📊 Accounting for Goodwill in Partnership
When partners change their profit sharing ratio
🎯 What is Profit Sharing Ratio?
Profit sharing ratio is the proportion in which partners share the profits and losses of their business.
Equal Partners
When partners contribute equally, they typically share profits in ratio 1:1
Unequal Partners
Partners may have different ratios like 2:3 or 1:2:1 based on their contribution
Changes Occur
Ratios can change due to business needs, partner availability, or new agreements
🤔 Why Do Profit Ratios Change?
Time Commitment
A partner may reduce their involvement in daily operations
Capital Contribution
Changes in financial investment by partners
Skill & Expertise
Recognition of specialized skills bringing more value
Business Growth
Expansion requiring different levels of responsibility
⚖️ Sacrificing & Gaining Ratio
❌ Negative Result: Partner has GAINED
Sacrificing Partner
Partner whose profit share decreases
Loses future profit share
Gaining Partner
Partner whose profit share increases
Gains future profit share
💡 Practical Example
Partners: Anil and Sunil
Old Ratio: 1:1 (Equal partners)
New Ratio: 1:3 (Anil reduces involvement)
Firm's Goodwill: ₹5,00,000
📊 Step-by-Step Calculation
Step 1: Calculate Old Shares
Anil's old share = 1/(1+1) = 1/2
Sunil's old share = 1/(1+1) = 1/2
Step 2: Calculate New Shares
Anil's new share = 1/(1+3) = 1/4
Sunil's new share = 3/(1+3) = 3/4
Step 3: Find Sacrificing/Gaining Ratio
Anil: 1/2 - 1/4 = 1/4 (Sacrificed)
Sunil: 1/2 - 3/4 = -1/4 (Gained)
Step 4: Calculate Goodwill Compensation
Anil's Loss: ₹5,00,000 × 1/4 = ₹1,25,000
Sunil's Gain: ₹5,00,000 × 1/4 = ₹1,25,000
🏆 Goodwill Compensation
When profit ratios change, the sacrificing partner should be compensated for their share in the firm's goodwill.
🧮 Calculate Goodwill
Use Average Profit, Super Profit, or Capitalization method
📊 Find Ratio Change
Determine who sacrificed and who gained and the sacrificing and Gaining ratio
💵 Calculate Amount
Multiply Firms goodwill by Sacrificing/Gaining ratio
📝 Journal Entry
Pass the journal Entry
📚 Journal Entry
The gaining partner compensates the sacrificing partner
To Sacrificing Partner's Capital Account ₹X
(Being goodwill compensation paid to sacrificing partner)
To Anil's Capital Account ₹1,25,000
(Being compensation for goodwill sacrifice)
🎯 4-Step Process
Find Goodwill Value
Calculate the firm's goodwill using appropriate method (Average Profit, Super Profit, or Capitalization)
Calculate Ratios
Find sacrificing and gaining ratios using: Old Ratio - New Ratio
Find Compensation
Calculate share in goodwill: Goodwill Value × Ratio Change
Pass Journal Entry
Debit gaining partner, Credit sacrificing partner with compensation amount
🔑 Key Takeaways
Fair Compensation
Ensures sacrificing partners are fairly compensated for their goodwill share
Maintains Relationships
Prevents disputes and maintains healthy business relationships
Systematic Approach
Follow the 4-step process for accurate and consistent calculations
Proper Documentation
Always record transactions with proper journal entries
🎉 Congratulations!
You now understand how to do Goodwill Adjustment at the time of change in profit sharing ratio