ZIMSEC O Level Principles of Accounting: Partnership Entries for Goodwill: Changes in Profit Sharing Ratios

  • The idea of goodwill has been explored in full here
  • We have also looked at the unique treatment of goodwill in partnership businesses here
  • Below we will look at what happens when there is a change in the profit sharing ratio of a partnership

Changes in profit sharing ratios

  • It is not uncommon for a partnership to change the profit sharing ratios of partners
  • This can be due to any number of reasons including:
  • A partner no longer works or contributes as they used to for some reason e.g. old age, injury or ill health
  • The skills of a partner have improved or deteriorated e.g. due to a course/training or infirmity
  • A partner now contributing more than in the past
  • Whatever the reason there are two methods to deal with such a change:
    1. By opening a Goodwill Account
    2. When no Goodwill Account is opened
  • Before using either method the partners first have to agree on the value of Goodwill
Method 1 using a Goodwill Account:
  1. First create a Goodwill Account via the following entries:
    1. DR Goodwill Account with each partner’s share of goodwill using the old profit sharing ratio
    2. CR The partners’ capital accounts with their share of goodwill using the old profit sharing ratio
  2. Optionally to close the Goodwill Account:
    1. DR Each partner’s account with their share of goodwill using the new profit sharing ratio
    2. CR The Goodwill Account with each partner’s share of goodwill using the new profit sharing ratio
Method 2 without using the Goodwill Account:
  1. Calculate each partner’s share of Goodwill using the old profit sharing ratios
  2. Calculate each partner’s share of Goodwill using the new profit sharing ratios
  3. Compare the two shares and:
    1. Where there is an increase DR that partner’s Account with the amount of the increase in share of Goodwill
    2. Where there is a Decrease CR that partner’s Account with the amount of the decrease in their share of Goodwill
  4. These entries should cancel each other

Which method to use? Which method is better?

  • Personally we prefer you use method 1 as it is more illustrative of the whole process
  • It is important to note that in the end the two methods have the same effect in the end
  • Please click here to see an actual example involving figures

To access more topics go to the Principles of Accounts Notes.