A partnership is never quite permanent. A new partner may be admitted, a partner may retire or die, or two businesses may combine. Each of these ends the old partnership and starts a new one, usually in the same books.
The accounting problem is fairness: the balances in the books show cost, not value, so the partners who leave, and those who join, must be treated as if the business were worth what it is really worth.
That is why changes in a partnership involve two adjustments: a revaluation of assets to their current values and the recognition of Goodwill, the extra value of the business over its net assets. This topic follows profit sharing and covers goodwill, admission, retirement and amalgamation. It is a regular source of 20-mark questions. The next topic starts incomplete records.
In 30 seconds
Goodwill is the value of the firm minus its net assets, and it is not normally kept in the books.
When a partner joins or leaves:
- (1) revalue assets, sharing any gain or loss in the Old profit-sharing ratio
- (2) Recognise goodwill: Dr Goodwill, Cr old partners’ capital in the Old ratio
- (3) Remove goodwill: Dr all continuing partners’ capital in the New ratio, Cr Goodwill
- (4) record the capital introduced by a new partner, or the amount paid or lent back to a retiring partner (a balance left in the firm is a loan)
A new partner pays for goodwill, so the capital credited may be less than the cash introduced. Goodwill may be valued as a multiple of average profit or of average excess profit.
Why a change needs adjustments
The old partnership ends and a new one begins, but the records usually continue with adjustments for the change of ownership. The aim is to find each partner’s share of the true worth of the firm. The balances on the capital and current accounts are shares of the net assets as recorded, and the assets are at cost, which may be far from value.
Two examples show the problem. A, B and C share equally. The firm bought land in 2001 for ₦2,500,000, and A leaves when it is worth ₦4,000,000. The gain of ₦1,500,000 is not in the books, so A’s capital misses his ₦500,000 share. In the second example, A leaves when net assets are ₦6,000,000 and the firm is valued at ₦9,000,000.
A’s share of net assets is ₦2,000,000, but his share of the firm’s value is ₦3,000,000. The fix is to revalue the assets so that all partners share any gain, and to recognise goodwill, the difference of ₦3,000,000.
Goodwill
Goodwill is the amount by which the value of a business exceeds the value of its net assets (assets less liabilities). It is an intangible asset that reflects trading potential, the ability to earn future profits. A successful business has goodwill, because buyers will pay more than the net assets are worth. Goodwill is not normally recognised in a partnership’s financial statements.
Circumstances that create goodwill include a good reputation, a prime location, a loyal customer base and skilled staff.
Revaluation does not change what partners share. A firm has net assets of ₦1,000,000, including a property with a market value ₦200,000 above its carrying amount, and the firm is valued at ₦1,800,000. Without revaluing, goodwill is 1,800,000 − 1,000,000 = ₦800,000. With the property revalued, net assets are 1,200,000, so goodwill is ₦600,000 and the revaluation gain is ₦200,000. The partners share ₦800,000 either way. In questions, the goodwill figure and any revaluation are normally given.
Valuing goodwill. The partnership agreement may set a formula. Two common ones are:
| Method | Example (profits: year 3 ₦100,000, year 2 ₦90,000, year 1 ₦80,000) |
|---|---|
| Value of the firm as a multiple of average profit | Average = 270,000 ÷ 3 = 90,000. Ten times = ₦900,000 for the firm. Goodwill is that value less net assets. |
| Goodwill as a multiple of average excess profit | Normal profit ₦60,000. Excesses 40,000 + 30,000 + 20,000 = 90,000, average 30,000. Two times = ₦60,000 goodwill. |
The standard entries
| Step | Debit | Credit | Ratio |
|---|---|---|---|
| Revalue assets (gain) | Asset or revaluation account | Old partners’ capital | Old |
| Recognise goodwill | Goodwill | Old partners’ capital | Old |
| Remove goodwill | Continuing and new partners’ capital | Goodwill | New |
| New partner pays in | Bank | New partner’s capital | |
| Retiring partner paid | Retiring partner’s capital | Bank, and loan account for any balance |
Admitting a new partner
The four steps are: measure goodwill (usually given), recognise it in the old ratio, remove it in the new ratio, and record the new partner’s capital. Example. R and S share equally with capital of ₦80,000 and ₦60,000. T is admitted with capital of ₦50,000, and the new ratio is 2:2:1. Goodwill is ₦30,000. Recognise: Dr Goodwill 30,000, Cr R 15,000 and S 15,000. Remove: Dr R 12,000 (2/5), S 12,000 (2/5) and T 6,000 (1/5), Cr Goodwill 30,000.
Capital accounts: R 80,000 + 15,000 − 12,000 = 83,000; S 60,000 + 15,000 − 12,000 = 63,000; T 50,000 − 6,000 = 44,000. T introduced ₦50,000 but his capital is ₦44,000, because he has paid for his share of goodwill.
