p ita l A/ c Dr. 750To Ca s h A/ c 2,000

(Cash with dra wn for 50% of th e ir sh areof goodwill)


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Vija y a n d San jay a r e pa r t n e r s i n a firm sh a r ing p ro fit s a nd lo s se s i n t h e r a t i oo f 3 : 2 . They dec ide t o adm it Ajay in t o pa r t n e r sh ip with 1 / 4 sh a r e i n p ro f it s .Aja y b r i n gs i n Rs . 30 ,000 fo r c ap i t a l and t he r equ i s it e am oun t o f p r em ium incas h . Th e goodwil l o f th e fi rm i s va lued a t Rs . 20 ,0 00 . The n ew profi t sha r ingr a t i o i s 2 : 1 : 1 . Vi j a y a n d S a n j a y w i t h d r a w t h e i r s h a r e o f g o o d w i l l .G ive n ec e s sa r y jou rn a l en t r i e s .

S o l u t i o n

(a ) Ajay wi ll b r ing Rs . 5 ,000 (1 / 4 o f Rs . 20 ,000 ) as h i s sha re o f goodwi ll (p rem ium )(b) Sacr i fi c ing Rat io is 2 :3 as ca lcu la ted be low:

For Vi jay, o ld ra t io i s 3 / 5 an d th e new ra t io is 2 / 4 , hen ce , h i s sacr i fi c ing ra t io is

=3 25 4

=1 2 -1 0

2 0=

22 0

F o r S a n j a y, old r a t i o is 2 / 5 a n d t h e n e w r a t i o is 1 / 4 , h e n c e , h i s s a c r i fic in g

r a t io is =2 15 4

= 8 52 0

=

32 0

B o o k s o f Vi ja y a n d S a n j a yJ o u r n a l

Date Particu lars L.F. Debit Cre d it (Rs .) (Rs .)

1 . Ca s h A/ c Dr. 35,000To Aja ys Ca p it a l A/ c 30,000To Good will A/ c 5,000

(The am oun t o f cap i ta l an d goodwil lbrou ght by Ajay)

2 . Good will A/ c Dr. 5,000To Vija ys Ca p it a l A/ c 2,000To S a n ja ys Ca p it a l A/ c 3,000

(the am oun t o f goodwil l b rou ght by Ajays h a r e d b y Vij a y a n d S a n j a y in t h e i rsacrif icing rat io)

3 . Vija ys Ca p it a l A/ c Dr. 2,000S a n ja ys Ca p ita l A/ c Dr. 3,000

To Ca s h A/ c 5,000(Cash with dra wn by Vi jay an d San jayfor th eir sh ar e of goodwill)

Note: Altern at ively, journ al en tr ies (1) an d (2) cou ld be a s follows:

b tors


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B o o k s o f Vi ja y a n d S a n j a yJ o u r n a l

Date Particulars L.F. Debit Cre d it (Rs .) (Rs .)

1 . Ca s h A/ c Dr. 35,000To Aja ys Ca p it a l A/ c 35,000

(Ajay brough t in Rs . 3 0 ,000 for cap i ta lan d Rs . 5 ,00 0 a s goodwil l)

2 . Aja ys Ca p it a l A/ c Dr. 5,000To Vija ys Ca p ita l A/ c 2.000To S a n ja ys Ca p ita l A/ c 3,000

(Am ou n t of goodwill brou ght in b y Ajaysh ared b y Vi jay an d San jay in the i rsacrif icing in the rat io of 2:3)

Wh en goodw ill a l read y exis ts in book s: The above treatment of goodwill wasbas ed on th e ass um pt ion tha t there was no goodwill accoun t in the b ooks of thefirm. However, It is qui te possible th at wh en a new pa rtn er brings in h is sh are of goodwil l in cas h, s ome a m oun t of goodwil l a lread y exists in books. In th at cas e,af ter credi t ing th e old pa rtn ers b y the am oun t of goodwill brought in b y the n ewpa rtn er, th e exist ing goodwill mu st b e wri t ten off by debit ing th e old pa rtn ers inth eir old profi t sha ring rat io. But , i f i t is d ecided t ha t th e goodwil l ma y cont inu eto appear in the books a t i t s o ld va lue , the amount to be brought in by newpa rtn er will have to be proport iona tely redu ced i .e . , He wil l be requ ired to br ingcas h only for th is sh ar e of th e excess of the a greed valu e of goodwil l over th eam oun t of goodwil l a lread y appea ring in books. For exam ple,

In i llust ra t ion 17, th e goodwil l of th e fi rm is valued a t Rs. 20 ,000 an d Ajaywho is ad mi t ted to 1 / 4 sh are in i t s p rofit s , b r ings in Rs . 5 ,000 a s h is sh are of goodwill . Su ppose, goodwil l a lready ap pear ed in books a t Rs. 10,000 a nd t her eis no decision t o retain i t . In t ha t cas e, after credi t ing Vijay an d Sa njay for th eam oun t of goodwil l brou ght in by Ajay, the followin g add it iona l jour na l entr ysh a ll be r ecord ed for writing off th e exist ing am ou n t of goodwill.


Vija ys Ca p it a l A/ c Dr. 6,000S a n ja ys Ca p ita l A/ c Dr. 4,000

To Good will A/ c 10,000(Goodwill written-off in old ratio)

In cas e, h owever, the pa rtners decide to maintain th e Goodwil l Accoun t a s i tis, t he n ew partn er is required to bring in a s his s ha re of goodwill only in respect of the d ifference between its t ota l value an d th e book valu e. In oth er wor ds , Ajay willbe required to bring in Rs. 2,500 on ly [1/ 4 of Rs. 1 0,0 00 (Rs 20 ,000 Rs. 10 ,000)].Which will be cred ited to old par tn ers in t h eir sacr ificin g ratio, an d n o entr y will bere cord ed for writing off th e existing am ou n t of goodwill.


