Question

A and B are partners sharing profits in the ratio of 3 : 2. On 1st April, 2022, they admit C as a new partner for `1/4`th share. C acquires `1/5`th of his share from A.

Goodwill on C’s admission is to be valued on the basis of the capitalisation of average profits of the last five years. Profits were:

Year ended

31st March, 2018 Profit ₹ 50,000
31st March, 2019 Profit ₹ 1,20,000 (including gain of ₹ 40,000 from sale of fixed assets)
31st March, 2020 Loss ₹ 60,000 (after charging a loss by Fire ₹ 50,000)
31st March, 2021 Loss ₹ 1,00,000 (after charging voluntary retirement compensation paid ₹ 1,50,000)
31st March, 2022 Profit ₹ 1,90,000

On 1st April, 2022, the firm had assets of ₹ 7,00,000 and external liabilities of ₹ 2,20,000.

The normal rate of return on capital is 12%.

C brings in ₹ 1,25,000 for his capital but is unable to bring his share of goodwill in cash.

1. You are required to calculate C’s share of goodwill,
2. Pass necessary journal entries, and
3. Calculate new profit-sharing ratios.

Hint:

C acquires `1/5`th of his share from A and the remaining `4/5`th of his share from B.

Answer 1

i. Calculation of C’s Share of Goodwill in the Firm:

Calculation of Average Normal Profit:

Year ended	Profit	Amount (₹)
31st March, 2018		50,000
31st March, 2019	1,20,000 − 40,000	80,000
31st March, 2020	60,000 − 50,000	− 10,000
31st March, 2021	1,00,000 − 1,50,000	50,000
31st March, 2022		1,90,000
		3,60,000

Average Normal Profit = `(3,60,000)/5`

= 72,000

Capitalised Value of Average Profits = `"Average Normal Profit"/"Normal Rate of Return" xx 100`

= `(72,000)/12 xx 100`

= 6,00,000

Capital Employed (Net Assets) = Total Assets − Outside Liabilities

= 7,00,000 − 2,20,000

= 4,80,000

Goodwill = Capitalised Value of Average Profits − Net Assets

= 6,00,000 − 4,80,000

= 1,20,000

C’s Share of Goodwill = `1,20,000 xx 1/4`

= 30,000

ii.

Journal Entry
Date	Particulars	L.F.	Debit (₹)	Credit (₹)
2022
April l	Bank A/c   ...Dr.		1,25,000
	To C’s Capital A/c			1,25,000
	(Amount of capital brought in cash)
April l	C’s Current A/c   ...Dr.		30,000
	To A’s Capital A/c			6,000
	To B’s Capital A/c			24,000
	(C’s share of goodwill credited to sacrificing partners in their sacrificing ratio of l : 4)

iii. Calculation of New Profit-Sharing Ratios:

C’s Share = `1/4`

C acquires `1/5`th of his share from A.

A’s Sacrifice = `1/5 xx 1/4`

= `1/20`

C acquires the remaining `4/5`th of his share from B

B’s Sacrifice = `4/5 xx 1/4`

= `4/20`

Sacrificing Ratio of A and B = `1/20 : 4/20` or 1 : 4

New Ratio = Old Ratio − New Ratio

A’s New Share = `3/5 - 1/20`

= `(3 xx 4)/(5 xx 4) - 1/20`

= `12/20 - 1/20`

= `11/20`

B’s New Share = `2/5 - 4/20`

= `(2 xx 4)/(5 xx 4) - 4/20`

= `8/20 - 4/20`

= `4/20`

C’s New Share = `1/4`

= `(1 xx 5)/(4 xx 5)`

= `5/20`

New Profit Sharing Ratio of A, B, and C = `11/20 : 4/20 : 5/20` or 11 : 4 : 5