Question

$X,Y$ and $Z$ are partners sharing profits and losses in the ratio of $5:3:2$ . From $1st$ April, $2018$ , they decided to share profits and losses equally. The Partnership Deed provides that in the event of any change in the profit-sharing ratio, the goodwill should be valued at two years' purchase of the average profit of the preceding five years. The profits and losses of the preceding years are :

Year	$2013-14$	$2014-15$	$2015-16$	$2016-17$	$2017-18$
Profit (Rs.)	$70,000$	$85,000$	$45,000$	$35,000$	$10,000$ (Loss)

Pass the necessary journal entries:

(i) When goodwill account is opened

(ii) When goodwill account is not opened

Answer 1

The treatment of goodwill in partnership accounts is a major adjustment. Goodwill in simpler terms is the reputation of a business valued in monetary terms. Whenever there is change in the constitution of the partnership, an adjustments need to be made to the goodwill.

In the given question there is change in profit sharing ratio of the partners and we have to value the goodwill on the basis of information provided and then adjustment entries needed to be passed.

1. valuation of Goodwill:- calculation of average profit

Total profits of 5 years= ( 70,000+85,000+45,000+35,000-10,000)/5

= 2,25,000/5 = 45,000

2. Value of goodwill based on 2 years purchase= 2 * 45,000= 90,000

Our next step will be the adjustment. We have to pass separate entries for the separate given situation.

1. When goodwill account is opened:- As we have to open a goodwill account, any entry needs to be passed through the goodwill account. So, in this case first we will distribute goodwill among the partners in old ratio and then write off the goodwill in the new ratio.

Goodwill A/c 90,000

To X' capital A/c 45,000

To Y' capital A/c 27,000

To Z' capital A/c 18,000

( Goodwill distributed in ratio 5:3:2)

X' capital A/c 30,000

Y's capital A/c 30,000

Z's capital A/c 30,000

To Goodwill A/c 90,000

( Goodwill written off in 1:1:1)

2. When Goodwill account is not opened:- In this case we have to pass journal entries through the capital accounts of the partners. As there is change in profit sharing ratio, it means one or more partner is purchasing from another partner. So, there is loss to some and gain for some partner.

So, first we need to find the gaining ratio of the partners.

Gaining Ratio = New ratio - Old ratio

X = 1/3 - 5/10 = -5/30

Y = 1/3 - 3/10 = 1/30

Z=1/3 - 2/10 = 4/30

X is the sacrificing partner and Y and Z are the gaining partner. So, Y and Z needs to compensate X.

Goodwill = 90,000 * 5/30= 15,000. So, now 15,000 amount of goodwill will be compensated to X by Y and Z in the ratio of 1:4 i.e gaining ratio.

Y's capital A/c 3000

Z's Capital A/c 12,000

To X's capital A/c 15,000