Accountancy · Ch 4 — Goodwill in Partnership Accounts
Need for Valuation of Goodwill in a Partnership Firm
Need for Valuation of Goodwill in a Partnership Firm
As long as the partnership continues exactly as it is, with no change in who the partners are or in how they share profits and losses, goodwill does not have to be measured or recorded — every partner continues to enjoy their share of the firm's earning capacity automatically. Valuation becomes necessary only when some event changes a partner's share in the firm's future profits, because at that point the value that the firm's reputation carries has to be fairly shared or compensated between the partners whose share is going up and the partners whose share is going down.
| Occasion | Why goodwill must be valued |
|---|---|
| Change in the profit-sharing ratio among existing partners | One or more partners gain a larger share of future profits while others sacrifice a share; the gaining partner(s) must compensate the sacrificing partner(s) for their share of the firm's goodwill. |
| Admission of a new partner | The new partner will, from now on, share in profits that the firm's existing goodwill helps generate, even though they did not help build that reputation; they must compensate the existing (sacrificing) partners for this benefit, usually by bringing in a premium for goodwill. |
| Retirement of a partner | The retiring partner gives up their share of future profits — and of the firm's goodwill — to the continuing partners; the continuing partners must compensate the retiring partner (or their account) for this. |
| Death of a partner | Exactly as with retirement, the deceased partner's share of the firm's goodwill up to the date of death belongs to their legal representatives and must be valued and credited to their account. |
The ratio in which one or more old partners give up (sacrifice) a share of their future profits, usually in favour of a new or gaining partner; goodwill compensation is paid to the sa …
The ratio in which the continuing/existing partners gain an increased share of future profits, typically on the retirement or death of a partner; the gaining partners compensate the …