Take a slow breath before you start. This chapter frightens a lot of students, and the reason is almost always the same: it looks like two chapters glued together. One half asks you to put a rupee value on something you cannot see or touch, and the other half asks you to reshuffle a partnership without anybody joining or leaving. Both halves are far gentler than they look once you see the single idea running underneath them, and that idea is what these notes are built around. Everything here follows the NCERT Accountancy — Partnership Accounts textbook for Class 12 and the CBSE syllabus for the 2026-27 session, so nothing you read is off-syllabus.
By the end of this page you will be able to define goodwill in your own words, list the factors that push its value up or down, and work through every method of valuation the board can ask for. You will handle the goodwill class 12 accountancy important questions that repeat year after year, follow a full set of valuation of goodwill solved examples step by step, and write clean change in profit sharing ratio journal entries without guessing which partner to debit. We will also fold in reserves, revaluation and the single adjusting entry, because in a real board paper they arrive together in one question, not separately.
One promise before we begin. Every rupee figure on this page has been worked out and checked, and every example is solved in full, so if your answer differs you can trace exactly where the two of you parted ways. If partnership itself still feels shaky, keep Accounting for Partnership Firms: Fundamentals open in another tab — that chapter covers capital accounts and profit distribution, which this one assumes you already have.
Meet Your Tutor
Goodwill adjustments become reliable once you identify who gains, who sacrifices and why compensation is due before writing any entry. I will help you calculate the old, new, sacrificing and gaining ratios in a fixed sequence, then use a quick debit-credit fairness check so each adjustment has a reason you can explain in the exam.
What You’ll Learn
- Meaning and Nature of Goodwill
- Factors Affecting the Value of Goodwill
- Need for Valuation of Goodwill
- The Four Methods of Valuation of Goodwill at a Glance
- Average Profit Method — Valuation of Goodwill Solved Examples
- Weighted Average Profit Method
- Adjustments to Normal Profits Before You Average Anything
- Super Profit Method
- Capitalisation of Average Profit and Capitalisation of Super Profit
- Change in Profit-Sharing Ratio Among Existing Partners
- Sacrificing Ratio and Gaining Ratio
- Treatment of Goodwill on Change in Ratio — Change in Profit Sharing Ratio Journal Entries
- Reserves and Accumulated Profits or Losses
- Revaluation of Assets and Reassessment of Liabilities
- Adjustment Through a Single Journal Entry — The Basket Rule
Your Game Plan
- Get comfortable with what goodwill is before touching a single formula. Two paragraphs, no maths.
- Learn to clean up the profit figures first. Almost every mark lost in valuation is lost here, not in the formula.
- Master the four valuation methods in order — average, weighted average, super profit, capitalisation. Each one is a small extension of the one before it.
- Switch to the second half: work out sacrifice and gain, then pass goodwill entries between existing partners.
- Add reserves and revaluation on top, and finish with the single adjusting entry using the Basket Rule.
- Close the notes and attempt the ten worksheet questions with the answers hidden. Only then peek.
Study Notes
Meaning and Nature of Goodwill
Imagine two identical sweet shops on the same street. Same size, same counters, same halwai, same prices. One has been there for thirty years; the other opened last Tuesday. If both were put up for sale today, nobody would pay the same price for them. The older one carries something extra — regulars who come without checking prices, a name people trust for a wedding order, suppliers who give it a longer credit period. That extra, converted into rupees, is goodwill (साख).
So goodwill is the value of a firm’s reputation — its proven ability to earn more than an ordinary firm of the same size would earn. Notice the wording carefully, because the examiner does. Goodwill is not the reputation itself. It is the money value of the extra profit that reputation is expected to keep producing.
Because goodwill has no physical form, it is classified as an intangible asset. But be careful with a second label. Goodwill is not a fictitious asset. A fictitious asset (such as deferred advertisement expenditure) has no value at all and is only sitting on the balance sheet waiting to be written off. Goodwill has real, sellable value — you simply cannot pick it up.
Accounting standards allow goodwill to be recorded only when it is purchased, that is, when a firm actually pays money for it while buying another business. Goodwill that a firm builds up by itself over the years is called self-generated or inherent goodwill, and it is never brought into the books. This single rule quietly explains why so many questions end with the instruction “goodwill is not to appear in the books of the firm”.
