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Difficulty: MediumTreatment and Valuation of Goodwill

Ngozi and Bello are partners in a firm sharing profits and losses in the ratio of 3:23:2. They admit Emeka into the partnership for a 14\frac{1}{4} share of future profits. Emeka pays N20,000\mathcal{N}20,000 in cash as his share of premium for goodwill, which is to be retained in the business. Which of the following correctly describes the ledger entry required to credit the existing partners for the goodwill premium?

  1. Credit Ngozi's Capital Account with N12,000\mathcal{N}12,000 and Bello's Capital Account with N8,000\mathcal{N}8,000Answer
  2. B
    Credit Ngozi's Capital Account with N10,000\mathcal{N}10,000 and Bello's Capital Account with N10,000\mathcal{N}10,000
  3. C
    Debit Ngozi's Capital Account with N12,000\mathcal{N}12,000 and Bello's Capital Account with N8,000\mathcal{N}8,000
  4. D
    Credit Ngozi's Capital Account with N15,000\mathcal{N}15,000 and Bello's Capital Account with N5,000\mathcal{N}5,000

Answer

Credit Ngozi's Capital Account with N12,000\mathcal{N}12,000 and Bello's Capital Account with N8,000\mathcal{N}8,000
When an incoming partner brings cash for premium for goodwill, the cash is debited to the Bank/Cash account and credited to the existing partners' capital accounts in their sacrificing ratio. With an old ratio of 3:23:2, Ngozi receives 35×N20,000=N12,000\frac{3}{5} \times \mathcal{N}20,000 = \mathcal{N}12,000 and Bello receives 25×N20,000=N8,000\frac{2}{5} \times \mathcal{N}20,000 = \mathcal{N}8,000.

Step-by-Step Solution

1
Determine the sacrificing ratio of the existing partners
Since no new ratio is explicitly stated, the sacrificing ratio equals the old profit-sharing ratio of 3:23:2 (total parts = 3+2=53 + 2 = 5).
When a new partner is admitted without specific new ratio details, existing partners sacrifice in their old profit-sharing ratio.
2
Calculate Ngozi's share of the goodwill premium
Ngozi's share = 35×N20,000=N12,000\frac{3}{5} \times \mathcal{N}20,000 = \mathcal{N}12,000
Multiply total premium by Ngozi's proportion of the sacrificing ratio.
3
Calculate Bello's share of the goodwill premium
Bello's share = 25×N20,000=N8,000\frac{2}{5} \times \mathcal{N}20,000 = \mathcal{N}8,000
Multiply total premium by Bello's proportion of the sacrificing ratio.
4
Formulate the credit entry to capital accounts
Credit Ngozi's Capital Account with N12,000\mathcal{N}12,000 and Bello's Capital Account with N8,000\mathcal{N}8,000.
Goodwill premium brought in cash is credited to old partners' capital accounts to compensate them for sacrificing future profit shares.

Key Concept

Accounting treatment of premium for goodwill on admission of a partner
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Topics

Treatment and Valuation of Goodwill

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