Treatment of Goodwill on Retirement or Death

Goodwill represents the value of the reputation, customer relationships and earning capacity the firm has built up — often substantially through the efforts of the very partner who is now leaving. Fairness requires that the outgoing partner (or, on death, their legal representative) be compensated for their share of this goodwill before their connection with the firm ends.

Step 1 — Determine the outgoing partner's share. The firm's goodwill is valued as at the date of retirement/death (by whatever method the firm follows — average profits, super profits, or capitalisation — as covered in earlier chapters), and the outgoing partner's share of this value is calculated using their OLD profit-sharing ratio, since that is the ratio in which they held a claim on the firm's goodwill.

Step 2 — Charge it to the gaining partners. This amount is compensation for the extra share the continuing partners will now enjoy, so it is charged to them in their GAINING ratio (not their old ratio, and not their new ratio) — through a simple capital account adjustment:

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

No separate Goodwill account needs to be opened or maintained under this method, which is why it is the one most commonly followed in practice and in examinations. …