Practice question. P and Q share 2:1 with capital of ₦600,000 and ₦500,000. M pays in ₦400,000, and the new ratio is 2:2:1. Goodwill is ₦150,000. P is credited 100,000 and Q 50,000. Goodwill is removed 60,000 from P, 60,000 from Q and 30,000 from M. The capitals are P ₦640,000, Q ₦490,000 and M ₦370,000.
Retirement or death of a partner
The steps are the same, except that the last step is the amount taken out: measure goodwill, recognise it in the old ratio, remove it in the new ratio among the remaining partners, and account for the capital the leaving partner takes. The balance due to a retired partner who is not paid immediately becomes a loan account in his name (May Diet 2024, Section A, Question 15). A deceased partner’s capital is due to his estate.
Example. P, Q and R share equally with capital of ₦80,000, ₦60,000 and ₦75,000. R retires, takes ₦50,000 in cash and leaves the rest as a loan. P and Q continue equally. Goodwill is ₦60,000. Recognise 20,000 to each. Remove 30,000 from P and 30,000 from Q.
- Capital.
P 80,000 + 20,000 − 30,000 = 70,000 - Q 60,000 + 20,000 − 30,000 = 50,000
- R 75,000 + 20,000 = 95,000, which is paid 50,000 in cash and 45,000 as a loan.
Practice question. J, K and L share equally with capital of ₦320,000, ₦210,000 and ₦120,000. K retires and leaves her balance as a loan. Land and buildings are revalued up by ₦1,800,000 and goodwill is ₦900,000. J and L will share 3:1 and goodwill is not kept. Revaluation: 600,000 each. Recognise goodwill: 300,000 each. Remove goodwill: J 675,000 and L 225,000. J = 320,000 + 600,000 + 300,000 − 675,000 = ₦545,000. K = 210,000 + 600,000 + 300,000 = ₦1,110,000, transferred to a loan. L = 120,000 + 600,000 + 300,000 − 225,000 = ₦795,000.
Forming a partnership from existing businesses
Two sole traders may combine their businesses, or a sole trader may take in a partner. Each business’s assets and liabilities are brought in at agreed values, so a revaluation account shows the gains and losses, which are credited or debited to that trader’s capital.
Capital contributed by each partner is then recorded, and the statement of financial position of the new firm is the sum of the assets and liabilities. In the Elegbe and Amuda question, Elegbe’s premises are revalued from ₦68,000,000 to ₦103,200,000, equipment of ₦10,300,000 is obsolete and ₦6,880,000 of receivables are written off. Net gain = 35,200 − 10,300 − 6,880 = ₦18,020,000, so his capital becomes 171,800 + 18,020 = ₦189,820,000.
Amuda brings new equipment of ₦10,800,000 and repays his loan from private funds, so his capital is 276,232 + 68,000 + 10,800 = ₦355,032,000. The new firm’s total assets are ₦544,852,000, equal to total capital (all in ₦’000).
The ideas in more depth
Slips to watch. The Elegbe and Amuda ledger shows the premises gain as 35,000 and the revaluation credit as 27,820 against capital of 17,820, and Elegbe’s opening capital as 172,000, where the statement gives 171,800. The correct revaluation gain is 18,020 (35,200 − 10,300 − 6,880), which gives the same closing capital of 189,820. In a typical practice solution, the current accounts stop at the profit share. Drawings of ₦15,000, ₦10,000 and ₦8,000 must still be deducted, leaving X ₦20,200, Y ₦24,200 and Z ₦22,600.
A typical exam layout. In May Diet 2024, Question 6, BIN Partnership has capital of ₦1,750,000 each for two equal partners. Ngor pays ₦1,500,000 for a 30% share, goodwill is ₦200,000 and not kept, and ₦600,000 of Ngor’s cash repays loan notes. Recognise goodwill: 100,000 each. Remove it: 35% (70,000) each from the old partners and 30% (60,000) from Ngor. Capitals: 1,780,000, 1,780,000 and 1,440,000. After repaying loan notes the cash is 800,000 + 1,500,000 − 600,000 = 1,700,000 and the loan notes are 400,000. Total assets are 5,700,000, which equals capital 5,000,000 plus loan notes 400,000 plus payables 300,000.
Worked example: Zaria Traders
Scenario. A and B share profits 3:2 with capital of ₦400,000 and ₦300,000. Their assets are property, plant and equipment ₦450,000, inventory ₦200,000, receivables ₦150,000 and cash ₦50,000, and payables are ₦150,000. C is admitted and pays ₦300,000 in cash. The new ratio is A 2, B 2, C 1. The property, plant and equipment are revalued up by ₦100,000, and goodwill of ₦250,000 is agreed but not kept in the books.
