Partnership
As per Indian Partnership Act, 1932, Partnership is the relation between two or more persons, who have agreed to share the profits and losses of a business carried on by all or any of them acting for all. Partners entering into a partnership are individually called Partners and the collective entity is called a firm.
Characteristics of Partnership
- It is an association of two or more persons.
- There should be an agreement entered into by all persons concerned. Though normally a partnership agreement is recorded in writing, it may be oral. However, to register a partnership agreement, it must be in writing.
- Profits or losses are to be shared equally between the partners, unless there is any specific agreement.
Partnership Deed
The terms of partnership as agreed by the partners is (called the Partnership Deed) recorded in a document. The Partnership Deed normally contains provisions regarding following matters regarding Partnership Accounts.
- The rate of interest on capital, drawings and loan.
- The ratio in which profits and losses are to be shared between the partners.
- Salary and remuneration payable to partners.
- Method of valuation of Goodwill on introduction, retirement or death of a partner.
- Treatment of losses arising out of the insolvency of a partner.
- Preparation of Accounts and its Audit.
Applicability of Partnership Act, 1932:
If there is no partnership deed, or the partnership deed is silent on any point, provisions of Indian Partnership Act, 1932 would be applicable:
- Equal share in profit or loss for all partners.
- Partners are not entitled to any remuneration or salary for the conduct of business.
- No interest on capital to be allowed.
- No interest on drawing.
- Loans or advances made to the firm carries interest @ 6% p.a.
Partners’ Accounts
Normally Partners Account means Capital Accounts, Current Accounts and Drawings Accounts of the partners, but sometimes, Interest Accounts and Partners Loan Accounts are also included in it.
Partners’ Capital Account: Partners’ Capital Account may be maintained under two methods.
- Fixed Capital: In this method,the partners are not allowed to change their capital except in extraordinary circumstances. If fixed capital is changed by partners’ agreement, additional capital introduced or withdrawn will be recorded in Capital A/c.
- Fluctuating Capital: In this method, the balance of capital accounts may not remain constant, but may fluctuate frequently. Normally all the entries relating to drawings, interest on drawings, interest on capital, salary or commission, share in profits or losses, etc are recorded in Capital A/c.
Partners’ Capital Account (Fixed)
| Dr. | Cr. | ||||
| Date | Particulars | Rs. | Date | Particulars | Rs. |
| To Cash A/c (Capital withdrawn) | By Balance b/d | ||||
| To Balance c/d (Closing balance) | By Cash A/c (Additional capital introduced) |
Partners’ Capital Account (Fluctuating)
| Dr. | Cr. | ||||
| Date | Particulars | Rs. | Date | Particulars | Rs. |
| To Drawings A/c | By Balance b/d (Opening balance) | ||||
| To Interest on drawings A/c | By Interest on capital A/c | ||||
| To P&L Appropriation A/c (loss) | By Salary A/c. | ||||
| By Partner’s Commission A/c | |||||
| By Interest on Loan A/c | |||||
| To Balance c/d | By P&L Appropriation A/c (Profit) |
Fixed vs Fluctuating Capital
There are two principal forms of Partners Capital. Partner’s Fixed Capital and Partner’s Fluctuating Capital
| Basis | Fixed Capital | Fluctuating Capital |
| Change in Capital | Under Fixed Capital method, Capital remains fixed as mutually agreed by the partners. | Under Fluctuating Capital method, Capital changes due to any transactions relating to partner. |
| Number of Accounts | Under Fixed Capital method, apart from Partners Capital A/c, Partner’s other Accounts are also maintained (like Current A/c). | Under Fluctuating Capital method only one account maintained i.e. Partners Capital A/c, in respect of each partner. |
| Adjustment entries | Under Fixed Capital method, adjustment entries like drawings, interest on capital, interest on drawings, salary, share in profit or loss, etc. are recorded in current account (not in capital accounts). | Under Fluctuating Capital method, all adjustment entries relating to partners are recorded in their capital a/c. |
| Change in Balance | Under Fixed Capital method, the Balance does not change except in special circumstances. | Under Fluctuating Capital method, the Balance goes on changing on every transaction with partner. |
| Nature and Presentation of Balance Sheet. | Under Fixed Capital method, Capital A/c always shows credit balance, Balances of Partner’s Other A/c’s are shown separately in the Balance Sheet. | Under Fluctuating Capital method only one Capital account for each Partner is maintained and its balances shown in Balance Sheet. |
Partner’s Current Account
Under fixed capital method, various transactions related to Partners are posted to a separate account (called Current Account). For example, Partner’s Current Account is credited in respect of share of profit of the partner, interest on capital, remuneration of the partner etc. and debited with drawings of the partner, interest on drawings of the partner, amount of shares of loss of the firm borne by the partner etc.
