Solving Partnership Retirement Goodwill Journal Entry

This problem involves the retirement of a partner and the necessary adjustment for goodwill in the partnership accounts. When a partner retires, the continuing partners usually compensate the retiring partner for their share of the firm's goodwill. This compensation is distributed among the continuing partners in their gaining ratio.

Given Information

• Old Profit Sharing Ratio of A, B, and C: 4:3:2
• Retiring Partner: B
• Future Profit Sharing Ratio of A and C: 5:3
• Total Goodwill of the firm: ₹1,08,000

Step-by-Step Calculation for Goodwill Adjustment

1. Calculate the Retiring Partner's Share of Goodwill

The retiring partner (B) is entitled to their share of the firm's goodwill based on the old profit sharing ratio.

B's old share = $\frac{3}{4+3+2} = \frac{3}{9}$

B's Share of Goodwill = Total Goodwill $\times$ B's old share

B's Share of Goodwill = ₹1,08,000 $\times \frac{3}{9}$

B's Share of Goodwill = ₹1,08,000 $\times \frac{1}{3}$

B's Share of Goodwill = ₹36,000

2. Calculate the Gaining Ratio of Continuing Partners

The gaining ratio is calculated as New Share minus Old Share for the continuing partners (A and C).

Old Ratio (A:B:C) = 4:3:2

New Ratio (A:C) = 5:3

Total Old Shares = 4 + 3 + 2 = 9

Total New Shares = 5 + 3 = 8

For Partner A:

A's Old Share = $\frac{4}{9}$

A's New Share = $\frac{5}{8}$

A's Gain = New Share - Old Share

A's Gain = $\frac{5}{8} - \frac{4}{9}$

To subtract, find a common denominator, which is 72.

A's Gain = $\frac{5 \times 9}{8 \times 9} - \frac{4 \times 8}{9 \times 8} = \frac{45}{72} - \frac{32}{72}$

A's Gain = $\frac{45 - 32}{72} = \frac{13}{72}$

For Partner C:

C's Old Share = $\frac{2}{9}$

C's New Share = $\frac{3}{8}$

C's Gain = New Share - Old Share

C's Gain = $\frac{3}{8} - \frac{2}{9}$

Common denominator is 72.

C's Gain = $\frac{3 \times 9}{8 \times 9} - \frac{2 \times 8}{9 \times 8} = \frac{27}{72} - \frac{16}{72}$

C's Gain = $\frac{27 - 16}{72} = \frac{11}{72}$

The Gaining Ratio of A and C is $\frac{13}{72} : \frac{11}{72}$, which simplifies to 13:11.

3. Calculate the Amount Payable/Receivable for Goodwill Adjustment

The retiring partner (B) will be credited with their share of goodwill (₹36,000). The continuing partners (A and C) who gain in the profit sharing ratio will compensate B in their gaining ratio (13:11). Their capital accounts will be debited.

Amount debited to A's Capital Account = B's Share of Goodwill $\times \frac{\text{A's Gain}}{\text{Total Gain}}$

Amount debited to A's Capital Account = ₹36,000 $\times \frac{13}{13 + 11} = ₹36,000 \times \frac{13}{24}$

Amount debited to A's Capital Account = ₹1,500 $\times$ 13 = ₹19,500

Amount debited to C's Capital Account = B's Share of Goodwill $\times \frac{\text{C's Gain}}{\text{Total Gain}}$

Amount debited to C's Capital Account = ₹36,000 $\times \frac{11}{13 + 11} = ₹36,000 \times \frac{11}{24}$

Amount debited to C's Capital Account = ₹1,500 $\times$ 11 = ₹16,500

Journal Entry for Goodwill Adjustment

The journal entry required is to debit the gaining partners' capital accounts and credit the retiring partner's capital account with their respective amounts calculated above.

This entry reflects that A and C, the continuing partners, are compensating B, the retiring partner, for his share of goodwill in their gaining ratio. The total amount debited (₹19,500 + ₹16,500 = ₹36,000) equals the amount credited to B's capital account.

Revision Table: Key Ratios and Shares

Additional Information: Accounting for Goodwill on Retirement

When a partner retires, the existing goodwill of the firm needs to be accounted for. There are usually two main scenarios:

• Goodwill is not shown in the books: In this case, the retiring partner's share of goodwill is calculated. The continuing partners compensate the retiring partner for this share in their gaining ratio. The journal entry involves debiting the gaining partners' capital accounts and crediting the retiring partner's capital account, as demonstrated in this problem.
• Goodwill is already appearing in the books: If goodwill already exists in the balance sheet, it is usually written off among all partners (including the retiring one) in their old profit sharing ratio before making any adjustment for the retiring partner's share of new goodwill valuation. The entry for writing off is debiting all partners' capital accounts in the old ratio and crediting the Goodwill Account. After this, the adjustment for the retiring partner's share of the *valued* goodwill is made as described above.

The method used depends on the partnership agreement and accounting policies.

The Gaining Ratio is crucial in partnership retirement or death cases as it determines how the continuing partners will share the retiring or deceased partner's share of profit and goodwill.