A firm may admit a new partner for various reasons such as Increasing Level of Capacity by Extra Capital Introduction, Spreading of Losses, Technical or other Skills and Knowledge.
In this Chapter of Accountancy, we will discuss about various accounting Problems and their solutions in a simple manner –
Problems –
1. Calculation of New Ratio and Sacrifice Ratio.
2. Valuation of Goodwill and their Accounting treatment.
3. Revaluation of Assets & Liabilities.
4. Distribution of Undistributed Profits and Losses among Partners.
5. Calculation of New Partner Capital and
6. Adjustment of old partners Capital.
Solutions –
1. Calculation of New Ratio and Sacrifice Ratio.
A. Calculation of New ratio (NPSR) :-
a. When Sacrifice Ratio is given in Question –
New Ratio (NPSR) = Old Ratio – Sacrifice Ratio
b. When Sacrifice Ratio is Not given in Question –
New Ratio (NPSR) = Remaining Profit Share × Old Ratio
B. Calculation of Sacrifice Ratio (If no information is given about sacrifice ratio in Question) –
a. When New Ratio is given in Question –
Sacrifice Ratio = Old Ratio – New Ratio
b. When New Ratio is not given in Question –
Sacrifice Ratio = Old ratio
Note :- Normally in Question information about sacrifice ratio is given in two ways –
i. When new Partner acquires of his share from old Partners is given –
Then,
SR = Acquired Share × new partner share
ii. When old partners surrendered his share is given –
Then,
SR = Old Partner Share × Surrendered Share
But, Here we have to remembered that if “from” word is given instead “of his Share” then it will be assumed that actual sacrifice ratio is given in question itself.
Further, if sacrifice ratio given in question’s total is equal to new partner share then also it will be assumed as actual sacrifice ratio.
2. Valuation of Goodwill & their Accounting treatment –
Goodwill – It is the amount which will be brought by a new partner in firm in addition to capital for taking share in future profits from old partners. It is also called Premium amount.
i. Valuation of Goodwill – There are various methods for calculating value of Goodwill of a firm some of methods is given as under –
ii. Actual Average Profit Method – In this method we have to calculate Actual Average Profit of a firm from information provided in question in the following way –
| Past Years | Amount of Profit | Adjustments (Given in Question) | Actual Profit or Adjusted Profit |
| 1st | ——– | (+) Normal Profit or regular income or gain (not considered in relevant year profit) | ——- |
| 2nd | ——– | (–) Normal Loss or regular expenses or losses (not charged from relevant year) | ——- |
| 3rd | ——– | (–) Abnormal Profit such as Lottery, like accidently arises and not regular income | ——- |
| 4th | ——– | (+) Abnormal Loss such as Loss by fire, such as accidently arises and not regular loss or Expenses | ——- |
Actual Average Profit = Total Actual Profit of Past Years / No. of Past Years
So, Goodwill = Actual Average Profit × No. of Years of Purchase
Weighted Actual Average Profit Calculation – If Actual profit is in increasing order or decreasing order then we use Weights and Calculates WAAP in the following way –
| Years | Actual Average Profits | Weights | Product (Actual Average Profit × Weight) |
| 1st | ——- | 1 | ——- |
| 2nd | ——- | 2 | ——- |
| 3rd | ——- | 3 | ——- |
| 4th | ——- | 4 | ——- |
WAAP = ∑Product / ∑Weights
So, Goodwill = WAAP × No. of Years of Purchase
2. Super Profit Method – Super Profit means an extra amount of profit earned above normal profit. It is an extra earning capacity of an individual firm in an industry from all other individual firms normal profit.
Super Profit = Actual Average Profit – Normal Profit*
So, Goodwill = Super Profit × No. of Years of Purchase
*Note :- Calculation of Normal Profit = Capital Invested × NRR (Normal rate of return) / 100
3. Capitalization Method – Capitalization refers to the market value of firm’s Goodwill. Goodwill can be find out by the following two ways –
i. By capitalization of Super Profit
ii. By capitalization of Average Profit
i. Capitalization of Super Profit –
Goodwill = Super Profit × 100/ NRR
B. Capitalization of Average Profit –
Goodwill = (Average Profit × 100/ NRR) – Capital invested in Business
4. Annuity Method – In this Method Goodwill is valued on the Present Value of Annuity factor of Super Profit/ Average Profit.
Goodwill = Super Profit/Average Profit × Annuity Factors
5. Hidden Goodwill – Sometimes in Question a new Partner is coming into firm and Contribute Amount but separate value of Capital and Goodwill is not given and new Partner is taking share in firm’s Future Profit in this case the value of Goodwill can be find out by the following formula –
Goodwill = Total Firm’s Capital – Total Partner’s Capital
6. Purchase Consideration Method – In this Method Value of Goodwill is assumed as a difference between Purchase Consideration Paid and Net Assets.
Goodwill = Purchase Consideration – Net Assets
*Net Assets = Total Purchased Assets – Total Liability Purchased
Accounting Treatment of Goodwill –
Goodwill is always distributed among sacrificing Partners in their sacrifice ratio. Accounting treatment of Goodwill depends upon the various cases which is discussed as under –
1. When amount of Goodwill is Privately paid by new partner –
In this case no amy goodwill is entered in books because no any amount is coming into firm as a Goodwill. So, In this case “NO ENTRY” will be passed for Goodwill.
2. When Amount of Goodwill Brought by New Partner in cash or in other kind –
In this case two entries will be passed in the books of firm –
Journal Entries –
a. For bringing of goodwill in cash –
Cash/Other kind A/C Dr.
To Goodwill A/C
b. For Distribution of Goodwill among Partners –
Goodwill A/C Dr.
To Sacrificing Partner’s Capital A/C
Note – If Partners withdraws their amount of Goodwill from firm then an additional journal entry for this purpose will also be recorded in the books of firm. i.e. –
c. For withdrawn of Goodwill amount from Firm –
Journal Entry –
Sacrificing Partner’s Capital A/C Dr.
To Cash A/C
3. When Amount of Goodwill doesn’t bring by New Partner in Cash – In this case we always assume that amount of Goodwill is brought with Capital so we always charge his capital A/c for the Goodwill.
Journal Entry –
New Partner’s Capital/Current A/C Dr.
To Sacrificing Partner’s Capital A/C
Author Bio
Practically I have not seen these accounting treatments whenever there is an admission of partners or change in partners.