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Sr ikant a nd Ram an are par tners in a firm s ha r ing profit s an d losses in th e ra t ioof 3:2. They decide to adm it Venk at into part ner sh ip with 1 / 3 sh are in th e profits.Venkat b r ings in Rs 30 ,000 as h i s cap i ta l . He a l so promises to br ing in then ecess ar y am oun t for his sh ar e of goodwill. On th e date of ad miss ion, th e goodwillha s been va lued a t Rs 24 ,000 an d th e goodwill accoun t a l ready appears in th ebooks a t Rs 12 ,000 . Venka t b r ings in th e necessary amou nt for h is sh are of goodwil l an d a grees th at th e exist ing goodwill accoun t b e wri t ten off.

Record the necessa ry journ a l en t r ies in th e books of the firm .

S o l u t i o nBo o k s o f S r ik a n t a n d R a m a n

J o u r n a l


1 . Ca s h A/ c Dr. 38,000To Ven k a t s Ca p ita l A/ c 30,000To Good will A/ c 8,000

(Amou nt b rough t in by Venka t as h i scap i ta l an d h i s sh are o f goodwil l)

2 . Good will A/ c Dr. 8,000To S r ik a n t s Ca p it a l A/ c 4,800

To Ra m a n s Ca p it a l A/ c 3,200(Goodwil l b rou ght in by Venka t sh aredby o ld p ar tn ers in th e ir ra t io of sacr i fi ce)

3 . S r ik a n t s Ca p it a l A/ c Dr. 7,200Ra m a n s Ca p it a l A/ c Dr. 4,800

To Good will A/ c 12,000(Goodwil l a lready appearing in bookswrit ten-off in the old rat io)

Note: S in c e n o t h i n g is g ive n a b o u t t h e r a t i o in w h i ch t h e n e w p a r t n e r a c q u i r es h is s h a r eof p rof i t f rom Sr ikan t and Raman, i t i s impl ied tha t they sacr i f i ce the i r share o f profi t in favour of Venkat in the old rat io i .e . , 3:2.

3 . 5 . 5 .2 R e v a lu a t io n M e th o d

This m ethod i s fo llowed when the n ew par tn er does no t b r ing in h i s sh are of goodwil l in cash . In su ch a s i tu at ion, the goodwill accou nt is raised in th ebooks of account by credi t ing the old partners in the old profi t sharing rat io.When goodwil l account is to be raised in the books of account there are twopossibilities,

(a ) No goodwil l app ears in b ooks a t th e t ime of adm iss ion , an d(b) Goodwill a lready ex is t s in books a t the t ime of admiss ion .


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(a ) When no goodw ill ex is t s in the books : When n o goodwil l exists in th e booksa t t he t ime of the a dm iss ion of a n ew par tn er, the goodwill accou nt mu s t bera ised a t i ts fu l l valu e. This ca n b e done by debit ing goodwil l accou n t with itsfu ll valu e an d credi t ing th e old pa rtn ers capi tal accoun ts in th eir profi t sha ringra t io. The journ al entry wil l be:

Good will A/ c Dr.To Old Partn ers Cap itals A/ c (ind ividu al ly)

(Goodwil l raised at ful l value in the old rat io)

Th e goodwil l th u s ra ised sh al l ap pear in th e balan ce sheet of th e firm at i tsfu ll value.


Ahu ja a nd Ba ru a a re par tn ers in a firm sh ar ing profit s an d losses in th e ra t io of 3 :2 . They dec ide to admi t Chau dh ary in to par tners h ip for 1 / 5 sh are of p rofit s ,which he acqu i res equa l ly from Ahu ja an d Baru a . Goodwil l is va lued a tRs . 30 ,000 . Cha u dha ry br ings in Rs . 16 ,000 as h is cap i ta l bu t is no t in aposi t ion to brin g an y am oun t for goodwil l. No goodwil l accou n t exists in booksof th e fi rm. Goodwil l accou nt is to be ra ised at ful l valu e. Record th e neces sa ry

jou rn al entr ies .

S o l u t i o n

B o o k o f Ah u j a a n d B a r u aJ o u r n a l


1 . Ca s h A/ c Dr. 16,000To Ch a u d h a r ys Ca p it a l A/ c 16,000

(Amou nt b rou ght for cap i ta l )

2 . Good will A/ c Dr. 30,000To Ah u ja s Ca p it a l A/ c 18,000To Ba r u a s Ca p it a l A/ c 12,000

(Goodwil l raised at ful l value in old rat io)

Note: G o od w il l s h a l l a p p e a r i n t h e b a l a n c e s h e e t a t R s . 3 0 , 0 0 0

Somet imes , a p ar tn er m ay br ing in a par t o f h i s sh are of goodwill. In su ch asi tu at ion , after dis tr ibu t ing the am oun t brou ght in for goodwil l am ong the oldpartners in their sacrif icing rat io, the goodwil l account is raised in the booksbas ed on th e por t ion of p remium not brou ght by the new pa r tner. For examp le ,Pooja an d Sa ndeep a re pa rtners sh aring profits in rat io of 3:3. They adm it Tush ar

as a new par tn er for 1 3 sh are in profit s . Tu sh ar i s to br ing in Rs . 30 ,000 as h i s


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S o l u t i o n

(a) When no goodw ill appears in the books

Bo o k s o f Ra m a n d R a h i mJ o u r n a l


1 . Ca s h A/ c Dr. 10,000To Ra h u ls Ca p ita l A/ c 10,000

(Am o u n t b r o u g h t b y R a h u l a s C a p i t a l)

2 . Good will A/ c Dr. 30,000To Ra m s Ca p it a l A/ c 18,000To Ra h im s Ca p it a l A/ c 12,000

(Goodwil l raised at ful l value in theo ld p rofi t sh ar ing ra t io )

(b ) When goodw ill appears in the books a t Rs 15 ,000

J o u r n a l


1 . Ca s h A/ c Dr. 10,000To Ra h u ls Ca p ita l A/ c 10,000

(Am o u n t b r o u g h t b y Ra h u l a s c a p i t a l)

2 . G ood will Dr. 15,000To Ra m s Ca p it a l A/ c 9,000To Ra h im s Ca p it a l A/ c 6,000

(Goodwill raised to i ts a gree value)

(c ) When the goodw ill appears in the books a t Rs 36 ,000

J o u r n a l


1 . Ca s h A/ c Dr. 10,000To Ra h u ls Ca p it a l 10,000

(Am o u n t b r o u g h t b y R a h u l a s c a p it a l )

2 . Ra m s Ca p it a l A/ c Dr. 3,600Ra h im s Ca p it a l A/ c Dr. 2,400

To Good will A/ c 6,000(Goodwil l brought down to i tsagreed v lau e)


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Norm ally, when goodwill is r aised in th e books of th e firm, it will be sh own inth e balan ce sheet at i ts agreed value. If, however, th e partn ers decide that a fternecessa ry ad ju s tm ents h ave been m ade in the o ld par tn ers cap i ta l accoun ts ,the goodwill should n o t appea r in th e firms ba lan ce shee t , th en i t ha s to bewritten off. This is d one by crediting the goodwill accou n t a nd debiting th e capitalaccoun ts of al l the p artn ers (inclu ding the n ew partn er) in the n ew profit sh aringra t io. The n et effect of su ch tr eatm ent will be th at th e new pa rtn er s ca pi talaccoun t s ta nds debited to th e extent of his sh are of goodwill and the old partn erscap ital accoun ts cr edi ted in t h e rat io of th eir sacrifice, an d th e goodwil l sh owsn il ba lan ce.


A and B are par tners shar ing prof i t s and losses equa l ly. They admi t C in topar tners h ip an d the n ew ra t io is fixed as 4 :3 :2 . C is u na ble to br ing an yth ingfor goodwil l bu t br ings Rs 25 ,000 as capi ta l . Goodwill of th e fi rm is valued atRs 18 ,000 . Give the necessa ry journ a l en t r ies as su ming tha t the par tners donot wan t goodwill to appear in the Balance Sh ee t .

S o l u t i o nB o o k s o f A a n d B

J o u r n a l


1 . Ca s h A/ c Dr. 25,000To Cs Ca p ita l A/ c 25,000

(C a s h b r o u g h t i n b y C a s C a p i ta l )

2 . G ood will 18,000To As Ca p it a l A/ c 9,000To Bs Ca p ita l A/ c 9,000

(Goodwill raised at i ts fu l l value)

3 . As Ca p ita l A/ c Dr. 8,000Bs Ca p it a l A/ c Dr. 6,000Cs Ca p it a l A/ c Dr. 4,000

To Good will A/ c 18,000(Goodwill written-off)

The net effect of th e ent r ies (2) and (3) ab ove is th at Cs Ca pital accoun t h asbeen d ebited by Rs. 4,000 an d As Cap ital accou n t an d Bs Cap ita l accou n tcredi ted in th eir sacr ificing rat io by Rs 1 ,000 (credi t Rs 9,00 0 debit Rs 8 ,000 )an d Rs 3,00 0 (credi t Rs 9 ,000 debit Rs 6 ,000 ) resp ect ively, an d goodwil l wil lsh ow n il ba lance .


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Sometimes, th e part ners ma y decide not to sh ow goodwil l accoun t an ywherein books (no t even in th e journ a l an d ledger ). In th a t ca se , fo r ad jus t men t of goodwil l, ju st on e entr y can be pa ss ed by debit ing th e new pa rtn er s ca pi talaccoun t with his s ha re of goodwill and crediting th e old pa rtn ers capital accoun tsin th eir rat io of sa crifice. If in Illus tra tion 21 we were to trea t goodwill in th ism an n er, th e en try for goodwill would h ave been as follows:


Cs Ca p it a l A/ c Dr. 4,000To As Ca p it a l A/ c 1,000

To Bs Ca p ita l A/ c 3,000(Adju stm en t for Cs sh ar e of goodwill)

The a bove en t ry ha s th e sa me effec t on par tn ers cap i ta l accou nts as journ a len tr ies (2) an d (3).

Box I

Accounting standard 10 (AS10) on Accounting for Fixed Assets in i ts Para 16s t a t e s t h a t G o o d w i l l , i n g e n e r a l , i s r e c o r d e d i n t h e b o o k s o n l y w h e n s o m econs idera t ion in m oney or moneys wor th h as been p a id fo r it . When ever a bu s inessi s acqu i red for a p r ice (payab le e ith er in cas h or in sh ares o r o therwise) which i sexcess o f the n e t as se t s t ak en over, th e excess i s t e rm ed a s goodwil l. Goodwil la r i s e s fr o m b u s i n e s s c o n n e c t i on s , t r a d e n a m e o r r e p u t a t i on o f a n e n t e r p r is e o r

from o th er in tan g ib le benef it s en joyed by an en te rpr i se .As a m at ter of fina n cial pru den ce, goodwill is written off over a period. However,ma ny en t e rpr i ses do n o t wr ite o ff goodwi ll an d re ta in i t a s a n a sse t .

In view of th e provision in p ar a 16 of th e Accoun ting Stan da rd 1 0 (AS-10),some experts feel th at in cas e of adm iss ion, ret i rement or deat h of a pa rtn er or acha nge in profit s ha r ing ra t io am ong the p ar tn ers , goodwill cann ot be ra ised inthe books of the f i rm, and al l entr ies relat ing to goodwil l on such occasionssh ould be recorded in books of the firm d i rect ly th rou gh th e pa r tners cap i ta laccou nt s on ly. This is s t retch ing the interp reta t ion of AS10 too far. What t hisaccoun t ing s ta nd ard imp lies i s th a t n ormal ly goodwill should n o t be broughtinto books u n less i t is paid for, an d when ever i t is recorded i t sh ould be writ ten -off over a period. Hence, credi t ing goodwil l accou n t with th e am oun t br ought in

by the incom ing partn er for his sh ar e of goodwil l an d th en tr an sferr in g it to oldpa r tn ers cap i ta l accou nt s b y debi t in g goodwi ll accoun t i s qu i te in order.Similar ly, when th e incoming partn er is u na ble to bring in t he n ecessary am oun tfor h is sh ar e of goodwill, ra isin g goodwill accou n t a t its a greed value b y creditin gth e old pa rtn ers in th en old profit sha ring ratio and th en writing it off im med iatelyby debit in g it to al l th e par tn ers ( inclu ding the n ew part n er) in th e new pr ofi tsharing rat io is also acceptable as effect ively i t is tent amount to purchase of


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goodwill becau se n ew par tn er s cap ita l accoun t ba lan ce s tan ds r educed b y h issh ar e of goodwil l. Th e sa m e logic equ al ly im plies to th e ad just m ent s m ad e forra is ing th e goodwil l accou n t to its goodwil l accou n t when i t a lready app ear s inthe ba lance shee t . What i s impor tan t i s tha t in the normal course of ra i s inggoodwil l as an asset should be avoided of and, i f and when i t is brought in tobooks, i t sh ould be wri t ten off in th e sh ortest p ossible period.