Goodwill paid = 8,20,000 − 7,00,000 = ₹ 1,20,000. This amount is purchased goodwill and it will appear on the asset side of Meher Traders’ balance sheet.
Meanwhile, Meher Traders’ own thirty-year reputation may be worth far more than ₹ 1,20,000 — but not one rupee of it enters the books, because nobody paid for it.
Normal profit = 5,00,000 × 12% = ₹ 60,000. Actual profit = ₹ 60,000.
Excess earning = 60,000 − 60,000 = nil, so goodwill = ₹ 0.
The firm may be forty years old with a lovely signboard. It still has no goodwill in the accounting sense, because it earns exactly what any similar firm would earn.
Why it works. Goodwill is a forward-looking number dressed up in past data. Nobody pays extra for what a firm earned last year; they pay extra because they believe the extra earning will continue. Past profits are used only because they are the most reliable evidence of what the future is likely to look like. Hold on to that sentence — it justifies almost every adjustment we make later.
Factors Affecting the Value of Goodwill
Once you accept that goodwill is stored-up earning power, the list of factors stops being something to memorise. Just ask of each item: does this make customers come back more often, or make each sale more profitable, or make the earnings safer? If yes, goodwill goes up.
| Factor | Why it raises goodwill | A quick example |
|---|---|---|
| Location | A shop customers pass anyway needs no persuasion to earn. | A chemist right outside a hospital gate. |
| Quality and consistency | Steady quality creates repeat buyers, and repeat buyers cost nothing to acquire. | A bakery whose bread tastes the same every single day. |
| Efficiency of management | Lower waste and better buying convert the same sales into higher profit. | A firm that never over-orders and never runs out. |
| Nature of the business | A stable, essential product means safer future earnings. | A dairy earns more predictably than a fireworks seller. |
| Length of establishment | Time is what turns customers into habits. | A forty-year-old tailor with three generations of clients. |
| Special advantages | Patents, licences, long-term supply contracts and trademarks keep rivals out. | An exclusive dealership for a district. |
| Access to capital and credit | Cheap finance and long supplier credit lift the profit that survives to the bottom line. | A firm buying on 90-day credit while selling for cash. |
| Risk involved | Lower risk means buyers accept a lower return, so they pay more for the same profit. | A government-supply contractor with assured orders. |
Firm A supplies medicines to a chain of government hospitals under a five-year contract. Firm B sells fashion accessories from a rented kiosk in a mall.
Both earn 2,40,000 ÷ 12,00,000 = 20% on capital. But a buyer of Firm A might accept a normal return of 10% (low risk), while a buyer of Firm B would demand 18% (high risk).
Firm A: normal profit = 12,00,000 × 10% = ₹ 1,20,000, super profit = ₹ 1,20,000.
Firm B: normal profit = 12,00,000 × 18% = ₹ 2,16,000, super profit = ₹ 24,000.
Identical profits, goodwill five times apart. Risk is doing all the work here.
Need for Valuation of Goodwill
A partnership firm does not value its goodwill every year for fun. It does so only when the arrangement between the partners changes, because that is the only moment when the built-up reputation has to be shared out fairly. There are five such moments, and every one of them is a chapter in your syllabus.
- Change in the profit-sharing ratio among existing partners — the second half of this very chapter.
- Admission of a new partner, who must pay for a share of a reputation he did not build. See Admission of a Partner.
- Retirement or death of a partner, who must be paid for the reputation he helped build. See Retirement or Death of a Partner.
- Dissolution of the firm, when the business is sold as a going concern rather than piece by piece.
- Amalgamation or sale of the firm to another business.
(a) P, Q and R share profits 2:2:1 and admit S for 1/5th share. Yes — S gains a share he never built.
(b) P, Q and R share 2:2:1 and simply revalue their building upward, ratio unchanged. No — nobody’s share moved.
(c) P, Q and R change their ratio from 2:2:1 to 1:1:1. Old shares 2/5, 2/5, 1/5; new shares 1/3 each. P and Q drop, R rises. Yes.
(d) P, Q and R share 1:1:1 and decide to change to 2:2:2. Old 1/3 each, new 1/3 each — the ratio 2:2:2 is 1:1:1. No, nothing has actually changed.
Case (d) is the trap. Always reduce both ratios to their simplest form before deciding.
