Accounting for Goodwill on Partner Retirement

When a partner retires from a firm, the existing goodwill shown in the books of accounts needs to be dealt with. Goodwill represents the value of the firm's reputation and future earning capacity. If goodwill already appears in the balance sheet, it signifies internally generated goodwill or purchased goodwill that hasn't been written off. Generally accepted accounting practice requires writing off this existing goodwill before the retirement accounting adjustments are made.

Why Write Off Existing Goodwill?

Existing goodwill appearing in the books often represents a past valuation or internally generated goodwill that should ideally not be shown unless it's purchased. Writing off this goodwill ensures that the balance sheet reflects a more accurate position at the time of partner retirement and avoids carrying forward an intangible asset whose value might be subjective or already accounted for in other ways (like revaluation of assets).

Accounting Treatment for Writing Off Existing Goodwill

The standard accounting treatment for writing off existing goodwill is to debit the capital accounts of all partners (including the retiring partner) in their old profit-sharing ratio and credit the Goodwill account. This reduces the value of goodwill to zero in the books and reduces the capital balances of all partners proportionally based on how they shared profits (and thus were responsible for building or carrying the goodwill) before the change in the firm's constitution.

Journal Entry for Writing Off Goodwill

In the given scenario, Gobind, Hari, and Pratap are partners, and goodwill appears in the books at ₹24,000 on Gobind's retirement. This ₹24,000 existing goodwill must be written off by debiting the capital accounts of all three partners (Gobind, Hari, and Pratap) in their old profit-sharing ratio.

Analyzing the Options

Let's look at the provided options:

• Option 1: By debiting all the partner capital accounts in old profit-sharing ratio. This aligns with the correct accounting principle for writing off existing goodwill.
• Option 2: By debiting remaining partner capital amount in the new profit-sharing ratio. This is incorrect. Existing goodwill is written off by all partners in the old ratio, not just the remaining ones in the new ratio.
• Option 3: By debiting retiring partner’s capital account from his share of Goodwill. This is incorrect. Existing goodwill is written off from all partners' accounts, not just the retiring partner's share.
• Option 4: By crediting all partner’s capital accounts in their old profit-sharing ratio. This is incorrect. Capital accounts are debited to reduce their balance when writing off an asset like goodwill.

Therefore, the correct method is to debit the capital accounts of all partners (Gobind, Hari, and Pratap) in their old profit-sharing ratio to write off the existing goodwill of ₹24,000.

Revision Table: Goodwill Treatment Summary

Additional Information: Partner Retirement and Goodwill

When a partner like Gobind retires, the partnership agreement changes. Besides writing off existing goodwill, the firm might also value the 'new' goodwill of the firm at the time of retirement. This newly valued goodwill represents the retiring partner's share in the firm's reputation built up to the date of retirement, plus the overall firm's earning capacity that the continuing partners will benefit from. The retiring partner is entitled to their share of this newly valued goodwill.

The adjustment for the retiring partner's share of newly valued goodwill is typically done by debiting the capital accounts of the gaining partners (Hari and Pratap, if they continue and gain) in their gaining ratio and crediting the retiring partner's capital account (Gobind) with his share of goodwill. This is a separate adjustment from writing off the existing goodwill.

In summary, existing goodwill is written off from all partners' accounts in the old ratio, while the retiring partner's share of newly valued goodwill is compensated by the remaining partners in their gaining ratio.