Accounting Treatment of Goodwill – Illustration

Accounting Treatment of Goodwill

The accounting treatment of goodwill includes the treatment of the amount of compensation received by the sacrificing partner(s) from the gaining partner(s). The gaining partner has to pay some amount to the sacrificing partner as a compensation. This amount of compensation is known as goodwill or premium for goodwill.

The Content covered in this article: –
  • What is the accounting treatment of Goodwill
    1. When Goodwill is adjusted through Partners’ Capital Accounts
    2. When Goodwill is Raised and Written off
  • What is the Accounting treatment of Existing Goodwill
    1. When Existing Goodwill is Written off 
    2. When Existing Goodwill is carried in the books of Accounts

What is the Accounting Treatment of Goodwill:

The amount of compensation paid by the gaining partner(s) to the sacrificing partner(s) will be treated as per decided by all old partners. They can record the amount received of premium for goodwill in the books or they can personally distribute this amount among all partners through partners’ capital account. The amount of premium for goodwill calculated with the following formula:

Amount of Premium for Goodwill = Value of Firm’s Goodwill X Share of Profit gained

(i) When Goodwill is adjusted through Partners’ Capital Accounts:- 

When there will be the treatment of the goodwill is adjusted through Partners’ Capital/Current accounts the following adjustment (journal) entry made and we explained these journal entries with the common illustration: – 

Illustration 1: 

A and B are the partners in AB Co. Ltd. they shared the profit of the firm in the ratio 3:2. But now they want to share profit in equal proportion in the future. So, A is sacrificing 1/10th of share and B is gaining 1/10th share. The amount of Goodwill of the firm is Rs 1,75,000. 

Calculate the amount of premium for goodwill and show the treatment of goodwill.

Solution: –

A’s Sacrificing share = 1/10th 

B’s Gaining Share = 1/10th

Amount of Firm’s Goodwill = 1,75,000

Calculation of the amount of premium for Goodwill which will be brought by B: –

Amount of Premium for Goodwill = Value of Firm’s Goodwill X Share of Profit gained
  = 1,75,000 X 1/10
  = 17,500/-    

So, B will pay 17,500 to A as compensation for sacrificing his share. The accounting treatment of goodwill will be explained with the different method as following: –

(a) In the case of Fluctuating Capitals Account maintained: –

In the case of Fluctuating Capital, we will pass journal entry through Partners’ Capital account. This is shown as the following: –

Date   Particulars
L.F. Debit Credit
           
  Gaining Partners’ Capital A/c Dr.   XXXX  
            To Sacrificing Partners’ Capital A/c     XXXX
  (Being adjustment of premium for goodwill.)      
         

Illustration 1 – Solution:

we have solved above illustration further with the above method of distribution of premium for goodwill: –

Date   Particulars
L.F. Debit Credit
           
  B’s Capital A/c Dr.   17,500  
            To A’s’ Capital A/c     17,500
  (Being adjustment of premium for goodwill.)      
         

(b) In the case of Fixed Capitals Account maintained: –

In the case of Fluctuating Capital, we will pass journal entry through Partners’ Current account. This is shown as the following: –

Date   Particulars
L.F. Debit Credit
           
  Gaining Partners’ Current A/c Dr.   XXXX  
            To Sacrificing Partners’ Current A/c     XXXX
  (Being adjustment of premium for goodwill.)      
         

Illustration 1 – Solution:

we have solved above illustration further with the above method of distribution of premium for goodwill: –

Date   Particulars
L.F. Debit Credit
           
  B’s Current A/c Dr.   17,500  
            To A’s Current A/c     17,500
  (Being adjustment of premium for goodwill.)      
         

