When the new Partner brings goodwill in cash

When a new partner brings his share of goodwill in cash, the amount is usually paid through the firm (not privately). If paid privately to the old partners, no journal entry is needed in the firm's books. But when paid through the firm, the accounting treatment follows a clear two-step logic.

Step 1: Record the cash brought in by the new partner — this includes both his capital and the premium for goodwill.

Step 2: Distribute that premium among the existing partners in their sacrificing ratio. The sacrificing ratio is the ratio in which the old partners give up their share of profits in favour of the new partner. Unless stated otherwise, the sacrificing ratio is the same as the old profit-sharing ratio.

There are two alternative ways to record these entries.

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Method 1: Using a Premium for Goodwill Account

This is the standard method shown in the textbook.

Why this works: The Premium for Goodwill account acts as a temporary account. It collects the goodwill amount from the new partner and then passes it on to the old partners. The old partners' capital accounts are credited because they are being compensated for the share of profits they have sacrificed.

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Method 2: Direct Adjustment Through New Partner's Capital Account

Instead of using a Premium for Goodwill account, the entire amount brought in (capital + goodwill) is first credited to the new partner's capital account. Then, the goodwill portion is debited from his capital account and credited to the sacrificing partners.

Both methods achieve the same final result. The textbook uses the first method (with Premium for Goodwill A/c) in most illustrations.

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What Happens After the Goodwill is Credited?

The old partners now have an increased balance in their capital accounts due to the goodwill. They have two choices:

1. Retain the amount in the business: No further entry is needed. The goodwill amount stays in the firm as additional capital of the old partners.

2. Withdraw the amount (fully or partially): An additional entry is passed to record the withdrawal.

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When Goodwall Already Exists in the Books

If the firm already has a goodwill account (from a previous purchase), that existing goodwill must be written off at the time of admission. This is done by debiting the old partners' capital accounts in their old profit-sharing ratio and crediting the Goodwill account.

After writing off the old goodwill, the new goodwill brought in by the incoming partner is recorded as usual.

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When the New Partner Does Not Bring Goodwill in Cash (Fully or Partly)

If the new partner cannot bring the full amount of goodwill in cash, the unpaid portion is debited to his Current Account (not Capital Account), and the sacrificing partners' capital accounts are credited.

Case 1: No goodwill exists in the books

Case 2: Part of the goodwill is brought in cash

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When Goodwill Exists in the Books and the New Partner Does Not Bring Cash

The process has two steps:

1. Write off the existing goodwill by debiting old partners' capital accounts in their old profit-sharing ratio and crediting Goodwill A/c. …