Treatment of Goodwill on the Death of a Partner

Goodwill reflects the value of the firm's reputation and earning capacity — value that has often been built up partly through the efforts of the very partner who has now died. Fairness requires that the deceased partner's estate be compensated for their share of this goodwill.

Step 1 — Determine the deceased partner's share. The firm's goodwill is valued as at the date of death (by whichever method the firm follows — average profits, super profits, or capitalisation), and the deceased partner's share of this value is worked out using their OLD profit-sharing ratio, since that is the ratio in which they held a claim on the firm's goodwill while alive.

Step 2 — Charge it to the gaining partners. This share is compensation for the enhanced future share the continuing partners will now enjoy, so it is charged to them in their GAINING ratio — through a simple capital account adjustment, with no separate Goodwill account needing to be opened:

Gaining Partners' Capital A/cs Dr (in gaining ratio) — To Deceased Partner's Capital A/c …