Examkin

Question

Difficulty: MediumTreatment and Valuation of Goodwill

Efe and Kemi are partners sharing profits and losses in the ratio of 3:13:1. They admit Segun into the firm, giving him a 15\frac{1}{5} share of future profits. The firm's goodwill is valued at ₦60,000\text{₦}60,000, and the partners agree that goodwill will be raised and immediately written off. What is the net entry required in Efe's capital account?

  1. Net credit of ₦9,000\text{₦}9,000Answer
  2. B
    Net debit of ₦9,000\text{₦}9,000
  3. C
    Net credit of ₦45,000\text{₦}45,000
  4. D
    Net debit of ₦36,000\text{₦}36,000

Answer

The correct adjustment is a net credit of ₦9,000\text{₦}9,000 to Efe's capital account.
When goodwill is created and immediately written off upon admitting a new partner, the firm credits existing partners in the old ratio (3:13:1) and debits all partners in the new ratio (3:1:13:1:1). Efe receives a credit of ₦45,000\text{₦}45,000 (34×₦60,000\frac{3}{4} \times \text{₦}60,000) and a debit of ₦36,000\text{₦}36,000 (35×₦60,000\frac{3}{5} \times \text{₦}60,000). The difference results in a net credit of ₦9,000\text{₦}9,000.

Step-by-Step Solution

1
Determine the new profit-sharing ratio
Segun's share = 15\frac{1}{5}. Remaining share = 1−15=451 - \frac{1}{5} = \frac{4}{5}. Efe's new share = 34×45=35\frac{3}{4} \times \frac{4}{5} = \frac{3}{5}. Kemi's new share = 14×45=15\frac{1}{4} \times \frac{4}{5} = \frac{1}{5}. The new ratio among Efe, Kemi, and Segun is 3:1:13:1:1.
Goodwill write-off must be shared among all partners in their new profit-sharing ratio.
2
Calculate goodwill credited to Efe when raised
Credit to Efe = 34×₦60,000=₦45,000\frac{3}{4} \times \text{₦}60,000 = \text{₦}45,000.
Goodwill is initially raised by crediting existing partners in their old profit-sharing ratio (3:13:1).
3
Calculate goodwill debited to Efe when written off
Debit to Efe = 35×₦60,000=₦36,000\frac{3}{5} \times \text{₦}60,000 = \text{₦}36,000.
Goodwill is written off by debiting all partners in their new profit-sharing ratio (3:1:13:1:1).
4
Determine the net adjustment for Efe
Net entry = Credit of ₦45,000\text{₦}45,000 - Debit of ₦36,000\text{₦}36,000 = Net credit of ₦9,000\text{₦}9,000.
Subtracting the debit from the credit gives the net capital account entry.

Key Concept

Accounting treatment of goodwill upon admission of a partner when goodwill is raised and written off.
Rate this question

Topics

Treatment and Valuation of Goodwill

More questions from this topic