Accountancy · Ch 3 — Reconstitution of a Partnership Firm — Admission of a Partner
Treatment of Goodwill
Treatment of Goodwill
When a new partner is admitted, they receive a share of the future profits of the firm. This share was previously enjoyed by the existing partners. Logically, the incoming partner must compensate the old partners for giving up a portion of their profit share. This compensation is called goodwill (or, more precisely, the premium for goodwill).
The core idea is simple: the new partner brings in an additional amount over and above their capital contribution. This extra amount is not for the firm's assets — it is a payment to the existing partners for the firm's reputation, customer base, and ability to earn super profits. The new partner is buying a right to share in these future super profits.
Accounting Treatment of Goodwill Brought in by the Incoming Partner
The textbook focuses on the most common method: the incoming partner brings their share of goodwill in cash. This cash is then distributed to the sacrificing partners (the old partners who have given up a part of their share).
The journal entry for this transaction is:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Bank A/c | Dr. | [Amount brought in as goodwill] | ||
| To Premium for Goodwill A/c | [Amount brought in as goodwill] | |||
| (Being the amount of goodwill brought in by the new partner) |
This entry records the receipt of cash. The 'Premium for Goodwill Account' is a temporary account that holds the amount until it is distributed.
The next step is to distribute this amount to the sacrificing partners in their sacrificing ratio. The sacrificing ratio is the ratio in which the old partners have given up their share of profit in favour of the new partner. (It is calculated as: Old Share – New Share).
The journal entry for distribution is:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Premium for Goodwill A/c | Dr. | [Total amount of goodwill brought in] | ||
| To Sacrificing Partner’s Capital A/c (Partner A) | [A’s share in the sacrifice] | |||
| To Sacrificing Partner’s Capital A/c (Partner B) | [B’s share in the sacrifice] | |||
| (Being the goodwill distributed to the sacrificing partners in their sacrificing ratio) |
The 'Premium for Goodwill Account' is closed after distribution. It never appears in the Balance Sheet. The amount is credited directly to the Capital Accounts of the sacrificing partners (not to the firm's Profit & Loss Account).
Why This Treatment?
The logic is straightforward. The existing partners have sacrificed a portion of their future earnings. The cash brought in by the new partner is their compensation for this sacrifice. Therefore, the amount is credited to their capital accounts, increasing their claim on the firm's net assets. The new partner's capital account is not affected by this transaction — they have simply paid cash to the old partners, not to the firm.
A Critical Distinction: Goodwill Brought In vs. Goodwill Already in Books
The textbook makes a clear distinction here. The treatment above applies only to the goodwill brought in by the incoming partner. This is a fresh inflow of cash. …