Required: the capital accounts and the statement of financial position after the admission.
- Revaluation gain. 100,000 in the old ratio 3:2: A 60,000, B 40,000.
- Recognise goodwill. 250,000 in the old ratio: A 150,000, B 100,000.
- Remove goodwill. In the new ratio 2:2:1: A 100,000, B 100,000, C 50,000.
- Capital accounts.
A: 400,000 + 60,000 + 150,000 − 100,000 = 510,000.
B: 300,000 + 40,000 + 100,000 − 100,000 = 340,000.
C: 300,000 − 50,000 = 250,000.
Total capital 1,100,000. - Statement of financial position.
Property, plant and equipment 550,000, inventory 200,000, receivables 150,000, cash 50,000 + 300,000 = 350,000.
Total assets 1,250,000.
Capital 1,100,000 plus payables 150,000 = 1,250,000.
Common mistakes in the exam
- Using the new ratio to credit goodwill, or the old ratio to remove it.
- Forgetting that a new partner’s capital is reduced by his share of goodwill.
- Leaving goodwill in the books when the question says it is not to be kept.
- Sharing a revaluation gain in the new ratio.
- Treating the balance owed to a retiring partner as capital instead of a loan, or paying it in full in cash.
- Forgetting to include goodwill when the capital is shown after retirement.
- Not including the cash introduced by a new partner in the statement of financial position.
- Using the wrong number of years or the wrong normal profit in a goodwill valuation.
Quick revision
- Goodwill = value of firm − net assets. Not normally in the books.
- Revaluation gain and goodwill recognised: old ratio. Goodwill removed: new ratio.
- New partner capital = cash introduced − share of goodwill.
- Retiring partner: cash plus a loan for the balance.
- Valuation: multiple of average profit, or of average excess profit.
Practice questions
These are original questions in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one first.
Section A style: multiple choice
Question 1. Goodwill is:
- The excess of the value of a firm over its net assets
- The net assets of the firm
- The cash balance
- The cost of non-current assets
Show the answer
A. It is the value of the business above its assets less liabilities.
Question 2. On admission of a partner, goodwill is first recognised by crediting:
- The new partner’s capital
- All partners’ capital in the new ratio
- The old partners’ capital in the old ratio
- Profit or loss
Show the answer
C. The old partners own the goodwill, so they are credited in their old ratio.
Question 3. When goodwill is removed from the books, the debit is to the partners’ capital accounts in:
- The old ratio
- Equal shares
- The new partner only
- The new profit-sharing ratio
Show the answer
D. Continuing partners and the new partner bear it in the new ratio.
Question 4. A firm is valued at ₦9m and its net assets are ₦6m. Goodwill is:
- ₦15m
- ₦3m
- ₦6m
- ₦9m
Show the answer
B. 9 − 6 = 3m.
Question 5. The average annual profit is ₦90,000 and the firm is valued at ten times average profit. The value of the firm is:
- ₦900,000
- ₦90,000
- ₦9,000,000
- ₦270,000
Show the answer
A. 10 × 90,000 = 900,000.
Question 6. Profits are ₦100,000, ₦90,000 and ₦80,000 over three years and normal profit is ₦60,000. Goodwill is two times the average excess profit. Goodwill is:
- ₦180,000
- ₦90,000
- ₦60,000
- ₦120,000
Show the answer
C. Excess profits average 30,000. Two times is 60,000.
Question 7. T introduces ₦50,000 on admission. Goodwill of ₦30,000 is not kept, and T has a one-fifth share. T’s capital after goodwill is removed is:
- ₦56,000
- ₦44,000
- ₦50,000
- ₦30,000
Show the answer
B. T bears 1/5 × 30,000 = 6,000, so 50,000 − 6,000 = 44,000.
Question 8. A retiring partner’s balance that is not paid in cash immediately is transferred to:
- Bank
- Goodwill
- Revaluation account
- A loan account in his name
Show the answer
D. It is a liability of the firm until paid.
Question 9. Two partnerships combining to form a new partnership is called:
- Appropriation
- Dissolution
- Amalgamation
- Realisation
Show the answer
C. Amalgamation is the combination of businesses.
Question 10. A gain on the revaluation of assets at a change in partnership is shared in:
- The old profit-sharing ratio
- The new profit-sharing ratio
- Equal shares
- The ratio of capital
Show the answer
A. The gain arose while the old partners owned the assets.
Section B style: written questions
Question 11 (10 marks). (a) Define goodwill and describe two methods of valuing it in a partnership. (6 marks) (b) Explain why assets are revalued and goodwill recognised when a new partner is admitted. (4 marks)
Question 12 (20 marks). A and B share profits equally with capital of ₦600,000 each. Their assets are property, plant and equipment ₦800,000, inventory ₦400,000, receivables ₦300,000 and cash ₦200,000, and their liabilities are a loan of ₦300,000 and payables of ₦200,000. C is admitted with ₦900,000 in cash for a 30% share, with A and B each taking 35%. Goodwill is ₦300,000 and is not kept. ₦200,000 of C’s cash repays part of the loan.
