Accounting for Goodwill on Partner Retirement

When a partner decides to retire from a partnership firm, the continuing partners take over the retiring partner's share in the business. This includes accounting for the value of the firm's goodwill, which represents the reputation and earning capacity built over time. The retiring partner is entitled to their share of this goodwill because they contributed to its creation during their time in the firm.

Crediting the Retiring Partner's Capital Account with Goodwill

Upon retirement, the retiring partner's capital account needs to be adjusted to reflect their share of various assets, liabilities, accumulated profits, losses, and the value of goodwill. Regarding goodwill, the retiring partner's capital account is credited with their specific share of the firm's total goodwill.

This credit compensates the retiring partner for their contribution to building the firm's reputation and earning potential, which the remaining partners will continue to benefit from. The corresponding debit is typically made to the remaining partners' capital accounts in their gaining ratio, as they are the ones who benefit from the retiring partner leaving and acquiring their share.

Analyzing the Options:

• <strong>His/her share of goodwill</strong>: This is the correct treatment. The retiring partner is compensated for their contribution to the firm's value by being credited with their portion of the goodwill.
• <strong>Goodwill (value) of the firm</strong>: The retiring partner does not receive the entire value of the firm's goodwill; they only receive their proportionate share. Crediting the full firm goodwill to one partner is incorrect.
• <strong>Share of goodwill of remaining partners</strong>: This is conceptually incorrect. The remaining partners' share of goodwill is what *they* are entitled to or what they might pay for the retiring partner's share. The retiring partner receives their *own* share, not the remaining partners'.
• <strong>Existing goodwill of the firm</strong>: Existing goodwill (goodwill already appearing in the balance sheet) is typically written off before retirement or handled separately. The question refers to the adjustment for the *current* value of goodwill at the time of retirement, not necessarily the value that might already be on the books from past transactions.

Therefore, the most appropriate amount to be credited to the retiring partner's capital account concerning goodwill is their calculated share of the firm's goodwill value at the time of retirement.

Revision Table: Partner Retirement and Goodwill

Additional Information: Accounting for Goodwill

There are different methods to account for goodwill upon a partner's retirement:

• <strong>Premium Method (or Memorandum Method)</strong>: Goodwill is not shown in the balance sheet. The retiring partner's share of goodwill is adjusted directly through the capital accounts of the remaining partners in their gaining ratio. This is the method conceptually explained by the correct answer.
• <strong>Revaluation Method (or Raising and Writing off Goodwill)</strong>:
  • First, goodwill is raised in the books at its full value by debiting Goodwill Account and crediting all partners' (including the retiring one) Capital Accounts in their old profit-sharing ratio. The retiring partner's account is credited with their share here.
  • Then, the raised goodwill is immediately written off by debiting the remaining partners' Capital Accounts (in their new profit-sharing ratio) and crediting the Goodwill Account. While this method involves a credit to the retiring partner's account, the direct adjustment method (Premium Method) is often simpler and focuses the transaction on the transfer of value from remaining partners to the retiring partner for their share of goodwill.
• <strong>Accounting Standard 10 (AS 10) / Ind AS 38</strong>: Under accounting standards, internally generated goodwill is generally not recognised as an asset in the balance sheet. Purchased goodwill is recognised. However, for partnership accounting purposes upon reconstitution (like retirement), the valuation and adjustment of internally generated goodwill among partners is common practice to ensure fair compensation to the retiring partner.

Understanding the concept of gaining ratio is crucial, as it determines how the cost of compensating the retiring partner for goodwill is shared among the continuing partners. Gaining Ratio = New Share - Old Share.