Question

A and B have been carrying on business in partnership with fixed capitals of ₹ 2,40,000 and ₹ 1,20,000 respectively and sharing profits in the same proportion. They decided that with effect from April 1, 2024 they would share profits and losses in the ratio of 3 : 2. For this purpose goodwill is to be valued at three years' purchase of the average of preceding three years' profits. The profits for the years ending 31st March were 2021 : ₹ 75,000; 2022 : ₹ 60,000; 2023 : ₹ 80,000 and 2024 : ₹ 1,30,000. Give the necessary journal entry.

Note: Since the capitals are fixed, adjustment will be made through current accounts.

Answer 1

Old profit-sharing ratio is based on fixed capitals:

A : B = ₹ 2,40,000 : ₹ 1,20,000 = 2 : 1

New ratio:

A : B = 3 : 2

Journal Entry
Date	Particulars	L.F.	Dr. ₹	Cr. ₹
	B's Current A/c Dr.		18,000
	To A's Current A/c			18,000
	(Being goodwill adjusted through Current Accounts on change in profit-sharing ratio.)

Working note:

1. Average Profit

Since the change is effective from 1 April 2024, take the preceding three years:

2021-22 = ₹ 60,000

2022-23 = ₹ 80,000

2023-24 = ₹ 1,30,000

Average Profit = `(60,000 + 80,000 + 1,30,000)/3`

= `(2,70,000)/3 = 90,000`

2. Goodwill

Goodwill = 3 years' purchase of average profit:

₹ 90,000 × 3 = ₹ 2,70,000

3. Gain or Sacrifice

A: `2/3 - 3/5 = (10 - 9)/15 = 1/15` sacrifice

B: `2/5 - 1/3 = (6 - 5)/15 = 1/15` gain

4. Goodwill Adjustment

`2,70,000 xx 1/15 = 18,000`

Since B gains and A sacrifices, B compensates A.

Also, because the capitals are fixed, the adjustment is made through Current Accounts.