Partners’ Current Account
| Dr. | Cr. | ||||
| Date | Particulars | Rs. | Date | Particulars | Rs. |
| To Balance b/d (Opening Debit balance) | By Balance b/d (Opening credit balance) | ||||
| To Drawings A/c | By Interest on capital A/c | ||||
| To Interest on drawings A/c | By Salary A/c. | ||||
| To P&L Appropriation A/c (loss) | By Partner’s Commission A/c | ||||
| To Balance c/d | By Interest on Loan A/c | ||||
| By P&L Appropriation A/c (Profit) |
Partner’s Drawings Account
Even when Current Account is maintained, a separate Partner’s Drawings account are often maintained, exclusively for amount withdrawn by partner for personal use.
At the end of the year, balance of drawings account is transferred either to Current Account or to Capital Account as the case may be.
Examples of Transactions related to Partners’ Drawings account
- Partner taking goods from the Partnership Business for personal use
Drawings A/c (Partner A/c) Dr
To Purchase A/c.
(Cost of goods taken by partner for personal use)
- Partner withdrawing money for Personal use
Drawings A/c (Partner A/c) Dr
To Bank (or Cash) A/c.
(Money withdrawn by partner for personal use)
Drawings should never be shown under Profit & Loss A/c
Partners’ Loan Account
Even when Current Account is maintained, a separate Partner’s Loan account are often maintained, exclusively for amount taken on loan by partner for personal use.
Partner taking Loan from the Partnership Business for personal use
Partner Loan A/c Dr
To Bank (or Cash) A/c.
Partner returning Loan to the Partnership Business
To Bank (or Cash) A/c Dr
Partner Loan A/c
Interest on Loan
In absence of any specific provision regarding Interest rate on loan to partners, @ 6% p.a. is charged as Interest on Loan given to Partner.
The Interest is posted into partner’s Current Account (or to a separate Ledger Account for Interest on Loan)
Profit and Loss Appropriation Account
Adjustment entries for interest on capital, interest on drawings, salary and share in profit or loss will be recorded through Profit and Loss Appropriation A/c.
Interest on Capital
| On allowing Interest on Capital A/c Interest on Capital A/c Dr To Partner’s Capital / Current A/c (Interest on Capital allowed to Partners) | On Closure of Interest on Capital A/c Profit and Loss Appropriation A/c Dr To Interest on Capital A/c (Interest on Capital transferred to Profit & Loss Appropriation A/c) |
You may replace the above two entries by the following entry
Profit and Loss Appropriation A/c Dr
To Partner’s Capital / Current A/c
(Interest on Capital allowed to Partners)
Interest on Drawings
| On charging Interest on Drawings Partner’s Capital / Current A/c Dr To Interest on Drawings A/c (Interest charged on Partner’s Drawings) | On Closure of Interest on Drawings A/c Interest on Drawing A/c Dr To Profit and Loss Appropriation A/c (Interest charged on Drawings of Partners) |
Partner’s Salary / Commission
| On allowing Salary or Commission Salary or Commission to Partners A/c Dr To Partner’s Capital / Current A/c (Salary or Commission paid to Partners) | On Closure of Salary /Commission to Partners A/c Profit and Loss Appropriation A/c Dr To Salary or Commission to Partners A/c (Salary or commission transferred) |
Appropriation of Net Profit
| Transfer to Reserve Profit and Loss Appropriation A/c Dr To Reserve A/c (Profit not distributed to Partner, transferred to Reserve) | Transfer to Partners’ Capital Profit and Loss Appropriation A/c Dr To Partner’s Capital (or Current) A/c (Net Profit distributed to Partner) |
Interest on Drawing
The Interest on Drawings is calculated at a fixed rate from the date of drawing till the last day of the accounting period.
Computation of Interest on Monthly Basis
- If a partner draws a fixed amount at the beginning of each month, interest on total drawing will be calculated on the whole amount for 6.5 months.
- If a partner draws a fixed amount at the end of each month, interest on total drawing will be calculated on the whole amount for 5.5 months.
- If a partner draws a fixed amount in the mid of the month, interest on total drawing will be calculated on the whole amount for 6 months.
Ex: A, K & N are equal partners. A withdraws Rs.1,000 at the beginning of each month. K withdraws Rs.1,000 at the end of each month. N withdraws Rs.1,000 in the mid of the month. Rate of interest on drawing is 10% p.a. Show how the interest on drawing will be calculated.
Interest for A (withdrawing at thebeginning of each month) : (1000 x 12) x (10 / 100) x (6.5/12) = Rs.650
Interest for K (withdrawing at theend of each month) : (1000 x 12) x (10 / 100) x (5.5/12) = Rs.550
Interest for N ((withdrawing at themiddle of each month) : (1000 x 12) x (10 / 100) x (6/12) = Rs.600
Calculation of the interest of drawings:
A withdraws at thebeginning of each month, so for the 1st month he will pay interest for 12 months on his withdrawal amount i.e. Rs.1,000. Similarly for the 2nd month he will pay interest for 11 months and so on.
Sum of the months based on beginning of each month for 12 months = (12+11+10 +9 +8 +7+6+5+4+3+2+1) month’s = 78 months. So effective average period = 78/12 = 6.5 months.
So, the interest of drawing’s = Rs. {1,000 x 6.5 x 10%} = Rs.650
K withdraws Rs.1,000 at theend of each month, so for the 1st month he will pay interest for 11 months on his withdrawal amount i.e. Rs.1,000. Similarly for the 2nd month he will pay interest for 10 months and so on.
Sum of the months based on end of each month = (11 + 10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1+ 0) month’s = 66 months.
So effective average period = 66/12 = 5.5 months.
So, the interest of drawing’s = Rs.{1,000 x 5.5 x 10%} = Rs.550
N withdraws Rs.1,000in the mid of the month, so for the 1st month he will pay interest for 11.5 months on his withdrawal amount i.e. Rs.1,000. Similarly for the 2nd month he will pay interest for 10.5 months and so on.
Sum of the months based on mid of the month = (11.5+10.5+9.5+8.5+7.5+6.5+5.5+4.5+3.5+2.5+1.5+.5) month’s =72 months. So effective average period = 72/12 = 6 months.
So, the interest of drawing’s= Rs.{1,000 x 6 x 10%} = Rs.600
Distribution of profit (when Partnership deed is silent)
Here is an example of Distribution of Profit among Partners
Ram, Rahim and Karim are partners in a firm. They have no agreement in respect of profit-sharing ratio, Interest on capital, interest on loan advanced by partners and remuneration payable to partners.
- Ram, who has contributed maximum capital, demands interest on capital at 10% p.a. and share of profit in the capital ratio. But Rahim and Karim do not agree.
- Rahim has devoted full time for running the business and demands salary at the rate of Rs.500 p.m. But Ram and Karim do not agree.
- Karim demands interest on loan of Rs.2,000 advanced by him at market rate of interest @ 12% p.a.
Resolve the dispute and prepare Profit and Loss Appropriation Account after transferring 10% of the divisible profit to Reserve. Net profit before taking into account any of the above claims amounted to Rs.45,000 at the end of the first year of their business.
As there is no partnership deed. Therefore, the following provisions of Indian Partnership Act are to be applied:
- No interest on capital is payable to any partner. Therefore, Ram is not entitled to interest on capital.
- No remuneration is payable to any partner. Therefore, Rahim is not entitled to any salary.
- Interest on loan is payable @ 6% p.a. Therefore, Karim is to get interest @ 6% p.a. on Rs.2,000.
- The profits should be distributed equally.
Profit and Loss Appropriation Account for the year ended ……..
| Dr. | Cr. | |||
| Particulars | Rs. | Particulars | Rs. | |
| To Interest on Karim Loan A/c | By Profit and Loss A/c | |||
| (6 % of Rs.2,000 ) | 120 | (Net Profit) | 45,000 | |
| To Reserve A/c | ||||
| 10% of Rs.(45,000 – 120) | 4,488 | |||
| To Partners’ Capital A/c:- (Share of Profit) [Note] | ||||
| Ram:- (1/3rd of Rs.40,392) | Rs.13,464 | |||
| Rahim:- (1/3rd of Rs.40.392) | Rs.13,464 | |||
| Karim:- (1/3rd of Rs.40,392) | Rs.13,464 | 40,392 | ||
| 45,000 | 45,000 |
Note: Profit after transfer of reserve = Rs.45,000 – (Rs.120 + Rs.4,488) = Rs.40,392. it will be divided among partners in their profit sharing ratio.
Partners Fluctuating Capital Account – Problems
Here is an example of Partners Fluctuating Capital Account
Fluctuating Capital
On 1st January, 2015, A, B and C enter into partnership contributing Rs.5,00,000, Rs.2,60,000 and Rs.2,40,000 respectively and sharing profits and losses in the ratio of 5:3:2. B and C are entitled to a salary of Rs.16,000 and Rs.14,500 respectively per year. Interest on capital is allowed at 5% p.a. 6% interest is charged on drawings.
During the year, A withdrew Rs.40,000. B Rs.25,000 and C Rs.15,000.
Interest on drawing being : A – Rs.2,250; B – Rs.1,125; and C – Rs.725. Profit in 2015 before the above mentioned adjustments was Rs.1,42,800.
Show how the profit is distributed and also prepare the Capital Accounts, if they were fluctuating.
Calculation of Interest on Capital @ 5% pa : A: on 500000 = 25,000, B: on 260000=13000, C: on 240000=12000. Total 50000
Profit and Loss Appropriation Account for the year ended 31.12.2015
| Particulars | Dr | Particulars | Cr |
| To Interest on Capital A/c (as per Note) | 50,000 | By Profit and Loss A/c (Net Profit) | 1,42,800 |
| To Partners’ Salaries A/c:- B: 16,000, C: 14,500 | 30,500 | By Interest on Drawings A/c (A:2250+B:1125+ C:725) | 4,100 |
| To Partners’ Capital A/c:- (Share of Profit) | 66,400 | ||
| 1,46,900 | 1,46,900 |
Partner’s Share of Profit : A- (66,400 x 5/10)= 33,200, B- (66,400 x 3/10)=19,920,
C- (66,400 x 2/10)=13,280, Total : 66,400
Partners’ Capital Accounts
| Dr. | Cr. | ||||||||
| Date | Particulars | A | B | C | Date | Particulars | A | B | C |
| 31.12.10 | To Drawings A/c | 40,000 | 25,000 | 15,000 | 1.1.2010 | By Bank A/c (cash introduced) | 5,00,000 | 2,60,000 | 2,40,000 |
| ,, | To Interest on Drawings A/c | 2,250 | 1,125 | 725 | 31.12.10 | By Interest on Capital A/c | 25,000 | 13,000 | 12,000 |
| ,, | To Balance c/d | 5,15,950 | 2,82,795 | 2,64,055 | ,, | By Partners’ Salary A/c | – | 16,000 | 14,500 |
| ,, | By P& L App. A/c(Share of Profit) | 33,200 | 19,920 | 13,280 | |||||
| 5,58,200 | 3,08,920 | 2,79,780 | 5,58,200 | 3,08,920 | 2,79,780 |
Partners Fixed and Fluctuating Capital Account – Problems
Here is an example of Partners Fixed and Fluctuating Capital Account
Fixed and Fluctuating Capital
A, B and C are partners in a firm with capital of Rs.1,00,000, Rs.80,000 and Rs.40,000 respectively. They share profits and losses as: (i) Up to Rs.20,000, in the ratio of 5:3:2; (ii) Above Rs.20,000, equally.
The net profit of the firm for the year ended 31st December, 2015 amounted to Rs.80,400 and the drawings of the partners were: A – Rs.12,000, B – Rs.10,000 and C – Rs.6,000.
Show the Profit and Loss Appropriation Account for the year ended 31.12.2015 and Capital Accounts of the partners when (i) Partners capitals are fixed, (ii) Partners’ capitals are fluctuating. 1. Interest on partners’ capitals to be paid @ 10% p.a. 2. Interest on drawings to be charged @ 5% p.a. 3. A to receive salary of Rs.6,000 p.a. 4. B and C to get commission @ 5% each on the net profit.
Computation of Interest & Commission
| Interest on Capital @10% p.a | Interest on Drawing @ 5% for 6 months | Partners’ Commission @ 5% | |||
| A – On 1,00,000 | 10,000 | A – On 12,000 | 300 | B – On 80,400 | 4,020 |
| B – On 80,000 | 8,000 | B – On 10,000 | 250 | C – On 80,400 | 4,020 |
| C – On 40,000 | 4,000 | C – On 6,000 | 150 | ||
| 22,000 | 700 | 8,040 |
Profit and Loss Appropriation Account for the year ended 31.12.2015
| Particulars | Dr | Particulars | Cr |
| To Interest on Capital A/c | 22,000 | By Profit and Loss A/c (Net Profit) | 80,400 |
| By Interest on Drawings A/c | 700 | ||
| To Partners’ Salary A/c:- A | 6,000 | ||
| To Commission A/c | 8,040 | ||
| To Partners’ Capital A/c:- (Share of Profit) | 45,060 | ||
| Total | 81,100 | 81,100 |
[Note : 1. Share of Profit : Upto 20,000 @ 5:3:2: A:10000, B:6000, C:4000.
