Q.Yash and Karan were partners in an interior designer firm. Their fixed capitals were ₹ 6,00,000 and ₹ 4,00,000 respectively. There were credit balances in their current accounts of ₹ 4,00,000 and ₹ 5,00,000 respectively. The firm had a balance of ₹ 1,00,000 in General Reserve. The firm did not have any liability. They admitted Radhika into partnership for 1/4th share in the profits of the firm. The average profits of the firm for the last five years were ₹ 5,00,000. Calculate the value of goodwill of the firm by capitalization of average profits method. The normal rate of return in the business is 10%.
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🔒 Start your 14-day free trial to unlock the full solution →Part (a)Concept understanding — Goodwill Definition Factors
Goodwill: The Invisible Asset of a Business
Start with an Everyday Intuition
Think of two identical chai stalls next to each other. Same menu, same prices, same location size. Yet one stall has a long queue of loyal customers every morning, while the other struggles. Why? Because the first stall has built something over years — trust, a reputation for the best cutting chai, regular customers who know the owner by name. That "something" is goodwill.
In business, goodwill is the extra value a firm has earned beyond its physical assets (cash, furniture, machinery) and recorded liabilities. It's the reason a buyer is willing to pay more for a business than the sum of its individual parts.
The Precise Meaning (NCERT Definition)
Goodwill is the value of the reputation of a firm in respect of the profits expected in the future over and above the normal profits earned by other firms in the same industry.
In simpler terms: Goodwill = the present value of a firm's future super profits — the extra profit it earns compared to a normal business of similar size.
Why Does Goodwill Matter?
Goodwill is not recorded in the books unless it is actually paid for. It arises in specific situations:
- When a new partner is admitted — the existing partners have built the reputation; the new partner must compensate them for it.
- When a partner retires or dies — the continuing partners must pay the outgoing partner for their share of the firm's reputation.
- When the firm is sold — the buyer pays for goodwill as part of the purchase price.
Without valuing goodwill, the incoming partner would get a free ride on the hard work of the existing partners. That's unfair — and accounting fixes this.
Factors Affecting the Value of Goodwill
The NCERT textbook lists these key factors that determine how much goodwill a firm has:
| Factor | What It Means |
|---|---|
| Location | A shop in a busy market has higher goodwill than one in a remote area. |
| Quality of products/services | Consistent quality builds customer loyalty. |
| Efficiency of management | Good managers keep costs low and profits high. |
| Nature of business | A business with stable demand (e.g., essential goods) has more reliable goodwill. |
| Favourable contracts | Long-term supply or sales agreements add value. |
| Customer loyalty | Repeat customers reduce marketing costs. |
| Market conditions | Monopoly or limited competition increases goodwill. |
Goodwill is not a fixed number. It changes with time, competition, and the firm's performance. It is valued only when a change in partnership occurs.
Accounting Treatment: The Journal Entry
When a new partner brings in their share of goodwill (in cash), the entry is:
Journal Entry:
| Date | Particulars | L.F. | Dr. (₹) | Cr. (₹) |
|---|---|---|---|---|
| Premium for Goodwill A/c Dr. | xxx | |||
| To Existing Partners' Capital A/cs (in sacrificing ratio) | xxx |
Explanation:
- Debit the asset account "Premium for Goodwill" (or simply "Goodwill A/c") — because the firm has received cash for an intangible asset.
- Credit the existing partners' capital accounts in their sacrificing ratio — because they have given up a portion of their future profits to the new partner.
The sacrificing ratio = Old ratio − New ratio. This is the ratio in which the old partners have given up their share of profits. Goodwill is always distributed in this ratio, not the old profit-sharing ratio.
Proforma: Partners' Capital Account (When Goodwill is Brought in Cash)
Here is the format as per NCERT for the Partners' Capital Account when a new partner brings goodwill in cash:
Partners' Capital Account
| Particulars | A (₹) | B (₹) | C (₹) | | Particulars | A (₹) | B (₹) | C (₹) |
|-------------|-------|-------|-------|---|-------------|-------|-------|-------| …
Part (b)Concept understanding — Sacrificing Ratio Definition
Let’s start with something you already know from everyday life.
Suppose you and your friend share a pizza equally — half each. One day, your friend says, “I’m not that hungry, you can have a bigger slice today.” So you take 60% and your friend takes 40%. Your friend has sacrificed 10% of the pizza in your favour. That 10% is the sacrificing ratio — the share your friend gave up so you could have more.
Now bring this into a partnership firm. Partners share profits in a fixed ratio (say 3:2). When a new partner is admitted, the old partners have to give up a part of their share to make room for the newcomer. The proportion in which they give up their shares is called the sacrificing ratio.
Precise meaning
Sacrificing ratio = Old ratio – New ratio (for each old partner).
If the result is positive, that partner has sacrificed. If negative, that partner has gained (which is called the gaining ratio, used at retirement).
For example, if A and B share profits 3:2, and they admit C for a 1/5th share, the new ratio might become 2:2:1. Then:
- A’s sacrifice = 3/5 – 2/5 = 1/5
- B’s sacrifice = 2/5 – 2/5 = 0
So A alone sacrifices 1/5th of the total profit. That 1/5th is the sacrificing ratio between A and B — here it’s simply 1:0.
Why does it matter?
Because the new partner brings in goodwill (a premium) to compensate the old partners for the share they gave up. That goodwill is distributed among the sacrificing partners in their sacrificing ratio. If you don’t calculate the sacrificing ratio correctly, you’ll distribute the goodwill unfairly — and that’s a serious accounting error.
Accounting treatment
When the new partner brings in his share of goodwill in cash:
-
Journal entry:
- Debit: Cash/Bank A/c (with the amount brought in)
- Credit: Premium for Goodwill A/c (with the same amount)
-
Then the premium is distributed to the sacrificing partners:
- Debit: Premium for Goodwill A/c
- Credit: Old Partners’ Capital A/cs (individually, in sacrificing ratio)
If the new partner does not bring in cash, the adjustment is done through the capital accounts directly (the new partner’s capital is debited, and the old partners’ capitals are credited).
Format: Capital Accounts (showing goodwill adjustment) …
Part (a)
Goodwill by Capitalisation of Average Profits
Capitalised value of firm = Average Profit ÷ Normal Rate = 5,00,000 ÷ 10% = ₹50,00,000.
Capital Employed (net assets, no liabilities):
| Item | ₹ |
|---|---|
| Yash's Fixed Capital | 6,00,000 |
| Karan's Fixed Capital | 4,00,000 |
| Yash's Current A/c | 4,00,000 |
| Karan's Current A/c | 5,00,000 |
| General Reserve | 1,00,000 |
| Total | 20,00,000 |
Part (a): Goodwill by capitalisation of average profits = ₹30,00,000.
Part (b): Three entries — goodwill ₹90,000 to Samiksha; P&L Dr ₹50,000 written off 5:3:2; IFF ₹40,000 absorbs ₹20,000 investment loss and distributes ₹20,000 surplus 5:3:2.
Part (a): Goodwill by Capitalisation of Average Profits
Capitalisation values the whole firm as if its average profit were the normal return on the capital it ought to employ; goodwill is the excess of that value over the actual net assets.
Working Notes
- Capitalised value = Average Profit ÷ Normal Rate = 5,00,000 ÷ 10/100 = ₹50,00,000.
- Capital Employed (net assets) = 6,00,000 + 4,00,000 (fixed capitals) + 4,00,000 + 5,00,000 (current accounts) + 1,00,000 (General Reserve) = ₹20,00,000. (No liabilities.) …
Showing the 12 most recent of 146 on this concept.
- CBSE 2026Set 67/4/11 markMCQQ.Assertion (A) : Goodwill is an intangible asset. Reason (R) : Goodwill is the value of the reputation of a firm in respect of profits expected in future over and above the normal profits. Choose the correct option from the following : (A) Both Assertion (A) and Reason (R) are correct and Reason (R) is the correct explanation of Assertion (A). (B) Both Assertion (A) and Reason (R) are correct, but Reason (R) is not the correct explanation of Assertion (A). (C) Assertion (A) is incorrect, but Reason (R) is correct. (D) Assertion (A) is correct, but Reason (R) is incorrect.
›Reveal solutionSolution
Goodwill is indeed an intangible asset, and the reason given correctly explains why — it is the value of a firm’s reputation that generates above-normal future profits.
Let’s begin with the assertion. In accounting, assets are classified as tangible or intangible. Tangible assets have physical substance — land, machinery, cash. Intangible assets do not; they are non-physical rights or advantages that bring economic benefit. Goodwill fits this definition perfectly: you cannot touch or see it, yet it has real value because it represents the firm’s ability to earn more than the average business in its industry. The NCERT textbook for Class 12 Accountancy (Part II) explicitly lists goodwill under “Intangible Assets” in the balance sheet format. So Assertion (A) is correct.
Now the reason. Goodwill arises from a firm’s reputation — its brand name, customer loyalty, location, quality of products, and management efficiency. These factors allow the firm to earn super profits, i.e., profits above the normal rate of return expected in that line of business. The textbook defines goodwill as “the value of the reputation of a firm in respect of the profits expected in future over and above the normal profits.” That is exactly what Reason (R) states. So Reason (R) is also correct. …
- CBSE 2026Set MARCH1 markMCQQ.'Goodwill' is which type of asset?(a) Tangible asset(b) Intangible asset(c) Current asset(d) Fictitious asset
›Reveal solutionSolution
Goodwill is an intangible asset, so the answer is (b).
Assets are broadly tangible (having physical existence, like machinery) or intangible (having value but no physical form, like goodwill, patents, trademarks). Goodwill represents the extra earning power and reputation of a firm; it has a real, realisable money value and can be sold along with the b …
- CBSE 2026Set MARCH1 markMCQQ.Which method is appropriate for the computation of goodwill when profit of every year is increasing?(a) Simple average(b) Weighted average(c) Annual growth rate(d) Compound growth rate
›Reveal solutionSolution
For a steadily rising profit trend, the weighted average profit method is appropriate, so the answer is (b).
Under the simple average method every year's profit gets equal importance, which understates goodwill when profits are on an upward trend. The weighted average method assigns increasing weights (1, 2, 3, ...) to successive years so that the most recent, higher profits influence …
- CBSE 2026Set MARCH1 markQ.What is weighted average profit?
›Reveal solutionSolution
Weighted average profit gives greater importance to recent profits while averaging past profits for goodwill valuation.
Weighted average profit is used to value goodwill when profits show a rising or falling trend. Each year's profit is multiplied by a weight (normally 1 for the earliest year, increasing to the highest weight for the most recent year). The sum of these products is then divided by the sum of the weights.
Weighted average profit = Total of (Profit x Weight) / Total of weights
…
- CBSE 2026Set MARCH1 markQ.Old Ratio – New Ratio = __________ Ratio.
›Reveal solutionSolution
Old Ratio - New Ratio = Sacrificing Ratio.
On admission of a partner, the existing partners surrender a portion of their profit share in favour of the incoming partner. The proportion in which they surrender is the sacrificing ratio, calculated as the difference between each old partner's old share and new shar …
- CBSE 2026Set ANNUAL1 markMCQQ.Consider the following statements: Statement (I): Sacrificing Ratio = Old Profit and Loss sharing ratio – New Profit and Loss sharing ratio. Statement (II): Super profit = Average profits – Normal profits. Choose the correct answer from the following options: A) Only statement (I) is wrong B) Only statement (II) is correct C) Statement (I) is wrong and statement (II) is correct D) Both statements (I) and (II) are correct
›Reveal solutionSolution
Both definitions are standard and correct, so option (D) applies.
Statement (I): Sacrificing Ratio = Old profit-sharing ratio - New profit-sharing ratio. This is the correct formula; it measures the share old partners give up to the incoming/gaining partner.
…
- CBSE 2026Set ANNUAL1 markMCQQ.If Nisha and Komal are sharing profits in the ratio of 4 : 3. They decided to distribute profits equally in future. The sacrifice of Nisha will be A) 1/14 B) 4/14 C) 4/7 D) 3/7
›Reveal solutionSolution
Nisha's sacrifice on moving from a 4:3 ratio to an equal ratio is 1/14 — option (A).
Old ratio of Nisha and Komal = 4 : 3, so Nisha's old share = 4/7.
New ratio = equal = 1 : 1, so Nisha's new share = 1/2.
Sacrifice = Old share - New share
= 4/7 - 1/2
= 8/14 - 7/14
= 1/14
…
- CBSE 2026Set ANNUAL1 markQ.Fill in the blank: The cash or non-cash item bought by a new partner to acquire a share in the firm's profit are called __________. (Capital/Goodwill (Premium))
›Reveal solutionSolution
The amount a new partner brings to acquire a share in profits is goodwill (premium).
On admission, an incoming partner acquires a share of future profits that the existing partners sacrifice. To compensate them, the new partner brings in an extra amount (in cash or in kind) called goodwill or premium for goodwill. This is …
- CBSE 2026Set ANNUAL1 markQ.Mahaveer and Jitendra are partners in a firm sharing profits in the ratio of 4 : 3. They admitted Vaibhav for 1/5th share in profit, which he received from Jitendra. Calculate the sacrificing ratio.
›Reveal solutionSolution
Only Jitendra sacrifices his 1/5th share, so the sacrificing ratio is entirely Jitendra's (Mahaveer nil).
Mahaveer and Jitendra share profits 4 : 3. Vaibhav is admitted for a 1/5th share, which he takes wholly from Jitendra.
- Mahaveer's sacrifice = 0 (his share is unchanged).
- Jitendra's sacrifice = 1/5 (he alone gives up the share). …
- CBSE 2026Set ANNUAL1 markMCQQ.Weighted average method of calculating goodwill is used when(a) Profit is equal(b) Profit has increasing trend(c) Profit has decreasing trend(d) Both (A) and (B)
›Reveal solutionSolution
The weighted average method is used when profits show an increasing (or definite) trend - option (b).
Under the simple average method all years' profits carry equal weight. But when profits are rising (or show a clear trend), recent years are a better guide to future earnings, so the weighted average method is used - higher weights are assigned to the later yea …
- CBSE 2026Set ANNUAL1 markQ.Fill in the blank: Sacrificing ratio is always ________ to gaining ratio.
›Reveal solutionSolution
Answer: Opposite / reverse.
Sacrificing ratio = Old ratio - New ratio (share given up), while gaining ratio = New ratio - Old ratio (share acquired). They are computed in opposite directions, so a sacrificing ratio is always the opposite (reverse) of a gaining r …
- CBSE 2026Set ANNUAL1 markQ.Answer in one word/sentence: The amount of goodwill brought by new partner is distributed to old partners in which ratio?
›Reveal solutionSolution
Answer: Sacrificing ratio.
The premium (goodwill) brought in by a new partner compensates the old partners for the share of profit they give up, so it is distributed among the …
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