Hidden Goodwill: Admission of a Partner
Goodwill is an intangible asset that is either self-generated or purchased. It is the value of benefits that a business has because of the factors that help in increasing its profitability say its location, favourable contracts, access to supplies and customer loyalty, etc. Goodwill is the reputation earned by the business through hard work, honesty and quality, and satisfactory services to customers. The efforts and hard work done by the existing partners frame the goodwill of the firm.
” Goodwill is the probability that the old customers will resort to the old place.” – Lord Eldon
Self-generated goodwill is not accounted for in books of accounts as per the accounting standards, whereas purchased goodwill, i.e., for which consideration has been paid is to be accounted for. New or incoming partners compensate the sacrificing partners or the existing partners for their share in future profit and loss of the firm by paying consideration for goodwill. The existing partners or sacrificing partners are compensated for their share of the sacrifice made towards the new partner in form of a premium of goodwill paid by the new partner. Goodwill is the value of the share of profit sacrificed by the sacrificing partner, in partnership.
At the time of admission of a partner, when the value of goodwill is not given or mentioned, it is called hidden or inferred goodwill. Hidden goodwill is calculated based on the inferred method of profit sharing ratio or capitalization. Hidden goodwill is not specified with the amount of capital that the new partner has to bring in as his share of capital in the firm. Goodwill is inferred with the share of capital brought in by the new partner.
Calculation of Hidden Goodwill:
Step 1: Calculate the net worth of the new firm based on the capital brought in by the new partner:
New Firm’s Capital =
Step 2: Calculate the new firm’s actual capital by adding the capital of all the partners (including the capital of the new partner).
Step 3: Calculate the firm’s goodwill by deducting the Actual Capital of the Firm (Calculated in Step 2) from the New Firm’s Capital (Calculated in Step 1).
Step 4: Calculate the new partner’s share of goodwill:
New partner’s share of goodwill =
Journal entries passed at the time of admission of the new partner:
A. For cash brought as a share of capital by the new partner:
A. For the share of goodwill brought by the new partner adjusted in the old partner’s Capital A/c in sacrificing ratio:
M and N are partners in the firm sharing profit and loss in the ratio of 5:3 with the capital of ₹2,05,000 and ₹1,85,000, respectively. P is admitted into the firm as the new partner for 1/5th share in the firm on 1st August 2022. P brings in ₹ 1,90,000 as his share of capital. Give Journal entries on P’s admission.
1. Calculation of Hidden Goodwill:
P’s Capital = ₹1,90,000 for share
Total capital of the New Firm =
= ₹1,90,000 x 5
Total Capital of all the partners = Capital of M + Capital of N + Capital of P
= ₹2,05,000 + ₹1,85,000 + ₹1,90,000
Goodwill of the Firm = Total capital of firm – Total capital of all partners
= ₹9,50,000 – ₹5,80,000
P’s share of Goodwill =
2. Calculation of Sacrificing Ratio:
The sacrificing ratio, in this case, will be the old profit sharing of M & N, i.e., 5:3.
Shreya and Rajni are business partners in the firm sharing profit and loss in the ratio of 6:4 having ₹1,59,000 and ₹1,60,000 as their respective capitals. Sarita is admitted as the new partner in the firm on 1st September 2022, and it was decided that the new profit sharing ratio between Shreya, Rajni, and Sarita will be 8:6:4, respectively. Sarita has to bring ₹95,000 as her share of capital. Pass necessary journal entries.
1. Calculation of Sacrificing Ratio:
2. Calculation of Hidden Goodwill:
Sarita’s Capital =₹95,000 for share
Total Capital of the New Firm =
Total Adjusted Capital of all the partners = Capital of Shreya + Capital of Rajni + Capital of Sarita
= ₹1,59,000 + ₹1,60,000 + ₹95,000
Goodwill of the Firm = Total capital of firm – Total adjusted capital of all partners
= ₹4,27,500 – ₹4,14,000
Sarita’s share in Goodwill =
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