(ii) When Goodwill is Raised and Written Off:- 

When there will be the treatment of the goodwill is adjusted by raising it the books of accounting and then after writing off this amount through partners capital/current account with the full amount. The following adjustment (journal) entries are made for this and we explained these journal entries with the common illustration: – 

Illustration 2: 

A and B are the partners in AB Co. Ltd. they shared the profit of the firm in the ratio 3:2. But now they want to share profit in equal proportion in the future. So, A is sacrificing 1/10th of share and B is gaining 1/10th share. The amount of Goodwill of the firm is Rs 1,75,000. 

Calculate the amount of premium for goodwill and show the treatment of goodwill.

Solution: –

Amount of Firm’s Goodwill = 1,75,000

The New Profit Sharing Ratio =  1: 1

Calculation of the amount of Total Goodwill credited to the Partners Capital Account in Old Profit Sharing Ratio: –

A’s Share of Goodwill = Firm’s Goodwill X 3/5
  = 1,75,000 X 3/5
  = 1,05,000/-    
B’s Share of Goodwill = Firm’s Goodwill X 2/5
  = 1,75,000 X 3/5
  = 70,000/-    

Calculation of the amount of Total Goodwill Debited to the Partners Capital Account in New Profit Sharing Ratio: –

A’s Share of Goodwill = Firm’s Goodwill X 1/2
  = 1,75,000 X 1/2
  = 87,500/-    
B’s Share of Goodwill = Firm’s Goodwill X 1/2
  = 1,75,000 X 1/2
  = 87,500/-    

The accounting treatment of the above-calculated amount of goodwill will be explained with the different method as following: –

(a) In the case of Fluctuating Capitals Account maintained: –

In the case of Fluctuating Capital, we will pass journal entry through Partners’ Capital account. This is shown as the following: –

Date   Particulars
L.F. Debit Credit
           
  Goodwill A/c Dr.   XXXX  
            To Partners’ Capital A/c     XXXX
  (Being Credited the full amount of goodwill among the partners’ capital account in the old profit sharing ratio)      
         
  Partners’ Capital A/c Dr.   XXXX  
            To Goodwill A/c     XXXX
  (Being Credited the full amount of goodwill among the partners’ capital account in the New profit sharing ratio)      
         
         

Illustration 1 – Solution:

we have solved above illustration further with the above method of distribution of premium for goodwill: –

Date   Particulars
L.F. Debit Credit
           
  Goodwill A/c Dr.   1,75,000  
            To A’s Capital A/c     1,05,000
            To B’s Capital A/c     70,000
  (Being Credited the full amount of goodwill among the partners’ capital account in the old profit sharing ratio)      
         
  A’s Capital A/c  Dr.   87,500  
  B’s Capital A/c  Dr.   87,500  
            To Goodwill A/c     1,75,000
  (Being Credited the full amount of goodwill among the partners’ capital account in the New profit sharing ratio)      
         

(b) In the case of Fixed Capitals Account maintained: –

In the case of Fluctuating Capital, we will pass journal entry through Partners’ Current account. This is shown as the following: –

Date   Particulars
L.F. Debit Credit
           
  Goodwill A/c Dr.   XXXX  
            To Partners’ Current A/c     XXXX
  (Being Credited the full amount of goodwill among the partners’ Current account in the old profit sharing ratio)      
         
  Partners’ Current A/c Dr.   XXXX  
            To Goodwill A/c     XXXX
  (Being Credited the full amount of goodwill among the partners’ Current account in the New profit sharing ratio)      
         
         

Illustration 1 – Solution:

we have solved above illustration further with the above method of distribution of premium for goodwill: –

Date   Particulars
L.F. Debit Credit
           
  Goodwill A/c Dr.   1,75,000  
            To A’s Current A/c     1,05,000
            To B’s Current A/c     70,000
  (Being Credited the full amount of goodwill among the partners’ Current account in the old profit sharing ratio)      
         
  A’s Current A/c  Dr.   87,500  
  B’s Current A/c  Dr.   87,500  
            To Goodwill A/c     1,75,000
  (Being Credited the full amount of goodwill among the partners’ Current account in the New profit sharing ratio)      
         

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