Te s t y o u r U n d e r s t a n d i n g I I

Choose th e cor rec t a l t e rna t ive 1 . At t h e t i m e o f a d m is s i on o f a n e w p a r t n e r, g en e r a l r e s e r ve a p p e a r i n g in t h e o ld

b a l a n c e s h e e t is t r a n s f e r re d t o :(a ) a l l p a r t n e r s c a p i t a l a c c ou n t(b ) n e w p a r t n e r s c a p i ta l a c co u n t(c ) o ld p a r t n e r s c a p i ta l a c co u n t(d ) n o n e o f t h e a b o ve .

2 . As h a a n d N is h a a r e p a r t n e r s s h a r i n g p r ofit in t h e r a t i o o f 2 : 1 . As h a s s o nAs h i s h w a s a d m i t t ed f or 1 / 4 s h a r e o f w h i ch 1 / 8 w a s g ift e d b y As h a t o h e r s o n .The remain ing was con t r ibu ted by Nisha . Goodwi l l o f the f i rm in va lued a tRs . 40 ,00 0 . How mu ch of th e goodwi ll wil l be c red i ted to t he o ld p ar tn er sc a p i t a l a c c ou n t .(a ) Rs . 2 , 50 0 ea c h(b ) Rs . 5 , 00 0 ea c h(c ) Rs . 20 ,0 0 0 ea c h(d ) No n e o f t h e a b o ve .

3 . A, B a n d C a r e p a r t n e r s i n a f ir m . If D is a d m it t e d a s a n e w p a r t n e r:(a ) o ld fir m i s d i s s o lve d(b ) o ld fi r m a n d o ld p a r t n e r s h i p is d i s s o lve d(c ) o ld p a r t n e r s h i p is r e c on s t i tu t e d(d ) No n e o f t h e a b o ve .

4 . O n t h e a d m is s io n o f a n e w p a r t n e r in c r e a s e in t h e va l u e of a s s e t s is d e b it e d t o:(a ) P r ofit a n d L os s Ad ju s t m e n t a c c o u n t(b ) As s e ts a c co u n t(c ) O ld p a r t n e r s c a p i ta l a c co u n t(d ) No n e o f t h e a b o ve .

5 . At t h e t im e o f a d m is s i on o f a p a r t n e r, u n d i s t r ib u t e d p r o fi ts a p p e a r in g in t h eba lance sh ee t o f the o ld fi rm i s t ran s fer red to th e cap i ta l accoun t o f:(a ) o ld p a r t n e r s in o ld p r o fi t s h a r i n g r a t io(b ) o ld p a r t n e r s in n e w p r o fit s h a r in g r a t io

(c ) a l l t h e p a r t n e r in t h e n e w p r o fi t s h a r i n g r a t i o.

3 . 5 .5 . 3 H id d e n G ood w ill

Somet imes t he valu e of goodwil l is not given at th e t ime of adm ission of a n ewpar tner. In s u ch a s itu a t ion i t has to be in fe r red from th e a r ra ngement of thecapi ta l an d profit sh ar ing ra t io. Su ppose , A an d B are pa r tners sh ar ing profit sequ al ly with ca pi tals of Rs. 45,000 ea ch. They adm it ted C as a n ew partn er for


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one-third sh are in the profit . C brings in Rs. 60,000 a s his capi tal . Based on th eam oun t brou ght in by C and h is sh are in profit , the to ta l cap i ta l of the n ewlycons t i tu ted f irm works ou t to be Rs .1 ,80 ,000 (Rs . 60 ,000 3). But th e ac tu a ltotal capi tal of A, B and C works ou t as Rs. 1,50,00 0 (Rs. 45,00 0 + Rs. 45,0 00+ Rs. 6 0,00 0). Hence, it can be inferred th at th e differen ce is on a ccoun t of goodwilli .e. , Rs. 30,0 00 (Rs. 1,8 0,00 0 Rs. 1,50 ,00 0). Wh ich is to be sh ar ed equ ally (oldra t io ) by A an d B. This sh a l l ra i se the i r cap i ta l accou nts to Rs . 60 ,000 each an dtota l cap ital of th e firm t o Rs. 1,80 ,00 0. Altern at ively, if goodwill ac cou n t is notto be ra ised , Cs ca p i ta l accou nt can be debi ted by Rs . 10 ,000 (h i s s ha re of goodwil l) an d A an d Bs Capital accou n ts credi ted by Rs. 5 ,000 each , an d f irm s

to ta l cap i ta l remains Rs . 50 ,000 .


Hem a nd Nem a re pa r tners in a firm sh ar ing profit s in t he ra t io of 3 :2 . The i rcap i ta l s were Rs . 80 ,000 a nd Rs . 50 ,000 resp ec t ive ly. They adm it ted Sam onJ an . 1 , 2 007 a s a new pa r tne r fo r 1 / 5 sha r e in t h e fu tu r e p rofit s . Sam b rou gh tRs. 60,00 0 as his ca pi tal . Calculate th e valu e of goodwill of th e firm an d recordnecessa ry journ a l en t r ies on Sam s ad miss ion .

