Ministry of Education

Cyril Potter College of Education

TVET Department
Business Studies Option
PBS 251: Advance Financial Accounting
Week Three (3)
Topic: Accounting for Partnership
Sub topic: Admission of a New Partner and Goodwill
Admission of a new Partner

Reasons for admission of a new partner

New partners may be admitted to a partnership, usually for one of three reasons:

1. As an additional partner, either because the business has grown or because someone is needed who has
different skills to those of the existing partners.
2. To replace a partner who ceases to be a member of the firm: this might be because of the retirement or
death of a partner.
3. To bring in additional capital.
When a new partner is admitted to an existing business, an important factor to be consider is goodwill.

Goodwill
Goodwill is an intangible asset that is associated with the purchase of one company by another.
Specifically, goodwill is the portion of the purchase price that is higher than the sum of the net fair value of
all of the assets purchased in the acquisition and the liabilities assumed in the process.

Reasons for payment of goodwill

In buying an existing business, which has been established for some time, there may be quite a few
possible advantages. Some of them are listed below.
 There is a large number of regular customers who will continue to deal with the business under a
new owner.

• The business has a good reputation.

• It has experienced, efficient and reliable employees.

 • The business is situated in a good location.

• It has good contacts with suppliers.

• It may have good brand names that are known and recognized within the industry.

Few of those advantages are available to a completely new business. For this reason, many people will
decide to buy an existing business and pay an extra amount for goodwill.

Methods of calculating goodwill

There is no single way of calculating goodwill on which everyone can agree. The seller will probably
want more for the goodwill than the buyer will want to pay. All that is certain is that, when an
agreement is reached between buyer and seller, the selling price includes the amount of goodwill.
Various methods are used to help buyer and seller come to an agreed figure. The calculations give
buyer and seller a figure with which to begin discussions of the value of the business. Very often, each
industry or occupation has its own customary way of calculating goodwill.

Method 1
Direct pay off of Goodwill without record (off the book)
When a new partner buys into the business, their capital is recorded into the books while their premium for
goodwill which is an additional amount. This amount is paid directly to the existing partners of the
business. No official record of this is made in the books.

Method 2
Premium paid is retained in the business BUT NO Goodwill account is opened
the extra premium for goodwill brought in by the new partner is debited to the Cash Book and Credited to
the Capital Account of the partner according to the original profit and loss sharing ratio. The Goodwill
Account the is not opened and the original partners’ Capital Accounts are increased.

Method 3
Opening a Goodwill Account
when the new partner has no extra cash to bring in for goodwill, a Goodwill Account is created. The double
entries are crediting the original partners’ Capital Account to the original profit and loss sharing ratio and
debiting the Goodwill Account.

Method 4
Goodwill with drawn by original partners
when the new partner has no extra cash to bring in as premium, a goodwill Account is created and the
original partners are entitled to withdraw this amount of goodwill.

Good will is placed on the Balance Sheet as Non-Current Account.

 Change in partnership
Andrew and Binta have been in partnership, sharing profits or losses in the ratio 4:3. They agreed
to admit Chen to the partnership, with profits or losses being shared between Andrew, Binta and
Chen in the ratio 3:2:1. On the date of the change in partnership, the partners’ capital and current
account balances were:

Partners Capital Current

Andrew $60,000 Cr $12,800 Cr

Binta $40,000 Cr $9,500 Cr

It was agreed that, at the date of Chen’s admission, the goodwill in the partnership was
valued at $42,000.

Step 1 – Recognise goodwill asset

The goodwill account is created by a debit entry of $42,000.

This value is credited to the old partners in the old profit or loss sharing ratio – ie 4/7 (or
$24,000) to Andrew and 3/7 (or $18,000) to Binta.

Thus, the new capital balances are:

Andrew $84,000 Cr ($60,000 Cr and $24,000 Cr)

Binta $58,000 Cr ($40,000 Cr and $18,000 Cr)

If goodwill is to continue being recognised in the partnership accounts, no further entries are
needed in relation to goodwill, as the only change is that a new asset of goodwill has been
created, and the capital balances of the old partners have increased by the same value.

Step 2 – Eliminate goodwill (if required by question)

If goodwill is not recognised going forward, it is eliminated by a credit entry in the goodwill
account, and debit entries in the partners’ capital accounts, based in the new profit or loss
sharing ratio:

Andrew $21,000 ($42,000 x 3/6)

Binta $14,000 ($42,000 x 2/6)

Chen $7,000 ($42,000 x 1/6)

As a result, the new capital balances are:

Andrew $63,000 Cr ($84,000 Cr and $21,000 Dr)

Binta $44,000 Cr ($58,000 Cr and 14,000 Dr)

Chen $7,000 Dr (share of goodwill eliminated)

Step 3 – Contribution of capital by new partner (if required by question)
If the question requires a contribution by any of the partners (or a repayment of capital) we
simply need to follow the normal principles of double-entry bookkeeping.

For example, the question may require the new partner to contribute cash so that the
opening capital balance is nil.

In this case, a credit of $7,000 would be needed in Chen’s capital account, so this is the
amount of cash that must be contributed.

The entries will therefore be:

Debit Bank $7,000

Credit Capital – Chen $7,000
Summary of journal entries

Profit for the year Dr Statement of profit or loss

Cr Appropriation account

Partners’ salaries Dr Appropriation account

Cr Partners’ current accounts

Interest on capital Dr Appropriation account

Cr Partners’ current accounts

Interest on drawings Dr Partners’ current accounts

Cr Appropriation account

Residual profit if profit for the year is greater than total of

 appropriations:

Dr Appropriation account
Cr Partners’ current accounts

if total of appropriations is greater than profit for

the year:

Dr Partners’ current accounts

Cr Appropriation account

Interest on loan from partner Dr Statement of profit or loss

Cr Bank account*/Accrued expenses**

Loan made by partner Dr Bank account /Capital account

† ‡

Cr Loan payable