(a) Prepare the goodwill account entries. (4 marks) (b) Prepare the partners’ capital accounts. (6 marks) (c) Prepare the statement of financial position after the admission. (10 marks)
A further written question
Question 13 (10 marks). J, K and L share equally with capital of ₦320,000, ₦210,000 and ₦120,000. K retires and leaves her balance as a loan. Land is revalued up by ₦1,800,000 and goodwill is valued at ₦900,000. J and L will share 3:1 and goodwill is not kept. Show the capital accounts. (10 marks)
Model answers
Show the model answer to Question 11
(a) Goodwill is the amount by which the value of the business exceeds the value of its net assets. Methods include valuing the firm as a multiple of average annual profits, so that goodwill is that value less net assets, and valuing goodwill directly as a multiple of the average annual profit in excess of a normal profit.
(b) Assets are carried at cost, which may differ from their value, and the business is usually worth more than its net assets. If nothing were done, the old partners would lose their share of the gain in value, and the new partner would obtain a share of it for nothing.
Revaluation and goodwill give the old partners credit for the value they built up, and the new partner pays for the share he takes.
Show the model answer to Question 12
(a) Recognise: Dr Goodwill 300,000, Cr A 150,000 and B 150,000. Remove: Dr A 105,000 (35%), B 105,000 (35%) and C 90,000 (30%), Cr Goodwill 300,000.
(b)
- A: 600,000 + 150,000 − 105,000 = 645,000.
- B: 645,000.
- C: 900,000 − 90,000 = 810,000.
- Total capital 2,100,000.
(c)
- Property, plant and equipment 800,000; inventory 400,000; receivables 300,000; cash 200,000 + 900,000 − 200,000 = 900,000.
- Total assets 2,400,000.
- Capital 2,100,000.
- Loan 300,000 − 200,000 = 100,000.
- Payables 200,000.
- Total 2,400,000.
Show the model answer to Question 13
Revaluation 1,800,000 shared equally: 600,000 each. Goodwill 900,000 recognised equally: 300,000 each. Goodwill removed in 3:1: J 675,000, L 225,000. J: 320,000 + 600,000 + 300,000 − 675,000 = 545,000. K: 210,000 + 600,000 + 300,000 = 1,110,000, transferred to a loan account. L: 120,000 + 600,000 + 300,000 − 225,000 = 795,000.
Pathfinder on Changes in partnership: admission, retirement and goodwill
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
From the previous syllabus. Asks for the journal entries needed to remove goodwill recognised on the admission of a new partner.
Revise first: The standard entries
From the previous syllabus. Asks what two partnerships combining is called, how goodwill is found from several years of profit, and when goodwill can be valued in a partnership.
Revise first: Goodwill
Asks what is true of goodwill, the journal for the amount due to a retired partner who is not paid immediately in cash, and which events lead to a change in a partnership agreement.
Revise first: Retirement or death of a partner
From the previous syllabus. Asks you to define goodwill and explain its recognition (3 marks), state three circumstances in which goodwill is created (3 marks), and, on the retirement of a partner with goodwill not kept, a car taken at a valuation and a loan at 12%, to prepare the capital, cash and loan accounts (6 marks) and the new statement of financial position (8 marks).
Revise first: Retirement or death of a partner
From the previous syllabus. In the first, two sole traders form a partnership and the statement of financial position is required. In the second, a sole trader takes a partner in on revalued assets, with equal capital, and asks for the revaluation account, the capital accounts and the statement of financial position.
Revise first: Forming a partnership from existing businesses
Asks you, for the admission of a new partner with goodwill not recorded and part of the cash repaying loan notes, for the goodwill account (2 marks), the capital accounts (4 marks) and the statement of financial position (10 marks), and to discuss two methods of valuing goodwill (4 marks).
Revise first: Admitting a new partner
From the previous syllabus. A new partner is admitted during the year on stated terms. Asks for the profit or loss and appropriation account for the year, on a pro rata time basis, and the partners’ current accounts.
Revise first: Admitting a new partner
Source: ICAN Pathfinder, Financial Accounting. Diets covered: November Diet, 2014, May Diet, 2016, May Diet, 2017, May Diet, 2018, November Diet, 2020, November Diet, 2021, November Diet, 2022, May Diet, 2023, November Diet, 2023 and May Diet, 2024 (the later ones are not all on the previous syllabus). Diets before November 2014, and November Diet, 2024 onwards, are not covered here.
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