S o l u t i o n

Va l u e o f F i r m s G o o d w i ll

S a m s ca p it a l = Rs . 6 0 ,0 0 0

S a m s s h a r e =15

Tota l ca p it a l of n ew fir m = 5 Rs.60 ,000 = Rs . 3 ,00 ,00 0Hem s +Nem s +Sa ms = Rs .8 0 ,0 0 0 + Rs . 5 0 ,0 0 0 + Rs .6 0 ,0 0 0

= Rs .1 ,90 ,000Good will of th e firm = Rs .1 ,1 0,0 00 (Rs . 3 ,0 0,0 00 Rs .1 ,9 0,0 00 )

S a m s s h a r e =15

Rs.1 ,10 ,00 0 = Rs . 22 ,000

B o o k s o f H e m , Ne m a n d S a mJ o u r n a l

Date Particulars L.F. Debit Cre d it 2007 Am ount A m ou n t

(Rs .) (Rs .)

1 . Ba n k A/ c Dr. 60,000To S a m s Ca p ita l A/ c 60,000

(Cash brou ght by Sam for h i s cap i ta l )


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2 . Good will A/ c Dr. 1 ,1 0 ,0 00To Hem s Ca p it a l A/ c 66,000To Nem s Ca p it a l A/ c 44,000

(Credit given for goodwil l to Hem an dN em o n S a m s a d m i s s i on )

Alterna tively, if goodwill accoun t is n ot to be ra ised, th e secon d journ al ent rypa ss ed for goodwill sh a ll be a s fallows.

S a m s Ca p it a l A/ c Dr. 22,000To Hem s Ca p ita l A/ c 13,200To Nem s Ca p ita l A/ c 8,800

D o I t Yo u r s e l f

1 . A fi rm s p r o fit s fo r t h e la s t t h r e e ye a r s a r e R s . 5 , 0 0 , 0 0 0 ; Rs . 4 , 0 0 , 0 0 0 a n dRs. 6,0 0,00 0. Calcu late valu e of fi rms goodwill on t h e ba sis of fou r years pu rcha se of the a verage profi t s fo r the l as t t h ree years . ( An s : R s . 2 0 , 0 0 , 0 0 0 )

2 . A fir m s p r o fit s f or t h e l a s t five y e a r s w e r e Rs . 2 0 , 0 0 0 , R s . 3 0 , 0 0 0 , R s . 4 0 , 0 0 0 ,Rs . 50 ,00 0 a nd Rs . 60 ,00 0 . Ca lcu la te th e va lu e of fi rms goodwil l on th e bas i sof th ree years pu rcha se of weighted average profits a fter u sing weight of 1,2,3,4an d 5 r espec t ive ly.

3 . A fir m s p r o fit s d u r in g 2 0 0 3 , 2 0 0 4 , 2 0 0 5 a n d 2 0 0 6 w e r e Rs . 1 6 , 0 0 0 ;R s . 2 0 , 0 0 0 ; R s . 2 4 , 0 0 0 a n d R s . 3 2 , 0 0 0 r e s p e c t ive ly. Th e f ir m h a s c a p i t a li n ve s t m e n t o f Rs . 1 , 0 0 , 0 0 0 . A fa i r r a t e o f r e t u r n o n i n v e s t m e n t is 1 8 % p . a .

Compu te goodwil l bas ed on th ree years pu rcha se of th e average sup er p rofi t sfor t h e la s t fou r ye a r s . ( Ans : R s . 1 5 , 0 0 0 )

4 . B a s e d o n t h e d a t a g iv en i n t h e a b o v e q u e s t i o n , c a lc u l a t e go o d wi ll b ycap ital isa t ion of su per p rofi ts m eth od. Wil l th e am ou n t of goodwil l be differen ti f i t is com pu ted b y cap i ta l isa t ion of average prof it s? Confi rm your an swer bynumerical verif icat ion.

5 . G ir i a n d S h a n t a a r e p a r t n e r s i n a fir m s h a r i n g p r o fit s e q u a l ly. Th e y a d m i tKachroo in to par tnersh ip who, in add i t ion to cap i ta l , b r ings Rs . 20 ,000 asgoodwill for 1/ 5th sh are of profi ts in t h e fi rm. What s h al l be journ al entr ies if:(a ) n o g o od w ill a p p e a r s i n t h e b o ok s o f t h e f ir m .(b ) g oo d w il l a p p e a r s i n t h e b o o k s o f t h e f ir m a t R s . 4 0 , 0 0 0 .

6 . A a n d B a r e p a r t n e r s i n a f ir m s h a r i n g p r ofit s i n t h e r a t i o o f 3 : 2 . Th e y a d m i t Cin to pa r tn ersh ip fo r 1 / 5 th sh are o f p rofi t s in th e fi rm. The goodwi ll o f th e fi rm

is va lued a t Rs . 1 ,0 0 ,000 . He is u na b le to b r ing in h i s sh are o f goodwil l. Wha twil l be the journal entr ies i f :(a ) Goodwil l i s ra i sed a t fu l l va lu e an d th en wr i t t en off.(b ) G o od w ill i s n o t r a is e d .

3 . 6 Ad ju s t m e n t fo r Ac c u m u l a t e d P r ofi t s a n d Lo s s e s

Somet imes a firm ma y have accum u la ted pr ofit s n o t ye t t ran sfer red to cap i ta laccoun ts of the par tners . Thes e are u su al ly in the firm of genera l reserve, reserve


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fu nd a nd / or Profit an d Loss Accou nt ba lan ce. The n ew par tner is not ent i t led toha ve any sh are in su ch accum u la ted profit s . These a re d is t r ibu ted am ong thepa rtn ers by t ran sferr ing it to their capi tal accou nt s in old profi t sh ar ing ra t io.Similar ly, if th ere are s ome accu m u lated loss es in th e form of a deb it ba lance of p rofit an d loss accoun t ap pear ing in the b a lance s hee t o f the f irm .

A remote poss ibi li ty, the sa me s hou ld also be t ran sferred to th e old pa rtn erscap i tal accou nt s (see I llu str at ion 23 ).


Rajind er an d Su r inder a r e par tn ers in a firm sh ar ing profit s in th e ra t io of 4 :1 .

On Apr i l 15 , 2007 they adm it Naren der as a new par tn er. On tha t da te therewas a balan ce of Rs. 20,000 in genera l reserve an d a d ebit balance of Rs. 10,000in the pr ofit an d loss a ccoun t of th e firm . Pas s n ecessa ry journ al entries regard ingadjus tmen t of a a ccum u la te a p rofit o r loss .

