Question

A and B are partners sharing profits and losses in the ratio 3 : 2. They decided to admit C as a new partner on 1st April, 2021 from the effective date. On 1st April, 2021 the Balance Sheet and terms of entries of A and B are as follows: \[ \begin{array}{|c|c|} \hline
Capital and Liabilities &
Amount (Rs.)
\hline \text{Capital A/c:} & 6,00,000
A & 3,00,000
B & 3,00,000
\text{Creditors} & 60,000
\text{Outstanding Expenses} & 15,000
\hline \text{Total Capital and Liabilities} & 6,75,000
\hline \end{array}
\begin{array}{|c|c|} \hline
Assets &
Amount (Rs.)
\hline \text{Plant} & 4,53,000
\text{Furniture} & 62,000
\text{Stock} & 84,000
\text{Debtors} & 36,000
\text{Cash} & 40,000
\hline \text{Total Assets} & 6,75,000
\hline \end{array} \]
The following are conditions of entries:

The profit in future will be distributed equally.
The capital of the firm was determined to be Rs. 6,00,000, which will be given in the profit ratio by the partners.
C will give the share of capital and goodwill in cash.
The valuation of goodwill will be done on the basis of over-value of two years’ purchases. The average net profit of the firm is Rs. 90,000 per year. The nominal profit on capital is 10% in nominal business.

Hint:

Goodwill valuation is essential when a new partner is admitted, as it reflects the firm's reputation and the value of its intangible assets.

Answer 1

Step 1: Calculation of Goodwill
The goodwill is calculated on the basis of the average net profit of the firm and the nominal profit on capital. \[ \text{Goodwill} = \text{Average Profit} \times \text{Number of Years' Purchase} \] \[ \text{Goodwill} = 90,000 \times 2 = 1,80,000 \]
Step 2: C's Share of Goodwill
C's share of goodwill will be calculated on the basis of the profit-sharing ratio, which is 3:2 for A and B and 1 for C. Hence, C's share is 1/3. \[ C's \text{ Share of Goodwill} = \frac{1}{3} \times 1,80,000 = 60,000 \]
Step 3: Calculation of C’s Capital Contribution
The capital of the firm is Rs. 6,00,000, and C’s share is 1/3 of the total capital: \[ C's \text{ Share of Capital} = \frac{1}{3} \times 6,00,000 = 2,00,000 \]
Step 4: Preparation of Capital Accounts of Partners
After admitting C, the total capital of the firm is Rs. 6,00,000. A and B share the profits in the ratio 3:2, and C will contribute Rs. 2,00,000 in capital. The capital accounts are adjusted as follows: \[ \text{C's Capital Account} = 2,00,000 \] \[ \text{A's Capital Account} = 3,00,000 \times \frac{3}{5} = 1,80,000 \] \[ \text{B's Capital Account} = 3,00,000 \times \frac{2}{5} = 1,20,000 \]
Step 5: Journal Entries for Capital Account and Goodwill:
The following journal entries are passed for admitting C as a partner:

On Admission of C:

Cash A/C
2,00,000

To C's Capital A/C
2,00,000
(C's share of capital contribution)
Goodwill Entry:

Goodwill A/C
1,80,000

To A's Capital A/C
1,08,000

To B's Capital A/C
72,000
(C's share of goodwill paid in cash)

Conclusion: These entries reflect the proper capital contributions and goodwill sharing among the partners. C will contribute Rs. 2,00,000 as capital and Rs. 60,000 as goodwill in cash.