ZIMSEC O Level Principles of Accounting: 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:
    1. Show the value of goodwill divided between old partners using the old profit/loss sharing ratios
    2. Then show the value of goodwill divided between partners (including the new partner) using the new profit sharing ratios
    3. Charge the partners with a goodwill gain for that gain
    4. 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:
    1. 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
    2. Without opening a Goodwill Account but the new partner pays for his/her share of Goodwill via the partnerhsip
    3. A Goodwill Account is opened but no cash is paid in by the partner for Goodwill
  • For method 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 the following entries are required:
    1. Establish the value of Goodwill usually its the partners who determine this and the value of goodwill is given in the exam
    2. Establish the goodwill that belongs to the old partners and record this in the books via the following entries:
      1. Dr Goodwill to the Goodwill Account
      2. Cr The old partner’s Capital Account with their share of goodwill using the old profit/loss sharing ratio
    3. Admit the new partner and then write off the Goodwill Account using the following entries:
      1. Dr Goodwill to the new partner’s Capital Account using the new profit/loss ratio
      2. Cr the Goodwill Account to goodwill account
    4. Alternatively the Goodwill Account can be ignored and the following entries are made:
      1. 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
      2. 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 Principles of Accounts Notes.