If the partners of a firm decide to change their Profit Sharing Ratio, the gaining partner must compensate the sacrificing partner. Following approach is suggested to deal with the Goodwill at the time of change in Profit sharing ratio:
Step 1: Write off the existing goodwill appearing in the books by passing the following journal entries:
All Partners' Capital/Current A/c Dr (In old ratio)
To Goodwill A/c
Step 2: Give credit of goodwill to the sacrificing partner and debit to the gaining partner.
(a) In case of fluctuating capitals
Gaining Partner's Capital A/c Dr
To Sacrificing Partner Capital A/c
(b) In case of fixed capitals
Gaining Partner's Current A/c Dr
To Sacrificing Partner Current A/c
The amount of compensation of goodwill is calculated as follow:
Amount of compensation payable By Gaining Partner to Sacrificing Partner = Total Goodwill of the firm x Share Gained
Amount of compensation payable By Sacrificing Partner to Gaining Partner = Total Goodwill of the firm x Share Sacrificed