The journal entry for treatment of goodwill, when a new partner brings his share of goodwill in cash and one of the old partners gains, involves the following: (A) Gaining Partner’s Capital Account is debited Choose the correct answer from the options given below:
(B) Premium for Goodwill Account is debited
(C) Sacrificing Partner’s Capital Account is credited
(D) Gaining Partner’s Capital Account is credited
(A), (B) and (C) only
Understanding Goodwill Treatment on Partner Admission
When a new partner is admitted into a partnership, one of the important adjustments required is for goodwill. Goodwill represents the value of the firm's reputation and future earning capacity. When a new partner joins, they often compensate the existing partners for a share of this goodwill, as they will now benefit from it.
The treatment of goodwill depends on various factors, including whether the new partner brings their share of goodwill in cash or not, and whether the goodwill already exists in the books.
Journal Entries for Goodwill Brought in Cash
In the specific case described in the question, the new partner brings their share of goodwill in cash. The typical journal entries involved are:
- Entry for receiving the cash for goodwill:
| Debit | Credit |
|---|---|
| Cash/Bank Account | Premium for Goodwill Account |
(Being goodwill amount brought in by the new partner)
- Entry for distributing the goodwill among the old partners:
| Debit | Credit |
|---|---|
| Premium for Goodwill Account | Sacrificing Partners' Capital Accounts |
(Being goodwill distributed among sacrificing partners in their sacrificing ratio)
Adjusting Goodwill When an Old Partner Gains
The question mentions a specific scenario where, in addition to the new partner's admission, one of the old partners gains from the change in profit-sharing ratio. This means that while some old partners sacrifice a share of profit (to the new partner and possibly the gaining old partner), one old partner actually gets a larger share. The gaining old partner also needs to compensate the sacrificing partners for their gain in profit share, related to goodwill.
This compensation is adjusted through the Capital Accounts of the old partners based on their net gain or sacrifice. The gaining old partner's capital account is debited, and the sacrificing partners' capital accounts are credited for their respective shares of goodwill.
The journal entry for this internal adjustment among old partners (and potentially the new partner if they contribute to the gain of an old partner, though the question implies an old partner gaining relative to other old partners) is:
| Debit | Credit |
|---|---|
| Gaining Partner's Capital Account (Old Partner) | Sacrificing Partners' Capital Accounts (Old Partners) |
(Being adjustment for goodwill among old partners due to change in profit sharing ratio)
Combining the entries, the distribution of the 'Premium for Goodwill' is made to the Sacrificing Partners. Additionally, any net gain/sacrifice among old partners is adjusted through their capital accounts.
Analyzing the Statements
Let's look at the statements provided in the question based on the journal entries discussed:
- (A) Gaining Partner’s Capital Account is debited: This statement is correct. As shown in the adjustment entry, a gaining old partner's capital account is debited to compensate the sacrificing partners for their share of goodwill.
- (B) Premium for Goodwill Account is debited: This statement is correct. When the goodwill amount brought in by the new partner is distributed, the 'Premium for Goodwill Account' is debited to close it.
- (C) Sacrificing Partner’s Capital Account is credited: This statement is correct. Sacrificing partners are credited to receive their share of the goodwill brought in by the new partner, and also potentially compensated by a gaining old partner.
- (D) Gaining Partner’s Capital Account is credited: This statement is incorrect. A gaining partner's capital account is debited, not credited, to make the goodwill adjustment among partners.
Based on the analysis, statements (A), (B), and (C) are involved in the journal entry treatment of goodwill in this specific scenario.
Revision Table: Goodwill Treatment Key Points
| Scenario | New Partner Brings Cash for Goodwill | Old Partner Gains |
|---|---|---|
| Cash Received | Cash/Bank A/c Dr. To Premium for Goodwill A/c |
Not directly related to cash receipt from new partner |
| Distribution of Premium | Premium for Goodwill A/c Dr. To Sacrificing Partners' Capital A/c (in sacrificing ratio) |
Gaining Partner's Capital A/c Dr. To Sacrificing Partners' Capital A/c (for value of goodwill share gained/sacrificed) |
| Net Effect on Capital | Sacrificing partners credited for their share | Gaining old partner debited, sacrificing old partner credited |
| Relevant Accounts | Premium for Goodwill A/c, Sacrificing Partners' Capital A/c | Gaining Partner's Capital A/c, Sacrificing Partners' Capital A/c |
Additional Information: Sacrificing and Gaining Ratio
Understanding sacrificing and gaining ratios is crucial for goodwill adjustments. These ratios represent the change in each partner's share of profits.
- Sacrificing Ratio: This is the ratio in which the old partners surrender a part of their share of profits in favour of the new partner or a gaining old partner. It is calculated as Old Share minus New Share. If the result is positive, it is a sacrifice.
- Gaining Ratio: This is the ratio in which a partner (new or old) acquires a share of profits from other partners. It is calculated as New Share minus Old Share. If the result is positive, it is a gain. An old partner can gain if the new profit sharing ratio among old partners changes significantly upon admission of a new partner.
The goodwill brought in by the new partner is distributed among the sacrificing partners in their sacrificing ratio. If an old partner gains, they must compensate the sacrificing partners (including those who sacrificed to the new partner and the gaining old partner) to the extent of their gain in the firm's goodwill value. This compensation happens through capital account adjustments.
Important Questions from Accounting for Partnership : Goodwill
Consider the following facts about valuation of Goodwill of a partnership firm:
A. Goodwill valuation is done on change in profit sharing ratio among the existing partners.
B. Goodwill is valued on admission of a partner, to know the amount to be paid by him to compensate sacrificing partner(s).
C. Goodwill valuation is done on the retirement of a partner to know the amount to be paid to him as compensation for his sacrifice.
D. Goodwill valuation is done at the time of dissolution of a firm which involves sale of business as a going concern.
E. Goodwill valuation is done during the distribution of profits of the partnership firm.
Choose the correct answer from the options given below:
In the context of a partnership firm, the need for valuation of goodwill arises in the following circumstances.
According to AS-26 on Intangible Assets:
(A) Internally generated goodwill should not be recognised as an asset
(B) Self-generated goodwill is accounted for in the books and shown as an asset
(C) Intangible assets should be written off as early as possible but not exceeding its estimated life
(D) Purchased goodwill is not recognised as an asset
(E) Can be written off even beyond 10 years depending upon the nature of the asset
Choose the correct answer:
Match List I with List II.
List - I List - II (A) Normal Rate of Return (I) Total Assets – Outside Liabilities (B) Number of years purchase (II) Usual return on capital employed (C) Capital Employed (III) Return over and above usual return in similar business (D) Super Profit (IV) Expected period for which returns are anticipated to accrue Choose the correct answer:
Under the capitalisation method of calculating goodwill, the term capital refers to:
