Journal Entries for Admission of a New Partner with Payment of Premium for Goodwill

Introduction:
When a new partner is admitted into an existing partnership, the goodwill of the firm needs to be adjusted as per the new profit-sharing ratio. In this scenario, A and B are partners in a firm and C is being admitted as a partner with a share of 1/7th in profits and losses. C is also paying a premium of ₹ 1400 for goodwill.

1. Recording the payment of premium for goodwill:
C's payment for goodwill needs to be recorded in the books of the firm. The journal entry for this will be:

Cash/Bank A/c Dr. ₹ 1400
To Goodwill A/c ₹ 1400

2. Adjusting the value of goodwill:
The existing value of goodwill in the books of the firm is ₹ 5600, which is based on the old profit-sharing ratio. To adjust the value of goodwill as per the new profit-sharing ratio, the following journal entry needs to be passed:

Goodwill A/c Dr. ₹ 2400
To A's Capital A/c ₹ 1600
To B's Capital A/c ₹ 800

Explanation:
As per the new profit-sharing ratio, A and B will continue to have their old profit-sharing ratio of 4/7th and 3/7th respectively. C is being admitted with a 1/7th share in profits and losses. Therefore, the total share of profits and losses will now be divided into 7 parts (4+3+1).

To adjust the value of goodwill as per the new profit-sharing ratio, we need to find out the difference between the old and new share of profits for A and B. For A, the old share was 4/7th, and the new share will be (4/7) x 6/7 = 24/49th. Therefore, the difference is 20/49th. For B, the old share was 3/7th, and the new share will be (3/7) x 6/7 = 18/49th. Therefore, the difference is 15/49th.

The total difference is 35/49th, which represents the share of profits that belongs to C. Therefore, the value of goodwill needs to be adjusted in such a way that A and B compensate C for this share of profits. The total value of goodwill is ₹ 5600, which represents 35/49th of the total profits. Therefore, the value of each part is ₹ 1600 (5600/35). A needs to compensate C for 20/49th of this value, which is ₹ 1600 x 20/49 = ₹ 653.06 (rounded off to ₹ 1600). B needs to compensate C for 15/49th of this value, which is ₹ 1600 x 15/49 = ₹ 492.31 (rounded off to ₹ 800).

Conclusion:
By passing these two journal entries, the books of the firm will be adjusted as per the new profit-sharing ratio and the payment of premium for goodwill by the new partner. These entries will ensure that the balance sheet of the firm reflects the true value of the goodwill and the capital accounts of the partners reflect their respective shares in the profits and losses of the firm.

How to profit sharing ratio