S o l u t i o n

B o o k s o f R a j in d e r, S u r i n d e r a n d Na r e n d e rJ o u r n a l

Date Particulars L.F. Debit Cre d it 2007 Am ount Am ount

(Rs .) (Rs .)

Apr.15 Gen er a l Res er ve A/ c Dr. 20,000To Ra jin d er s ca p it a l A/ c 16,000To S u r en d er s ca p it a l A/ c 4,000

(Genera l Reserve ba lan ce t ran s fer redto the cap i ta l account o f Ra j inder andS u r i n d e r o n N a r e n d e r s a d m i s s i on )

Ra jin d er s Ca p it a l A/ c Dr. 8,000S u r en d er s Ca p it a l A/ c Dr. 2,000

To Pr ofit a n d Los s A/ c 10,000(Debi t ba lan ce of Profi t an d Loss A/ ct ran s fer red to o ld pa r tn ers cap i ta la c c o u n t s )

3 . 7 R e v a lu a t i o n o f As s e t s a n d R e a s s e s s m e n t o f Li a bi li t i e s

At the t ime of admission of a new partner, i t is a lways desirable to ascertainwhether th e ass e t s o f the f irm are sh own in books a t the i r cur r en t va lu es . Incase th e ass e t s a r e overs ta ted or u nders ta ted , th ese a re reva lued . S imi la r ly, areas sess men t of the l iabi li t ies is a lso done so tha t th ese are br ought in th e booksa t th e ir cor rec t va lues . At t imes th ere may a lso be some un recorded as se t s an d


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l iab i li t ies of the f irm . Th ese a lso ha ve to be b rou ght int o the books of the f irm .For th i s pu rpose th e firm ha s to prepa re the Revalua t ion Accou nt . The ga in orloss on reva lua t ion of each ass e t an d l iab i lity is t r an sfer red to th is a ccoun t a ndfinal ly i ts balance is t ransferred to the capi tal accounts of the old partners inth eir old profit sh ar ing ra tio. In oth er words , th e revalua tion accou n t is creditedwith incr eas e in th e valu e of each as set a nd d ecreas e in i ts l iab i lit ies becau se i tis a ga in an d i s deb i ted with decrease in th e va lue of ass e t s an d increase in i t sl i ab i l i t i es i s deb i ted to reva lua t ion account because i t i s a loss . S imi la r lyunrecorded asse t s a re c red i ted and unrecorded l iab i l i t i es a re debi ted to therevaluat ion account . I f the revaluat ion account f inal ly shows a credi t balance

th en i t ind icates net gain a nd if there is a debi t balance th en i t ind icates net loss .Which will be t ran sferred to the cap i tal accou nt s of th e old pa rtn ers in old rat io.The jou rn a l en t r ies recorded for reva lua t ion of as se t s a nd reass essm ent of

liab ilities ar e a s follows:(i) For increas e in th e va lue of an ass e t

As s e t A/ c Dr.To Reva lu a t ion A/ c (Ga in )

(ii) For reduc t ion in th e va lue of an as se tReva lu a t ion A/ c Dr.

To As s et A/ c (Los s )(iii) For app reciat ion in th e am oun t of a l iab i li ty

Reva lu a t ion A/ c Dr.To Lia b ilit y A/ c (Los s )

(iv) For reduc t ion in the am oun t of a l iab i lityLia b ility A/ c Dr.

To Reva lu a t ion A/ c (Ga in )(v) For an un recorded a s se t

As s e t A/ c Dr.To Reva lu a t ion A/ c (Ga in )

(vi) For an u nr ecorded l iab i lityReva lu a t ion A/ c Dr.

To Lia b ilit y A/ c (Los s )(vii) For t ra ns fer of gain on Revalu at ion i f credi t ba lan ce

Reva lu a t ion A/ c Dr.To Old Pa r t n er s Ca p it a l A/ cs (Old r a t io)(ind ividu al ly)

(viii) For t ran sferr ing loss on r evalu at ionOld p a r tn er s Ca p it a l A/ cs Dr.

(In d ivid u a lly) (Old r a t io)To Reva lua t ion A/ c

Note: En tr ies ( i), (i i), (i ii ) an d (iv) ar e recorded only with th e am ou nt increa se a nd decrea sein th e va lue of ass e t s a nd l iab i l it i e s .


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Followin g in Balan ce Sh eet of A an d B wh o sh ar e profits in th e ra t io of 3:2.

B a la n c e S h e e t o f A a n d B a s o n A p r i l 1 , 2 0 0 7

Liabilities Am ount Assets Am ount (Rs .) (Rs .)

Su n d ry cr ed itors 20,000 Ca s h in h a n d 3,000Ca p t ia ls Deb t or s 12,000

A 30,000 Stock 15,000B 2 0 ,0 0 0 50,000 Fu rn itu re 10,000

Pla n t a n d Ma ch in er y 30,0007 0 ,0 0 0 7 0 ,0 0 0

On th a t d a te C i s adm it ted in to the pa r tn ersh ip on th e fo llowing te rms :1 . C is t o b r ing in Rs . 15 ,000 a s c ap i t a l an d Rs . 5 ,000 a s p r emium fo r

goodwil l for 1/ 6 sh ar e.2 . The va lu e of s tock is redu ced by 10% whi le p lan t an d ma chinery is

app rec ia ted by 10%.3 . F u r n i tu r e i s r eva lu e d a t Rs . 9 ,0 0 0 .4 . A provis ion for doub t fu l deb ts i s to be crea ted on su nd ry debtors a t 5%

an d Rs. 200 is to be p rovided for a n electr icity bi ll .

5 . Inves tment wor th Rs . 1 ,000 (no t men t ioned in th e ba lan ce shee t ) is to bet a ken in to accoun t .6. A credi tor of Rs. 100 is n ot likely to claim h is mon ey and is to be wri t ten

off.Record jour na l entr ies an d prepa re revaluat ion accou nt an d capi tal accoun t

of par tn ers .

S o l u t i o n

B o o k s o f A , B a n d CJ o u r n a l

Date Particulars L.F. Debit Cred it 2007 Am ount Am ount

(Rs .) (Rs .)