The Four Methods of Valuation of Goodwill at a Glance
There are four methods in your syllabus, and students often treat them as four unrelated formulas to be crammed. They are not. They are four answers to one question — how much extra earning power does this firm have, and what is that worth today? — asked with different amounts of information available.
| Method | What it needs | The formula | When the question points here |
|---|---|---|---|
| Average Profit | Past profits only | Average Profit × Number of years’ purchase | Only a list of profits is given, with no weights and no capital employed. |
| Weighted Average Profit | Past profits + weights | Weighted Average Profit × Number of years’ purchase | Weights are stated, or profits show a clear rising or falling trend. |
| Super Profit | Profits + capital employed + normal rate of return | (Average Profit − Normal Profit) × Number of years’ purchase | Capital employed and a normal rate of return both appear. |
| Capitalisation | Profits + capital employed + normal rate of return | Capitalised Value − Capital Employed, or Super Profit ÷ Normal Rate | The word ‘capitalisation’ appears, or you are asked for the value of the whole firm. |
Average Profit Method — Valuation of Goodwill Solved Examples
This is the simplest method and the one you will meet first. Add up the profits of the given years, divide by the number of years to get the average, then multiply the average by the agreed number of years’ purchase. That is the whole method.
where Average Profit = Total Adjusted Profits ÷ Number of Years
2021-22 — ₹ 80,000; 2022-23 — ₹ 1,00,000; 2023-24 — ₹ 90,000; 2024-25 — ₹ 1,30,000.
Goodwill is to be valued at 3 years’ purchase of the average profit.
Step 1 — total the profits. 80,000 + 1,00,000 + 90,000 + 1,30,000 = ₹ 4,00,000
Step 2 — average. 4,00,000 ÷ 4 = ₹ 1,00,000
Step 3 — multiply by years’ purchase. 1,00,000 × 3 = ₹ 3,00,000
Goodwill of the firm is ₹ 3,00,000.
Step 1. A loss is entered as a negative figure, never skipped:
1,10,000 − 20,000 + 70,000 + 1,40,000 + 1,50,000 = ₹ 4,50,000
Step 2. 4,50,000 ÷ 5 = ₹ 90,000
Step 3. 90,000 × 2 = ₹ 1,80,000
Note that we still divided by 5, not by 4. The loss year is a year of trading and it counts.
Why it works. Averaging is a way of saying “ignore the flukes”. One brilliant year or one terrible year tells a buyer nothing about the future; the middle of several years tells him a great deal. Multiplying by years’ purchase then answers a different question — “for how many years do we believe this extra earning will last?” Three years’ purchase is simply the partners’ shared belief that the advantage will hold for about three years.
Weighted Average Profit Method
Suppose a firm’s profits have climbed steadily every year. A plain average treats the oldest, weakest year exactly like the newest, strongest one — which is unfair to a firm that is clearly improving. The weighted average method fixes this by giving recent years more say.
Goodwill = Weighted Average Profit × Number of Years’ Purchase
Step 1 — multiply each profit by its weight.
90,000 × 1 = 90,000
1,05,000 × 2 = 2,10,000
1,20,000 × 3 = 3,60,000
1,35,000 × 4 = 5,40,000
Total of products = ₹ 12,00,000; total of weights = 1 + 2 + 3 + 4 = 10
Step 2 — weighted average. 12,00,000 ÷ 10 = ₹ 1,20,000
Step 3 — goodwill. 1,20,000 × 3 = ₹ 3,60,000
Compare: the plain average would have been (90,000 + 1,05,000 + 1,20,000 + 1,35,000) ÷ 4 = ₹ 1,12,500, giving goodwill of only ₹ 3,37,500. The weighted method recognises the upward trend and rewards it by ₹ 22,500.
Why it works. A buyer is purchasing next year, not four years ago. If profits are rising, next year most resembles the latest year, so the latest year deserves the heaviest weight. If profits are falling, the same logic applies — heavier weight on the recent, weaker years pulls the valuation down, which is exactly right.
Adjustments to Normal Profits Before You Average Anything
This is where most marks are won and lost. The profits printed in a question are raw book profits. Before averaging, you must convert them into normal maintainable profits — the profit the firm can be expected to repeat, year after year. Anything unusual comes out; anything regular that was left out goes in.
| What appears in the question | What you do | Reason |
|---|---|---|
| Abnormal gain (insurance claim, profit on sale of a fixed asset, lottery, speculation gain) | Subtract from that year’s profit | It will not happen again next year. |
| Abnormal loss (fire, theft, flood, loss on sale of a fixed asset) | Add back to that year’s profit | Not a normal operating cost, so it understates true earning power. |
| Expense that should have been charged but was not (partner’s salary, rent of a partner’s premises, insurance premium) | Subtract from every affected year | It is a genuine future cost and must reduce maintainable profit. |
| Income earned but not recorded, expected to continue | Add to that year’s profit | It is a genuine recurring income. |
| Closing stock overvalued | Subtract from that year’s profit | Overvalued closing stock inflates profit. |
| Closing stock undervalued | Add to that year’s profit | Undervalued closing stock deflates profit. |
| Non-trading income (interest on government bonds, rent from a let-out portion) | Subtract if the related investment is excluded from capital employed | Otherwise you count the same earning twice. |
On checking, you find: (i) the 2023-24 profit includes an insurance claim of ₹ 15,000 received for a one-off flood; (ii) the 2024-25 profit is after charging a loss by fire of ₹ 10,000; (iii) a partner’s remuneration of ₹ 24,000 per year has not been charged in any year and is to be charged in future; (iv) the closing stock of 2024-25 was overvalued by ₹ 6,000. Goodwill is 2 years’ purchase of average profit.
2022-23: 1,20,000 − 24,000 (remuneration) = ₹ 96,000
2023-24: 1,45,000 − 15,000 (abnormal gain) − 24,000 = ₹ 1,06,000
2024-25: 1,60,000 + 10,000 (abnormal loss added back) − 24,000 − 6,000 (stock overvalued) = ₹ 1,40,000
Total adjusted profit = 96,000 + 1,06,000 + 1,40,000 = ₹ 3,42,000
Average profit = 3,42,000 ÷ 3 = ₹ 1,14,000
Goodwill = 1,14,000 × 2 = ₹ 2,28,000
New total = 96,000 + 1,06,000 + 1,20,000 = ₹ 3,22,000; average = ₹ 1,07,333.33; goodwill = ₹ 2,14,666.67.
One reversed sign has moved the answer by ₹ 13,333 and produced an ugly fraction. In this chapter, an ugly decimal is usually a warning bell rather than a genuine answer — go back and check your signs before you write it down.
Why it works. Remember that goodwill is the price of future extra earning. A flood claim will not arrive next year, so leaving it in would make a buyer pay for money he will never see. A partner’s salary that begins next year is a real future cost, so leaving it out would make the firm look more profitable than it will be. Every adjustment is simply honesty about the future.
Super Profit Method
The average profit method has one weakness: it ignores how much capital the firm needed to earn that profit. A firm earning ₹ 1,00,000 on capital of ₹ 3,00,000 is a far better business than one earning ₹ 1,00,000 on capital of ₹ 20,00,000, yet the average profit method values them the same. The super profit method repairs this.
Super Profit = Average (Maintainable) Profit − Normal Profit
Goodwill = Super Profit × Number of Years’ Purchase
Capital employed is normally taken as Total Assets (excluding goodwill, fictitious assets and non-trade investments) minus Outside Liabilities. In most Class 12 questions it is simply given to you, or it equals the partners’ total capital plus reserves.
Normal profit = 8,00,000 × 12% = ₹ 96,000
Super profit = 1,40,000 − 96,000 = ₹ 44,000
Goodwill = 44,000 × 3 = ₹ 1,32,000
Step 1 — adjusted average profit. 1,60,000 − 25,000 = ₹ 1,35,000
Step 2 — normal profit. 10,00,000 × 10% = ₹ 1,00,000
Step 3 — super profit. 1,35,000 − 1,00,000 = ₹ 35,000
Step 4 — goodwill. 35,000 × 2.5 = ₹ 87,500
Skipping step 1 would have given super profit of ₹ 60,000 and goodwill of ₹ 1,50,000 — an error of ₹ 62,500 from one missed line.
Normal profit = 7,00,000 × 15% = ₹ 1,05,000
Super profit = 90,000 − 1,05,000 = −₹ 15,000
The super profit is negative, so the firm earns less than a normal business would. Goodwill is taken as nil. You never record negative goodwill in a partnership question. Write the working, state the conclusion, and move on.
