The retiring partner is entitled to his share in firms Goodwill as he has also put in efforts in the formation of firm's Goodwill. The retiring partner is paid back his share in the assets of the firm. Goodwill is also an asset for the firm. So retiring partner is paid his share from Goodwill as well.
The retiring partners share of Goodwill is paid by the remaining partners who gains due to his retirement.
Find Value of Firm's Goodwill
First Goodwill valuation on the date of retirement of a partner is done as per the terms of the partnership agreement as per either average profits, super profits or capitalization method for valuation of Goodwill.
Find the share of Retiring Partner in Firms Goodwill
Share of Retiring partner in Firms Goodwill = Firms Goodwill X Profit share of retiring partner
Find Gaining ratio of remaining partners
Find gaining ratio of remaining partners by the formula New ratio - Old ratio for each partner. It is not necessary that all the remaining partners will gain. Thus some partners may gain and some may sacrifice and the share of some may not get impacted at all. But Goodwill contribution will be made only by the gaining partners.
The contribution of each gaining partner is calculated by multiplying the share of goodwill of the retiring partners with the gaining ratio.
Journal entry
Gaining Partners Capital/Current A/c Dr..
To Sacrificing Partners Capital/Current A/c
Current A/c's are used if the firms follows fixed capital account method and current accounts are separately maintained. If the question is silent than it is assumed that the fluctuating method of capital is followed
If Goodwill already exists in the Books of Accounts
It is written off among all the partners as per the following entry :
All Partners Capital/Current A/c Dr.. (In Old Ratio)
To Goodwill A/c
Current A/c's are used if the firms follows fixed capital account method and current accounts are separately maintained. If the question is silent than it is assumed that the fluctuating method of capital is followed
Any Balance sheet prepared after passing the above entry will not have any Goodwill on the assets side as it is already written off.
Note :
It is possible that along with the retiring of a partner the profit sharing ratio of remaining partners is also changed. In such case if any remaining partners is also sacrificing then he will also receive the share of goodwill from the gaining partner. The journal entry will be same as above.
Hidden Goodwill
If the retiring partner is paid any amount is excess of what is due to him at the time of retirement then the excess amount paid is considered Goodwill. Example Suppose Mr A is retiring and amount due to him in capital account is Rs 1 Lakh. If he is paid Rs 1.2 Lakhs on retirement then Rs 20K will be considered as Hidden Goodwill. Accounting entry is same as explained above.