Cambridge IGCSE Accounting(0452)/O Level Principles of Accounts(7110) Notes: Accounting for Partnerships: Goodwill and Partnership businesses: When a new partner is admitted
- It is not uncommon for a partnership business to admit a new partner
- This is happens for any number of reasons including:
- To admit a partner with new skills
- When the firm is expanding
- To replace a partner who is leaving the firm, retiring or has died
- Whatever the reason a new partner is in effect buying a stake in the existing business
- They therefore ought to be charged for the share of goodwill they are inheriting
- The following steps are taken when recording goodwill when a new partner is admitted into the business:
- Show the value of goodwill divided between old partners using the old profit/loss sharing ratios
- Then show the value of goodwill divided between partners (including the new partner) using the new profit sharing ratios
- Charge the partners with a goodwill gain for that gain
- Compensate those partners who have lost their portion of goodwill
- Now there are generally three ways of recording these steps in the books depending on the circumstances surrounding the new admission:
- Without using a Goodwill Account and no entries are made in the books because the new partner pays the partners privately without the funds flowing through the partnership
- Without opening a Goodwill Account but the new partner pays for his/her share of Goodwill via the partnerhsip
- A Goodwill Account is opened but no cash is paid in by the partner for Goodwill
- For method b the new partner’s cash payment is used to compensate those who have lost out in the new profit sharing ratio
- The goodwill is divvied up according to what each of the old partners have lost
- You are unlikely to meet scenario a and b so you only ever need to consider scenario c
- In method c the following entries are required:
- Establish the value of Goodwill usually its the partners who determine this and the value of goodwill is given in the exam
- Establish the goodwill that belongs to the old partners and record this in the books via the following entries:
- Dr Goodwill to the Goodwill Account
- Cr The old partner’s Capital Account with their share of goodwill using the old profit/loss sharing ratio
- Admit the new partner and then write off the Goodwill Account using the following entries:
- Dr Goodwill to the new partner’s Capital Account using the new profit/loss ratio
- Cr the Goodwill Account to goodwill account
- Alternatively the Goodwill Account can be ignored and the following entries are made:
- Cr Capital account of those partners who are losing out in the new partnership in terms of Goodwill share with the amount of loss they are suffering in the new partnership
- Dr Capital accounts of those partners who are gaining a share of Goodwill with the amount of Goodwill they are gaining
- An example concerning Goodwill when a new partner is admitted can be found here
Calculating Goodwill Given the new partner’s contribution
- You should always assume that the new partner’s share of goodwill corresponds to their share of profit
- For example if D joins A, B and C in a partnership and pays $5 000 Goodwill then
- If you are further told that the four share profits/losses equally then the total Goodwill before and after the admission would be $20 000 i.e. \boxed{Total \medspace Goodwill=\dfrac{5 000}{4}}
To access more topics go to the Cambridge IGCSE Accounting(0452)/O Level Principles of Accounts(7110) Notes.