Why it works. Think of the normal rate of return as the rent that capital charges. Any owner could park ₹ 8,00,000 in an ordinary business and collect 12%. Only the profit above that is genuinely produced by the firm’s reputation, skill and customer base — and only that part deserves to be paid for. Super profit isolates it exactly.
Capitalisation of Average Profit and Capitalisation of Super Profit
Capitalisation reverses the direction of thinking. Instead of asking “how many years of extra profit shall we pay for?”, it asks “if this profit were normal, how much capital would a firm need to produce it?” Dividing a profit by a rate answers that question, and the answer is called the capitalised value.
Capitalised Value of the Firm = Average Profit ÷ Normal Rate of Return
Goodwill = Capitalised Value − Capital Employed (net assets)
Capitalisation of Super Profit
Goodwill = Super Profit ÷ Normal Rate of Return
When capital employed and net assets are the same figure, both routes must give exactly the same goodwill.
Step 1 — capitalised value of the firm.
1,50,000 ÷ 12.5% = 1,50,000 × 100 ÷ 12.5 = ₹ 12,00,000
Step 2 — goodwill.
12,00,000 − 9,50,000 = ₹ 2,50,000
In plain words: a normal firm would need ₹ 12,00,000 of capital to earn ₹ 1,50,000. This firm earns it with only ₹ 9,50,000. The ₹ 2,50,000 it does not need is its reputation.
Route A — capitalisation of average profit
Capitalised value = 1,20,000 ÷ 15% = ₹ 8,00,000
Goodwill = 8,00,000 − 6,00,000 = ₹ 2,00,000
Route B — capitalisation of super profit
Normal profit = 6,00,000 × 15% = ₹ 90,000
Super profit = 1,20,000 − 90,000 = ₹ 30,000
Goodwill = 30,000 ÷ 15% = ₹ 2,00,000
Identical, as they must be. Use Route B as a thirty-second check on Route A in the exam hall.
Why it works. A rate of return and a capital amount are two sides of the same coin. Saying “12.5% return” is the same as saying “eight rupees of capital for every one rupee of annual profit”, because 1 ÷ 0.125 = 8. So dividing profit by the rate simply converts a yearly earning into the lump of capital that ordinarily produces it. Anything the firm earns without needing that lump is goodwill.
| Purchase methods (average, weighted, super) | Capitalisation methods | |
|---|---|---|
| Core operation | Multiply by years’ purchase | Divide by normal rate of return |
| What it produces | A negotiated price for a few years of advantage | The total capital value implied by the earnings |
| Needs capital employed? | Only the super profit method does | Always |
| Typical answer size | Smaller | Larger, because it assumes the advantage lasts indefinitely |
| Give-away words in the question | “at three years’ purchase” | “capitalising”, “capitalised value”, “value of the firm” |
Change in Profit-Sharing Ratio Among Existing Partners
Now the second half of the chapter. Nobody joins the firm and nobody leaves. The same partners simply agree that from a certain date they will share profits differently — perhaps because one partner is reducing his working hours, or another has brought in extra capital, or a partner has taken over a new territory.
This looks harmless, but accounting treats it as a serious event. Think of the firm as a pizza that the partners have been baking together for years. Changing the ratio means someone hands over a slice he already owned. The slice contains a share of everything the firm has quietly built up but never recorded: its goodwill, its reserves and the hidden increase in the value of its assets. The partner receiving the slice must pay for all of it.
1. Value goodwill and adjust it between the sacrificing and gaining partners.
2. Distribute reserves and accumulated profits or losses.
3. Revalue assets and reassess liabilities, and share the resulting profit or loss.
4. Adjust the partners’ capital accounts and prepare the new balance sheet.
Every one of these is shared in the old ratio or adjusted through sacrifice and gain — never in the new ratio alone.
Old shares (denominator 6): A = 3/6, B = 2/6, C = 1/6
New shares (equal, so 1/3 each, written over 6): A = 2/6, B = 2/6, C = 2/6
A has gone from 3/6 to 2/6 — his share has fallen.
B has gone from 2/6 to 2/6 — no change at all.
C has gone from 1/6 to 2/6 — his share has risen.
So A gives up, C receives, and B is a bystander. Before writing any entry, always produce these three lines. They decide the entire question.