Above Rs.20,000 equally. i.e 45,060 – 20,000 = Rs.25,060 will be shared equally
A. 8353,B. 8353C.C.8354.
Total : A- (10000+8353)= 18,353, B- (6000+8353)= 14,353, C- (4000+8353)= 12,354
Fixed Capital Method:
Partners’ Capital Accounts
| Dr. | Cr. | ||||||||
| Date | Particulars | A | B | C | Date | Particulars | A | B | C |
| 31.12.15 | To Balance c/d | 1,00,000 | 80,000 | 40,000 | 1.1.15 | By Balance b/d | 1,00,000 | 80,000 | 40,000 |
Partners’ Current Accounts
| Dr. | Cr. | ||||||||
| Date | Particulars | A | B | C | Date | Particulars | A | B | C |
| 31.12.15 | To Drawings A/c | 12,000 | 10,000 | 6,000 | 31.12.15 | By interest on Capital A/c | 10,000 | 8,000 | 4,000 |
| ,, | To Interest on Drawings A/c | 300 | 250 | 150 | ,, | By Partners’ Salary A/c | 6,000 | – | – |
| ,, | To Balance c/d | 22,053 | 16,123 | 14,224 | ,, | By Partners’ Commission A/c | – | 4,020 | 4,020 |
| ,, | By P&L Appro. A/c (W. | 18,353 | 14,353 | 12,354 | |||||
| 34,353 | 26,373 | 20,374 | 34,353 | 26,373 | 20,374 |
Fluctuating Capital Method:
Partners’ Capital Accounts
| Dr. | Cr. | ||||||||
| Date | Particulars | A | B | C | Date | Particulars | A | B | C |
| 31.12.15 | To Drawings A/c | 12,000 | 10,000 | 6,000 | 1.1.15 | By Balance b/d | 1,00,000 | 80,000 | 40,000 |
| ,, | To Interest on Drawings A/c(w.n-2) | 300 | 250 | 150 | 31.12.15 | By interest on Capital A/c | 10,000 | 8,000 | 4,000 |
| ,, | To Balance c/d | 1,22,053 | 96,123 | 54,224 | ,, | By Partners’ Salary A/c | 6,000 | – | – |
| ,, | By Partners’ Commission A/c | – | 4,020 | 4,020 | |||||
| ,, | By P&L Appro. A/c | 18,353 | 14,353 | 12,354 | |||||
| 1,34,353 | 1,06,373 | 60,374 | 1,34,353 | 1,06,373 | 60,374 |
Partnership Accounts – Goodwill Valuation
Goodwill is an intangible asset. It represents extra earning capacity of the firm and value of reputation of the firm.
Normally goodwill is recorded in the books only when consideration in money or money’s worth has been paid for it. As a matter of financial prudence, goodwill is written off over a period of time though many enterprises prefer to retain it as an asset.
Methods of Partnership Firm Goodwill valuation
- Average profit basis : Computed onaverageProfits of the past few years and adjusted for expected change in future.
- Super profit basis : Computed onexcess profit, that can be earned by a firm, over and above the normal profit usually earned by similar firms, under similar circumstances
- Annuity basis : Present value of super profits computed for such period, applying Annuity rate
- Capitalization basis : Computed oncapitalized value (value which a buyer of the business would be willing to pay) of business or total value of business.
Partnership Goodwill Valuation on Average Profit Basis
In Partnership Goodwill Valuation on Average Profit Basis method, the profits of the past few years are averaged and adjusted for expected change in future.
- Computation of Average Profit : Calculate average profit on the basis of the past few years’ profits after having adjusted for any expected change in future. Average may be simple or weighted.
