Question

A and B are partners sharing profits and losses in the ratio of 3 : 1. It was decided that with effect from 1st April, 2024 the profit sharing ratio will be 5 : 3. Goodwill is to be valued at 2 years' purchase of average of 3 years' profits. The profits for the year ending 31st March 2022, 2023 and 2024 were 36,000, ₹32,000 and 40,000 respectively.

Pass the necessary journal entry for the treatment of goodwill.

Answer 1

	Journal Entries
Date	Particulars	L.F.	Dr. ₹	Cr. ₹
	B's Capital A/c Dr.		9,000
	To A's Capital A/c			9,000

Working note:

Old profit-sharing ratio:

A : B = 3 : 1

New ratio:

A : B = 5 : 3

1. Calculate Goodwill

Average profit of 3 years:

`(36,000 + 32,000 + 40,000)/3`

= (1,08,000)/3

= ₹ 36,000

Goodwill = 2 years' purchase of average profit:

₹ 36,000 × 2 = ₹ 72,000​

2. Calculate Gain or Sacrifice

A

Old share: `3/4`

New share: `5/8`

Sacrifice: `3/4 - 5/8 = 6/8 - 5/8 = 1/8`

So, A sacrifices 1/8.

B

Old share: `1/4`

New share: `3/8`

`1/4 - 3/8 = 2/8 - 3/8 = -1/8`

Therefore, B gains 1/8.

Thus, B must compensate A for the sacrifice.

3. Goodwill Adjustment

A's sacrifice:

₹ 72,000 × `1/8`

= ₹ 9,000​