Sacrificing Ratio and Gaining Ratio
These two ratios are the engine of the whole second half. Both are found from one subtraction, done in two directions.
Gaining Share = New Share − Old Share (a positive answer means the partner has gained)
Do only the first subtraction for every partner. A positive result is a sacrifice; a negative result is a gain of that same size.
| Sacrificing Ratio | Gaining Ratio | |
|---|---|---|
| Formula | Old Share − New Share | New Share − Old Share |
| Who has it | Partners whose share has fallen | Partners whose share has risen |
| Effect on the capital account | Credited with goodwill compensation | Debited with goodwill compensation |
| Where else you meet it | Admission of a partner | Retirement or death of a partner |
| Total across all partners | Total sacrifice = Total gain, always | Total gain = Total sacrifice, always |
A: 3/6 − 2/6 = 1/6 sacrifice
B: 2/6 − 2/6 = nil
C: 1/6 − 2/6 = −1/6, that is 1/6 gain
Check: total sacrifice 1/6 = total gain 1/6. Correct.
Sacrificing ratio: A alone, 1/6. Gaining ratio: C alone, 1/6.
X: 5/10 − 2/10 = 3/10 sacrifice
Y: 3/10 − 3/10 = nil
Z: 2/10 − 5/10 = −3/10, that is 3/10 gain
Check: 3/10 sacrificed, 3/10 gained. Correct.
Even though all three numbers in the ratio look different, only two partners are actually involved in any adjustment.
P: 3/5 − 1/2. Over tenths: 6/10 − 5/10 = 1/10 sacrifice
Q: 2/5 − 1/2 = 4/10 − 5/10 = −1/10, that is 1/10 gain
If the goodwill of the firm is valued at ₹ 2,00,000, the amount to be adjusted is 2,00,000 × 1/10 = ₹ 20,000, moving from Q to P.
Why it works. A partner’s share of profit is a claim on every future rupee the firm earns. When that claim shrinks by 1/6, the partner has handed over 1/6 of all future earning power — which is precisely 1/6 of the firm’s goodwill. The partner whose claim grows by 1/6 has received exactly that. Multiplying the firm’s goodwill by the sacrifice or gain fraction is therefore not a rule to memorise; it is the definition of goodwill applied to a fraction.
Treatment of Goodwill on Change in Ratio — Change in Profit Sharing Ratio Journal Entries
Here is the good news: on a change in ratio there is only one goodwill entry to learn. Because no cash comes in from outside, the compensation simply moves from the gaining partner’s capital account to the sacrificing partner’s capital account.
To Sacrificing Partner’s Capital A/c
(Being adjustment for goodwill on change in profit-sharing ratio)
Amount = Firm’s Goodwill × Gaining (or Sacrificing) Share.
Never open a Goodwill Account for this. Never bring in cash.
Step 1 — sacrifice and gain. A sacrifices 1/6; B nil; C gains 1/6 (worked out in Example 16).
Step 2 — amount. 3,60,000 × 1/6 = ₹ 60,000
Step 3 — the entry.
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| C’s Capital A/c Dr. | 60,000 | |
| To A’s Capital A/c | 60,000 | |
| (Being adjustment for goodwill on change in profit-sharing ratio) | ||
Step 1 — write off the existing goodwill in the OLD ratio 3:2.
P: 40,000 × 3/5 = ₹ 24,000 Q: 40,000 × 2/5 = ₹ 16,000
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| P’s Capital A/c Dr. | 24,000 | |
| Q’s Capital A/c Dr. | 16,000 | |
| To Goodwill A/c | 40,000 | |
| (Being existing goodwill written off among the partners in their old ratio) | ||
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| Q’s Capital A/c Dr. | 20,000 | |
| To P’s Capital A/c | 20,000 | |
| (Being adjustment for goodwill on change in profit-sharing ratio) | ||
Net effect on Q: debited 16,000 and 20,000, so his capital falls by ₹ 36,000. Together the capitals fall by ₹ 40,000, which is exactly the goodwill removed from the assets. The balance sheet still balances.
From Example 17: X sacrifices 3/10, Z gains 3/10, Y nil.
