Treatment of Goodwill

Goodwill is the value of a firm’s reputation and its good brand name in the market. A firm earns goodwill through its hard work. Goodwill helps a firm in winning the trust and faith of the customers by fulfilling their demands in both qualitative and quantitative aspects. It can be said that the goodwill of a firm is a result of the past efforts made by it which helps a firm to earn higher profits in present and in the future as well. Treatment of Goodwill is discussed below

Treatment of Goodwill

As per the Accounting Standard 26 of ICAI, goodwill is recorded in the books only when some consideration in money or money’s worth has been paid for it. This practice is mandatory to follow. In the case of admission, retirement, death, or change in profit sharing ratio among existing partners, Goodwill Account cannot be raised as no consideration is paid for it. This implies that the goodwill of a partnership firm is self-generated goodwill, that is, the firm itself evaluates the value of the goodwill. The AS-26 standard specifies that goodwill should be immediately written off after it has been raised. That is, as per this accounting standard, goodwill has to be adjusted through Partners’ Capital Account

There are various cases for treatment of the goodwill in the books of accounts on the eve of admission of a new partner.

Various cases for treatment of the goodwill

However; an important point that is to be taken care of is that irrespective of any case of goodwill, if goodwill already appears in the Balance Sheet of the Old Firm, then first of all this goodwill is to be transferred (i.e. written-off) to the old Partners’ Capital A/c in their old profit sharing ratio. It is done by debiting the old partners’ capital account and crediting the goodwill account in their old profit sharing ratio.

Cases of Goodwill

Case 1: When the new partner pays his share of goodwill privately to the old partners

No accounting entry is recorded in the books of account in this case.

Case 2: When Share of Goodwill is brought in Cash and retained in the Business

When the new partner brings his/her share of goodwill in cash, it is transferred to sacrificing Partner’s Capital Account in their sacrificing ratio. In short, it can be said that the existing partners share the amount of goodwill brought in by the new partner in their sacrificing ratio.

Case 3: When the Goodwill is brought in by the New Partner and is Withdrawn by the Old Partners (fully or partly)

In Case 2, we learned that the premium for goodwill brought in by the new partner is retained in the business. That is, the old partners are not withdrawing this amount of premium of goodwill. But, in case, if the old partners decide to withdraw the premium either fully or partly, then an additional Journal entry is passed.

Case 4: When Only a Part of Premium or Goodwill is brought in by the New Partner in Cash

There may be a situation when the new partner is not able to bring the whole amount of his/her share of goodwill in cash. In such a case, the premium for the goodwill account is credited with the amount of premium which is brought in by the new partner. At the time of the transfer of the premium amount to the sacrificing partners’ capital account, the new partner’s capital account is to be debited with the unpaid amount of premium (i.e. the amount which he/she is unable to bring).

Case 5: When the New Partner is not able to bring his Share of Goodwill or Premium in Cash at all

At the time of admission, when the new partner is not able to bring his/her whole share of goodwill, then the New Partner’s Capital Account is debited and old Partners’ Capital A/c will be credited in their sacrificing ratio with the amount of goodwill that is not brought by the new partner.

Case 6: When the Premium for Goodwill is brought in Kind

There may be a situation when on admission, the new partner does not bring his share of goodwill in cash. Instead he/she brings his/her share of goodwill in kind (usually in form of the assets). In such a case, all the assets brought in by the new partner are debited and a share of the premium for goodwill is credited.

Also, Read

Profit and Loss Account

A profit and Loss Account is the second financial statement prepared by an organization. This account is prepared to ascertain the net results of a firm in form of net profit earned or net loss incurred during an accounting period.

Accounting Software

Accounting software is an integral part of the computerized accounting system. The accounting software should be selected after considering the level of skill and proficiency of the accounting professionals.

What are Accounting Reports?

Accounting Reports: When the collected data is processed and manipulated in a useful sense that can be understood by the users without any ambiguity, then it becomes information.

Transaction Processing System

Transaction Processing System (TPS) refers to a computerized system that records, processes, validates, and stores routine transactions that occur in various functional areas of a business on daily basis.