Ade and Bola are partners in a business sharing profits and losses in the ratio of 3:2. Th… — JAMB UTME

Ade and Bola are partners in a business sharing profits and losses in the ratio of $3:2$ . They agree to admit Chidi into the firm with a $\frac{1}{5}$ share of future profits. The firm's goodwill is valued at $\text{N}50,000$ . If goodwill is raised in the books of the firm and immediately written off, what is the net financial effect on Bola's capital account?

Net credit of $\text{N}4,000$ Answer
B
Net debit of $\text{N}4,000$
C
Net credit of $\text{N}20,000$
D
Net debit of $\text{N}16,000$

Answer

Bola's capital account receives a net credit of

\text{N}4,000

When goodwill is raised and written off, existing partners are credited in the old profit-sharing ratio (

3:2

) and all partners are debited in the new profit-sharing ratio (

12:8:5

). Crediting Bola with

\text{N}20,000

and debiting Bola with

\text{N}16,000

leaves a net credit of

\text{N}4,000

in Bola's capital account.

Step-by-Step Solution

Calculate the new profit-sharing ratio among Ade, Bola, and Chidi

Chidi's share =

\frac{1}{5}

. Remaining share =

1 - \frac{1}{5} = \frac{4}{5}

. Ade's new share =

\frac{3}{5} \times \frac{4}{5} = \frac{12}{25}

. Bola's new share =

\frac{2}{5} \times \frac{4}{5} = \frac{8}{25}

. Chidi's new share =

\frac{5}{25}

. New ratio =

12:8:5

When a new partner is admitted, the remaining share after deducting the new partner's fraction is distributed among existing partners according to their old ratio.

Calculate Bola's share when goodwill is raised in the old ratio (

3:2

)

Credit to Bola's Capital Account =

\frac{2}{5} \times \text{N}50,000 = \text{N}20,000

Goodwill is raised by crediting the existing partners' capital accounts in their old profit-sharing ratio.

Calculate Bola's share when goodwill is written off in the new ratio (

12:8:5

)

Debit to Bola's Capital Account =

\frac{8}{25} \times \text{N}50,000 = \text{N}16,000

Goodwill is written off by debiting all partners' (including the new partner) capital accounts in their new profit-sharing ratio.

Determine the net effect on Bola's capital account

Net effect =

\text{N}20,000\text{ (Credit)} - \text{N}16,000\text{ (Debit)} = \text{N}4,000\text{ (Net Credit)}

Comparing the total credit and debit entries gives the overall adjustment to Bola's capital account.

Key Concept

Treatment of Goodwill upon Admission of a Partner (Raising and Writing Off)

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