Book-Keeping and Accountancy · Ch 4 — Reconstitution of Partnership (Retirement of Partner)
Treatment of Goodwill on Retirement
Treatment of Goodwill on Retirement
A firm's goodwill — the value of the reputation it has built up over the years, letting it earn more than a similar new firm would from the same volume of business — does not disappear when a partner retires; it belongs, at the moment of retirement, to ALL the partners in their existing (old) profit-sharing ratio, including the one who is leaving. Since the retiring partner will no longer be there to enjoy any future benefit from that goodwill, he must be compensated, at the time he leaves, for his share of it.
Retiring Partner's Share of Goodwill
The retiring partner's OLD profit-sharing share multiplied by the firm's total goodwill (as valued by whichever method — Average Profit, Super Profit, or Capitalisation — the question specifies), representing the value he must be paid for the reputation he helped build.
Accounting treatment (goodwill not raised in the books)
The standard MSBSHSE treatment does not open, or keep open, a separate Goodwill Account in the firm's books. Instead, the retiring partner's share of goodwill is adjusted entirely through the partners' own Capital Accounts:
- The retiring partner's Capital Account is credited with his share of the firm's goodwill.
- The continuing partners' Capital Accounts are debited, in their Gaining Ratio — never the old ratio, and never the new ratio, unless one of those happens to coincide with the gaining ratio — since it is exactly the continuing partners who will enjoy the extra profit share that goodwill represents, from the date of retirement onward.
| Transaction | Journal Entry |
|---|---|
| Retiring partner's share of goodwill adjusted through capital accounts | Continuing Partner 1's Capital A/c ...Dr (his share, gaining ratio); Continuing Partner 2's Capital A/c ...Dr (his share, gaining ratio); To Retiring Partner's Capital A/c (his total share of goodwill) |
The retiring partner's share of the firm's goodwill (his old share × total goodwill) is credited to his own Capital Account, and debited to the continuing partners' Capital A …