Accounting Treatment for Goodwill On Admission Of Partners ( Part 2 of 3 )

October 14th, 2008 Comments off
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Earlier, method 1 wherein goodwill Recorded in FULL in the books had been discussed.

The second method is as follows:

Method No. 2:

SCENARIO NO 1: Where Goodwill is NOT recorded in the books

· Goodwill is not recorded in the books hence NO goodwill account is open

· Incoming partner pay his proportion of the agreed value of goodwill in CASH.

· Additional cash brought in by new partner is known as premium and is credited to the Capital Accounts of the existing partners in their old profit sharing ratio

Accounting entries:

Debit: Cash Account [Total Cash bought in by the new partners]

Credit: New Partner’s Account( capital introduced)

Credit: Existing/old partners ( premium for goodwill)

Illustration:

Jim and John are partners sharing profits 50:50. They admit Alex who introduces $10,000 as capital and $2000 as premium for goodwill. The new profit sharing ratio is :40:40:20

Partners’ Capital Account

DR

CR

$

$

$

Jim

John

Alex

Cash-Capital

10,000

Cash Goodwill

1,000

1,000

Cash At Bank Account

DR

$

CR

$

Cash received from Alex($10,000+$2,000)

12,000

SCENARIO 2: Where Goodwill is Opened and then Written off from the books

· This is a more tedious way of doing it.

· You need to open a Goodwill account in the books and then write off using the new profit sharing ratio

· Using this method you still get back the result as scenario one where goodwill is never open/created in the books.

Accounting Entries:

Debit: Goodwill Account with total value of goodwill

Credit: Old/existing partner’s capital account with goodwill in old profit sharing ratio

Illustration:

Jim and John are partners sharing profits 50:50. They admit Alex who introduces $10,000 as capital and $2000 as premium for goodwill. The new profit sharing ratio is :40:40:20

Solution:

To record the goodwill, first compute the value:

Alex paid $2,000 for his 20% share

Therefore goodwill = $10,000

Goodwill Account

DR

$

CR

$

Capital Accounts:

Jim: 50%

5,000

Capital Account:

Jim: 40%

4,000

John: 50%

5,000

John:40%

4,000

Alex:20%

2,000

10,000

10,000

Partners’ Capital Account

DR

$

$

$

CR

$

$

$

Jim

John

Alex

Jim

John

Alex

Goodwill account

4,000

4,000

2,000

Cash-Capital

10,000

Cash-Goodwill

2,000

Goodwill Account

5,000

5,000

Note: The net amount credited to the old/existing partners’ capital accounts are the same as scenario one viz: Jim:$1,000 and John $1,000

Click here for ALL articles under the heading of Partnership Account

Click here to see Method 3

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