change in the profit sharing ratio - treatment of goodwill
DESCRIPTION
When there is amendment in the profit sharing ratio, an adjustment is required in esteem of goodwill. The goodwill can be considered in the books of account in any of the following ways:TRANSCRIPT
Change in the Profit Sharing Ratio
- Treatment of Goodwill
When there is amendment in the profit sharing ratio, an adjustment is required in esteem of
goodwill. The goodwill can be considered in the books of account in any of the following
ways:
Case 1: Goodwill is created in the books of the partnership at entire value but it is written
off instantly.
In this case, goodwill is created by crediting all the partners in the existing ratio and written-off
in the new ratio. The following entries are passed:
For Creating Goodwill
Goodwill Account (entire value)
To All Partners’ Capital Account (existing ratio)
For Writing Off Goodwill
All Partners’ Capital Account (new ratio)
To Goodwill Account (entire value)
Case 2: Adjustment is to be made devoid opening Goodwill Account.
In this case, the adjustment for goodwill is to be created through the partners’
capital accounts. The account of a partner will be debited if he makes a gain in his
right of goodwill. On the contrary, his account will be given credit when he makes a
forgo in his right of goodwill. The entry will be:
Gaining Partners’ Capital Account
To forgoing Partners’ Capital Account
ILLUSTRATION:
X,Y and Z are partners sharing profits and losses in the ratio of3:2:1. They have decided to alter the
profit sharing ratio 2:2:1. The goodwill of the firm is valued at $6,000.
Pass Journal Entries under the subsequent cases when:
(i) Adjustment is to be made devoid of opening goodwill account
(ii) When goodwill is created in the books of the partnership firm at entire value
however written off instantly.
SOLUTION:
In the books of the Partnership firm Journal
Date Particulars $ $
(i) Y Capital Account
(refer note)
400
Z Capital Account 200
To X Capital Account 600
(Being adjustment for goodwill through partners’ capital a/c)
(b) Goodwill Account 6,000
To X Capital Account 3,000
To Y Capital Account 2,000
To Z Capital Account 6,000
(Being the goodwill written-off in the new profit sharing ratio)
Notes: Right of Goodwill prior change in the profit sharing ratio is 3:2:1 – 3,000; 2,000; 1,000. Right o goodwill after alter in the ratio is 2:2:1 – 2,400; 2,400; 1,200. Therefore forgo is 600 (cr.) (3000-2400) Gain is 400 (dr.) (2400-2000) and 200 (dr.) (1200-1000).
