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Long Answer Questions · Q5

Q.Explain how will you deal with goodwill when new partner is not in a position to bring his share of goodwill in cash.

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When a new partner cannot bring their share of goodwill in cash, the existing partners adjust the goodwill through their capital accounts in the sacrificing ratio, without any cash changing hands.

The Concept: Goodwill Adjustment Without Cash

When a new partner is admitted, they must compensate the existing partners for the firm's goodwill — the reputation and earning power built by the old partners. Normally, the new partner brings cash for their share, which is then distributed to the old partners in their sacrificing ratio.

But what happens when the new partner cannot bring cash? The accounting treatment changes fundamentally. Instead of a cash transaction, we make a book adjustment directly through the partners' capital accounts.

The key principle: the new partner's share of goodwill is treated as a liability they owe to the old partners. Since they can't pay cash, we simply reduce the new partner's capital (as if they paid) and increase the old partners' capitals (as if they received payment). This is done by:

  • Debiting the new partner's capital account (their share of goodwill)
  • Crediting the old partners' capital accounts in their sacrificing ratio

This works because the new partner's capital account represents their net claim on the firm. By debiting it, we reduce their claim — effectively making them "pay" by accepting a lower capital balance. The old partners' capitals increase, reflecting the compensation they should have received.

Watch out

Common Mistake

Students often debit the goodwill account itself. That's wrong — goodwill already appears in the books at its agreed value. We're not creating or writing off goodwill; we're adjusting who owns it. The entry is between capital accounts only.

The Journal Entry

The standard journal entry when the new partner cannot bring cash for goodwill:

DateParticularsL.F.Debit (₹)Credit (₹)
New Partner's Capital A/cDr.xxx
To Old Partner 1's Capital A/cxxx
To Old Partner 2's Capital A/cxxx
(Being new partner's share of goodwill adjusted through capital accounts in sacrificing ratio)

Why This Treatment?

Think about what goodwill represents. When a new partner joins, they get a share of future profits that the old partners earned through past effort. The old partners sacrifice a portion of their profit share. The new partner should compensate them for this sacrifice.

If the new partner brings cash, the entry is:

  • Cash A/c Dr. (with goodwill amount)
  • To Old Partners' Capital A/c (in sacrificing ratio)

If no cash comes, we simply skip the cash step and directly adjust capitals:

  • New Partner's Capital A/c Dr. (reducing their claim)
  • To Old Partners' Capital A/c (increasing their claim)

The net effect on the firm's total capital is zero — only the distribution among partners changes.

Tip

Shortcut

Remember: "No cash, no goodwill account." When the new partner doesn't bring cash, you never touch the goodwill account. The adjustment is purely between capital accounts.

Example to Illustrate

Suppose A and B share profits 3:2. They admit C for 1/5th share. Goodwill is valued at ₹1,00,000. C cannot bring cash.

Step 1: Calculate C's share of goodwill

C's share = 1,00,000 × 1/5 = ₹20,000

Step 2: Determine sacrificing ratio

Old ratio = 3:2

New ratio needs to be calculated (assuming C takes equally from both):

Sacrifice by A = 3/5 - 2/5 = 1/5

Sacrifice by B = 2/5 - 1/5 = 1/5

Sacrificing ratio = 1:1

Step 3: Journal entry

DateParticularsL.F.Debit (₹)Credit (₹)
C's Capital A/cDr.20,000

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