ACCOUNTANCY A LEVEL(FORM SIX) NOTES – MODE OF PAYMENT(2)

Mode of Payment

(i) Cash paid to all partners outside the business or paid privately.

(ii) Cash paid through the firm or business; such cash may be:

• Raised in the business as additional working capital.
• Withdrawn by old partners either fully or partially.

(iii) Goodwill raised in the books:

• When the new partner cannot pay in cash for his share in goodwill, partners’ capital accounts will be raised proportionally by bringing in goodwill in the books.
• In this case, goodwill must be recorded at its full value in the following ways:

1. Goodwill raised and retained in the books at full value.
2. Goodwill raised and written off either fully or partly.
3. Goodwill raised without opening a goodwill account in the books.

b) When the goodwill is already appearing in the books:

• When goodwill appears in the books (appeared in the balance sheet), it means it has already been recorded and credit given to partners.
• Therefore, the new partner need not contribute for goodwill.
• If the new partner brings in cash for goodwill in this case, it should be treated as additional capital and the goodwill should be cancelled out.

Accounting Entries for Goodwill

1. When no goodwill appears in the balance sheet

– When incoming partner pays money for goodwill privately: In this case, there is no entry.

2. When incoming partner brings in cash and it is retained in the business

Debit: Cash a/c (with cash brought)

Credit: Goodwill a/c

Debit: Goodwill a/c (old partners)

Credit: Old partners’ capital a/c (sharing ratio)

Example I

A and B are partners carrying on a business; their profit sharing ratio is 3:2. They decide to admit C into the firm. Their new profit sharing ratio is 2:2:1 for A, B, and C respectively. C pays Shs. 10,000/= as goodwill. This money was left in the business.

Required: Draw journal entries to record the goodwill.

Journal Entries

III. When Incoming Partner Pays Cash for Goodwill and That Money Is Withdrawn by Old Partners

Debit: Cash a/c (with cash brought)

Credit: Goodwill a/c

Debit: Goodwill a/c

Credit: Old partners’ capital a/c

Debit: Old partners’ capital a/c

Credit: Cash a/c

(With old profit sharing ratio).

Example 2

X and Y are equal partners carrying on business as accountants and auditors. They decided to admit W with a share of profit in the business. W paid Shs. 30,000 as goodwill in cash. But old partners decided to withdraw all the money paid for goodwill.

Required: Draw up journal entries to record the above.

Journal Entries

IV. When Incoming Partner Does Not Bring Cash

• When the new partner does not bring cash for goodwill, the goodwill account is raised in the books of account and is allowed to remain in the books.
• It is agreed to estimate the value of goodwill for that particular business. However, an adjustment is made in the old partners’ capital accounts in proportion to the loss suffered by old partners.

Entries

1. Adjustments

Dr: New partner’s capital a/c

Cr: Old partner’s capital a/c

Dr: Goodwill a/c

Cr: Old partner’s capital a/c (with old profit sharing ratio).

Example

M and N are partners with PSR 3:2. They decided to admit O as a new partner to the business; they agreed new profit sharing ratio is 4:3:3 for M, N, and O respectively. But it was further agreed that unrecorded goodwill of Shs 105,000.00 is to be raised in the books of the firm.

Required: Show journal entries to show:

• (a) Loss suffered by M and N
• (b) Goodwill shared by M and N

Determine the proportion of loss suffered on admitting O.

Determine O’s share of goodwill:

O’s share = Amount of goodwill × Sacrificed ratio

= 105,000 × () = 31,500

Journal Entries

Revaluation of Assets and Liabilities

When a new partner is admitted, it is very important to revalue all assets depending on market value rather than their cost or written down value. This ensures that the financial position of the firm reflects the true value of its assets and liabilities, providing a fair basis for profit sharing and capital adjustments.

Open Revaluation Account

Decrease in Assets

Increase in Liability

Decrease in Liability

Revaluation Account Results (Transfer)

In case of profit on revaluation:

Debit: Revaluation a/c

Credit: Capital a/c

In case of loss on revaluation:

Debit: Capital a/c

Credit: Revaluation a/c

Exercise

Balance Sheet as at 31/12/1997

On 1st January 1998, they admit John to bring in 10,000 as capital. The profit and loss sharing ratio is 3:1:1 respectively; old profit and loss sharing ratio was 3:2.

The assets to be revalued:

• Freehold = 27,000
• Motor cars = 4,000
• Office Equipment = 2,500
• Stock = 3,750
• Unrecorded liabilities = 500
• Creditors overcast by 200

Required:

• Journal Entries

Journal Entries as at 1^st January, 1998

Ojwang, Onyango and Othorong’ong’o Statement of Financial Position as at Date

Exercises (NECTA 2002)

1. Polpot and Goldberg are in partnership with capitals of Shs 20,000,000 and Shs 12,000,000 respectively. The partnership agreement provided that profits shall be shared after giving Goldberg a salary of Shs 2,240,000 and giving both partners interest on capital at 8 percent per annum.

The net profit for the year was Shs 10,320,000. Shs 40,000 is to be written off the goodwill account.

Required: Write up the Appropriation Account for the year.

DR Profit and Loss Appropriation A/C CR

Retirement of a Partner

This is when a partner leaves a partnership firm due to various reasons, e.g., age limit.

Example; NECTA 2007

A, B, and C were carrying on a business as partners sharing profit in the ratio of 5:3:2 respectively. On 31^st March 1991, their balance sheet stood as follows:

C retired on the above-mentioned date on the following terms:

• (a) Freehold Premises to be appreciated by 20%.
• (b) Furniture & Fittings to be reduced by Tshs 2,255.
• (c) Provision for doubtful debts to be created on trade debtors at 5%.
• (d) Goodwill account be raised by Tshs 60,000, the agreed value of the firm’s goodwill. The amount finally due to C be paid immediately. A and B bring in Tshs 20,000 each to facilitate the payment. A and B agree to share profits in the ratio of 3:2 respectively immediately after C’s retirement and write off goodwill account.

You are required to prepare:

• Partner’s capital a/c
• Cash Book
• The balance sheet of A and B for the year ended March 1994

DR Partner’s Capital Account CR

DR Cash at Bank CR

Balance Sheet for the Year Ended 31^st March 1994