Ap r il Ba n k A/ c Dr. 20,00001 To Cs ca p it a l a ccou n t 15,000

To Good will A/ c 5,000(C a s h b r o u g h t i n b y C a s c a p i t a la n d g oo d w ill / p r e m i u m )


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02 Good will A/ c Dr. 5,000To As Ca p it a l A/ c 3,000To Bs Ca p ita l A/ c 2,000

(Premiu m d ivided betweenA and B in sacrif icing rat io 3:2)

03 Reva lu a t ion A/ c Dr. 3,100To S tock A/ c 1,500To Fu r n itu r e 1,000To Pr ovis ion for Dou b t fu l Deb t A/ c 600

(Reva lua t ion in th e va lue of asse t son reva lua t ion)

04 Pla n t a n d Ma ch in er y A/ c Dr. 3,000In ves tm en t A/ c 1,000

To Reva lu a t ion A/ c 4,000(Increa se in th e va lu e of as se t son reva lua t ion)

05 Reva lu a t ion A/ c Dr. 200To Ou t s t a n d in g E lec t r icity A/ c 200

(Amou nt p rovided for ou ts tan d ingelectricity bill)

06 S u n d ry Cr ed it or s A/ c Dr. 100To Reva lu a t ion A/ c 100

(Amount not l ikely to be claimedby the credi tors wri t ten off)

07 Reva lu a t ion A/ c Dr. 800To As Ca p ita l A/ c 480To Bs Ca p ita l A/ c 320

(Profi t on reva lua t ion of ass e t s a ndre-ass essm ent o f l iab i li t ie s t r an s fer redto A an d B in o ld p rofi t sha r ing ra t io )

R e v a l u a t i o n Ac c o u n t Dr. Cr.

Particulars Am ount Particula rs Am ount (Rs .) (Rs .)

S tock 1,500 Pla n t a n d Ma ch in er y 3,000Fu r n it u r e 1,000 In ves tm en ts 1,000

Pr ovis ion for Dou b t fu l 600 Su n d r y Cred itors 100Ou ts ta n d in g E lect r icit y 200Profi t on Revaluat iont ran s fer red to :

As Ca p it a l 480Bs Ca p it a l 320

4 ,1 0 0 4 ,1 0 0


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P a r t n e r s C a p i t a l A c c o u n t s Dr. Cr.

Da t e Pa rt icu la rs A B C Da t e Pa rt icu la rs A B C 2 0 0 7 (R s . ) (R s . ) (R s . ) 2 0 0 7 (R s . ) (R s . ) (R s . )

Ap r. 0 1 B a l a n c e 3 3 , 4 8 0 2 2 , 3 2 0 1 5 , 0 0 0 Ap r. 1 B a l a n c e b / d 3 0 , 0 0 0 2 0 , 0 0 0c / d Ba n k 1 5 , 0 0 0

Good will 3 , 0 0 0 2 , 0 0 0Reva lu a tion 4 8 0 3 2 0(Profit)

3 3 , 4 8 0 2 2 , 3 2 0 1 5 , 0 0 0 3 3 , 4 8 0 2 2 , 3 2 0 1 5 , 0 0 0


Given b elow is the Balan ce Sheet of A an d B, who are car ryin g on pa rtn ersh ipbu s iness a s on March 3 1 ,2007. A an d B sh are pr ofit s in th e ra t io of 2 :1 .

Ba l a n c e S h e e t o f A a n d B a s a t M a r c h 3 1 , 2 0 0 7

Liabilities Am ount Assets Am ount (Rs .) ( Rs .)

Bills Pa ya b le 10,000 Ca s h in h a n d 10,000Su n d ry cr ed itors 58,000 Ca s t a t b a n k 40,000Ou t s t a n d in g exp en s es 2,000 Su n d ry d eb tors 60,000Ca p it a ls S tock 40,000

A 1,80 ,000 Pla n t a n d m a ch in er y 1 ,00 ,00 0B 1 ,5 0 ,0 0 0 3 ,3 0 ,0 00 Bu ild in g 1 ,50 ,00 0

4 ,0 0 , 0 0 0 4 ,0 0 ,0 0 0

C is a dm it ted as a p ar tn er on th e da te of the ba lan ce shee t on the followingterms:1 . C will b r ing in Rs 1 ,00 ,000 a s h i s c ap it a l and Rs 60 ,000 a s h i s sha r e o f

goodwil l for 1/ 4 s ha re in pr ofi ts .2 . P lan t is t o be app rec ia t ed t o Rs 1 ,20 ,000 an d t he va lue o f bu ild ings is t o be

app rec ia ted by 10%.3 . S toc k is found ove rva lued by Rs 4 ,000 .4 . A provis ion for doub t fu l deb ts i s to be c rea ted a t 5% of debtors .5 . C red it or s we re un recorded t o t he ext end o f Rs 1 ,000 .

Record reva lua t ion Accou nt , p ar tn ers cap i ta l accou nts , an d th e BalanceShee t o f the cons t i tu ted f irm afte r ad miss ion of the n ew par tn er.


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S o l u t i o nB o o k s o f A a n d B

R e v a l u a t i o n Ac c o u n t Dr. Cr.

Particulars Am ount Particula rs Am ount (Rs .) (Rs .)

S t ock in h a n d 4,000 Pla n t a n d m a ch in er y 20,000Pr ovis ion for d ou b t fu l d eb t s 3,000 Bu ild in gs 15,000Creditorsp r ofit on r eva lu a t ion 1,000t ran s fer red to :

As Ca p it a l 18,000Bs Ca p it a l 9 ,0 0 0 27,000

3 5 ,0 0 0 3 5 ,0 0 0

P a r t n e r s C a p i t a l A c c o u n t s Dr. Cr.