- Computation of Goodwill : Goodwill = Average Profit x No. of years purchase of average profit
Ex.: Profits of a partnership firm for the last five years were Rs.25, 000, Rs.35,000, Rs.50,000, Rs.65,000 and Rs.75,000. The simple average profit per year is (Rs.2,50,000 / 5) = Rs.50,000. However, a clear increasing trend is noticed and therefore average profit may be arrived at by assigning appropriate weights for each succeeding year
| Year | Profit | Weight | Weighted Profit | Weighted Average Profit = Rs.8,80,000/15 = Rs.58, 667. Goodwill is valued at three years’ purchase of profit: As per Weighted Average : 58,667 x 3 = 1,76,000 (apprx)As per Simple Average : 50,000 x 3 = 1,50,000 |
| 1 | 25,000 | 1 | 25,000 | |
| 2 | 35,000 | 2 | 70,000 | |
| 3 | 50,000 | 3 | 1,50,000 | |
| 4 | 65,000 | 4 | 2,60,000 | |
| 5 | 75,000 | 5 | 3,75,000 | |
| 15 | 8,80,000 |
Partnership Firm Goodwill Valuation on Super Profit Basis
In Partnership Firm Goodwill Valuation on Super Profit Basis method, goodwill is valued on the basis of super profits earned by firm. Super Profit is the amount of excess profit that can be earned by a firm, over and above the normal profit usually earned by similar firms, under similar circumstances.
Computation of Super Profit
- Calculation of Average Profits : Average profit earned during the past few years
- Calculation of Normal profits = Capital Employed x Normal rate of profit /100.
- Calculation of Super profits : = Actual Average Profits – Normal Profits.
Valuation of Goodwill
- Goodwill = Super Profits x No. of years’ purchased.
Ex. A firm earned profits as follows in last three years. 1st yr: 7200, 2nd yr : 8400, 3rd yr : 9600. Capital Employed : Rs 40000, Normal rate of Return : 12% pa. Calculate Goodwill on basis of 2 years of purchase on super profits
Computation of Profit
- Average Profit = (7,200 + 8,400 + 9,600) /3 = (25,200 / 3) = 8,400.
- Normal Profit = Capital employed x Normal rate of profit /100 = 40,000 x (12/100) = 4,800
- Super Profit = Average profit – Normal Profit = 8,400 – 4,800 = 3,600
Valuation of Goodwill
- Goodwill = 3,600 (super profit per year) x 2 (number of years of purchase of goodwill) = 7,200
Partnership Goodwill Valuation on Annuity Basis
If a firm is making super profits, the period (in years) the firm will continue to get this super profit is estimated. Present value of super profits for such period is found out by Annuity Method applying Annuity rate from Annuity Table. Partnership Goodwill Valuation on Annuity Basis is computed as follows:
Goodwill = Super Profit x Present Value of Rs.1 by Annuity Method.
Example: Capital employed Rs.2,00,000; Normal rate of profit is 10%; Present value of annuity of Rs.1 for 3 years at 10% is Rs.2.48685. Average profit for 3 years is Rs.24,000. Find out goodwill by Annuity Method.
Computation of Profit
- Average Profit = 24,000.
- Normal Profit = 20,000
- Super Profit = Average profit – Normal Profit = 24000-20000 = 4000
Valuation of Goodwill under Annuity Method = 4,000 x 2.48685 = Rs.9947.4
Partnership Goodwill valuation on Capitalisation Method
Under Partnership Goodwill valuation on Capitalisation Method, goodwill is valued on the basis of capitalized value of business or total value of business. Capitalized value of business means the value which a buyer of business will be ready to pay for a particular business.
Ex. Future maintainable profits are Rs.25,000, normal Profit rate is 20% and capital employed is Rs.1,00,000
Capitalized value of business = (Further maintainable profits x 100) /Normal rate = 25,000 x (100/20) = 125000
Capitalized value of business = 125000, Capital employed = 100000. Value of goodwill = (Capitalized value of business ) – (Capital employed)= 125000-100000=25000
If Capitalized value of business is less than capital employed, value of goodwill will be NIL
Partnership Firm Hidden Goodwill
In some cases, value of full value of goodwill may not be shown in books. The Partnership Firm Hidden Goodwill (portion of goodwill not shown in books) may be calculated with reference to the total capital of the firm and the profit sharing ratio
Ex: A and B are partners with capitals of Rs.10, 000 and Rs.20, 000 respectively and sharing profits equally. They admitted C as their partner with one-fourth profits of the firm on the payment of Rs.12, 000.
Calculation of Hidden Goodwill:
C brings Rs. 12,000 for its ¼ th share. So, total capital of the firm is= 12000¸ (1/4) = 12,000 x 4 = 48,000 (taking C’s capital as base). So, Old partners’ capital should have been = 48,000 – 12,000= 36,000. But their combined capital is Rs. 30,000
So, Hidden goodwill= 36,000- 30,000= 6,000.
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