Da t e Pa rt icu la rs A B C Da te Pa rt icu la rs A B C 2 0 0 7 (R s . ) (R s . ) (R s . ) 2 0 0 7 (R s . ) (R s . ) (R s . )

M a r c h B a l a n c e c / d 2 , 3 8 , 0 0 0 1 , 7 9 , 0 0 0 1 , 0 0 , 0 0 0 M a r ch B a la b c e b / d 1 , 8 0 , 0 0 0 1 , 5 0 , 0 0 03 1 3 1 Ba n k 1 , 0 0 , 0 0 0

G oo dw ill 4 0 , 0 0 0 2 0 , 0 0 0R eva lu a t io n 1 8 , 0 0 0 9 , 0 0 0

2 ,3 8 ,0 0 0 1 ,7 9 ,0 0 0 1 ,0 0 ,0 0 0 2 ,3 8 ,00 0 1 ,7 9 ,0 0 0 1 ,0 0 ,0 0 0

B a la n c e S h e e t o f A, B a n d C a s o n Ap r i l 0 1 , 2 0 0 7

Liabilities Am ount Assets Am ount (Rs .) (Rs .)

Bills Pa ya b le 10,000 Ca s h in h a n d 10,000Su n d ry Cred itors 59,000 Ca s h a t b a n k 2 ,00 ,00 0Ou t s t a n d in g E xp en s es 2,000 Su n d ry Deb tors 60,000Ca p it a ls Les s : Pr ovis ion for 3 ,0 0 0 57,000

A 2,38 ,000 d ou b t fu l d eb t sB 1,79 ,000 Stock 36,000

C 1 ,0 0 ,0 0 0 5 ,1 7 ,0 00 Pla n t a n d Ma ch in er y 1 ,20 ,00 0Bu ild in gs 1 ,65 ,00 0

5 ,8 8 , 0 0 0 5 ,8 8 ,0 0 0


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D o I t Yo u r s e l f

1 . As la m , J a c k a b , H a r i a r e eq u a l p a r t n e r s w it h c a p i t a ls o f R s . 1 ,5 0 0 , R s . 1 ,7 5 0an d Rs . 2 ,000 respec t ive ly. They agree to adm i t Sa tnam in to equa l par tnersh ipupon payment in cash of Rs . 1 ,500 for one- four th share o f the goodwi l l andRs . 1 ,800 as h i s cap i ta l , bo th su ms to rema in in th e bus iness . The l iab i l it i e so f t h e o ld f ir m a m o u n t R s . 3 , 0 0 0 a n d t h e a s s e t s , a p a r t f ro m c a s h , c on s i s t o f Motors Rs . 1 ,200 , Fur n i tu re Rs . 400 , S tock Rs . 2 ,650 , Debtors of Rs . 3 ,780 .The Motors and Fu rn i tu re were reva lu ed a t Rs . 950 a nd Rs . 380 respec t ive ly,a n d t h e d e p r e c ia t i on w r i tt e n - o ff. As c e r t a in c a s h in h a n d a n d p r e p a r e t h eba lance sh ee t o f the f irm a fte r Sa tn am s ad miss ion .

2 . B en u a n d S u n i l a r e p a r t n e r s s h a r i n g p r ofit s i n t h e r a t io of 3 : 2 on Ap r il 1 ,2 0 0 3 . I n a w a s a d m i tt e d fo r 1 / 4 s h a r e w h o p a i d Rs . 2 , 0 0 , 0 0 0 a s c a p it a l a n dRs . 1 ,00 ,000 / - fo r p remium in cash . At the t ime of ad miss ion , genera l rese rvea m o u n t i n g t o R s . 1 , 2 0 , 0 0 0 / - a n d p r o fit a n d l o s s a c c ou n t a m o u n t i n g t oR s . 6 0 , 0 0 0 a p p e a r e d o n t h e a s s e t s i d e o f t h e b a la n c e s h e e t .R e qu i r e d : R ec o r d n e c e s s a r y jo u r n a l en t r i e s t o r e co r d t h e a b o ve t r a n s a c t io n s .

3 . As h o o a n d R a h u l a r e p a r t n e rs s h a r in g p r o fit s i n t h e r a t io o f 5 :3 . G a u r a v w a sa d m i tt e d fo r 1 / 5 s h a r e a n d w a s a s k e d t o c on t r i b u t e p r o p o r t io n a t e c a p i t a l a n dRs. 4,000 for premium (goodwil l) . The Capitals of Ashoo and Rahul , af ter al lad ju s tm ents re la t ing to reva lua t ion , goodwil l e tc . , worked ou t to be Rs . 45 ,000an d Rs . 35 ,00 0 resp ec t ively.Required: Calcu late New Profi t sha ring rat io, capi tal to be brou ght in by Gau rava n d r e c o r d n e c e s s a r y jo u r n a l e n t r ie s fo r t h e s a m e .

3 . 8 Ad j u s t m e n t o f C a p it a l s

Sometimes, a t th e t ime of adm ission, th e partn ers a gree tha t th eir capi tals s hou lda lso be ad jus ted s o as to be propor t iona te to the i r p rofit sh ar ing ra t io. In s u cha s itu a t ion , i f the ca p i ta l o f the n ew par tn er is g iven , th e sam e can be u sed a s abase for ca lcu la t ing the new capi ta l s o f the o ld par tners . The cap i ta l s thusas cer ta ined sh ould be comp ared wi th the i r o ld cap i ta l s a fte r a l l ad jus tmen tsrelat ing to goodwil l reser ves a nd revalu at ion of as sets an d l iab i li t ies , e tc . h avebeen made; and then the par tner whose cap i ta l fa l l s shor t , wi l l b r ing in thenecessary am oun t to cover the sh or tage and th e par tn er who has a s u rp lus , willwith dra w the excess am oun t of capi ta l . (See Il lu str at ion 26)


A an d B a re pa r tn ers s ha r ing profit s in the r a t io of 2 :1 . C is a dm it ted in to thefirm for 1/ 4 s ha re of profi ts . C brings in Rs. 20,000 in resp ect of his ca pi tal . Thecapitals of old partners A and B, af ter al l adjustments relat ing to goodwil l ,r ev a lua t i on o f a s s e t s and l i ab i l i t i e s , e t c . , a r e Rs . 45 ,000 and Rs . 15 ,000resp ect ively. It is agreed th at pa rtn ers cap i tals shou ld be accordi

3-ch. (admission of a partner) (ver.-4)

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