Amount = 1,50,000 × 3/10 = ₹ 45,000
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| Z’s Capital A/c Dr. | 45,000 | |
| To X’s Capital A/c | 45,000 | |
| (Being adjustment for goodwill on change in profit-sharing ratio) | ||
Why it works. The existing goodwill in the books was earned under the old arrangement, so it belongs to the partners in the old ratio — hence writing it off in 3:2, not in the new ratio. The fresh valuation is then handled as a pure transfer, because the firm as a whole has neither gained nor lost anything; only the partners’ claims on each other have shifted. Total capital of the firm stays exactly the same, which is why the two amounts in the entry are equal.
Reserves and Accumulated Profits or Losses
A general reserve sitting on the balance sheet is profit the partners earned in earlier years and chose not to withdraw. It belongs to them in the ratio in which they were sharing when it was created — the old ratio. The same is true of a credit balance in the Profit and Loss Account. Accumulated losses and fictitious assets such as deferred advertisement expenditure work the same way with the signs reversed.
Credits (90,000 + 30,000 = ₹ 1,20,000):
A: 1,20,000 × 3/6 = ₹ 60,000 | B: × 2/6 = ₹ 40,000 | C: × 1/6 = ₹ 20,000
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| General Reserve A/c Dr. | 90,000 | |
| Profit and Loss A/c Dr. | 30,000 | |
| To A’s Capital A/c | 60,000 | |
| To B’s Capital A/c | 40,000 | |
| To C’s Capital A/c | 20,000 | |
| (Being reserves and accumulated profits distributed among the partners in their old ratio) | ||
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| A’s Capital A/c Dr. | 12,000 | |
| B’s Capital A/c Dr. | 8,000 | |
| C’s Capital A/c Dr. | 4,000 | |
| To Advertisement Suspense A/c | 24,000 | |
| (Being accumulated loss written off among the partners in their old ratio) | ||
Why it works. Suppose the reserve were left alone. Next year, if the firm were wound up, that reserve would be shared in the new ratio — handing the gaining partner a share of money earned before he was entitled to it. Distributing it now, in the old ratio, freezes each partner’s rightful claim at the moment the arrangement changed. That is the whole purpose.
Revaluation of Assets and Reassessment of Liabilities
Book values drift away from reality. Land bought in 2009 sits in the books at cost while its market value has tripled; a machine may be worth less than its book figure; a creditor may have been forgotten altogether. On a change in ratio, these hidden gains and losses must be recognised so that they land in the old ratio, where they were earned.
The tool for this is the Revaluation Account, also called the Profit and Loss Adjustment Account. It is a nominal account: losses on the debit side, gains on the credit side, and the balancing figure is the revaluation profit or loss shared in the old ratio.
Debit the Revaluation Account when an asset decreases in value, a provision has to be created or increased, or an unrecorded liability comes to light.
Remember it as: good news for the firm → credit; bad news → debit.
(i) Land is to be appreciated by ₹ 80,000
(ii) Stock is to be reduced by ₹ 15,000
(iii) A provision for doubtful debts of ₹ 5,000 is to be created
(iv) An unrecorded creditor of ₹ 10,000 is to be brought into the books
(v) Outstanding wages of ₹ 4,000 are no longer payable
Credit side (gains): Land 80,000 + Outstanding wages written back 4,000 = ₹ 84,000
Debit side (losses): Stock 15,000 + Provision for doubtful debts 5,000 + Unrecorded creditor 10,000 = ₹ 30,000
Profit on revaluation = 84,000 − 30,000 = ₹ 54,000
Shared in the old ratio 3:2:1 — A ₹ 27,000, B ₹ 18,000, C ₹ 9,000.
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| Revaluation A/c Dr. | 54,000 | |
| To A’s Capital A/c | 27,000 | |
| To B’s Capital A/c | 18,000 | |
| To C’s Capital A/c | 9,000 | |
| (Being profit on revaluation transferred to the partners’ capital accounts in their old ratio) | ||
Credit side: 12,000. Debit side: 60,000 + 18,000 = 78,000.
Loss on revaluation = 78,000 − 12,000 = ₹ 66,000
Shared 3:2:1 — A ₹ 33,000, B ₹ 22,000, C ₹ 11,000.
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| A’s Capital A/c Dr. | 33,000 | |
| B’s Capital A/c Dr. | 22,000 | |
| C’s Capital A/c Dr. | 11,000 | |
| To Revaluation A/c | 66,000 | |
| (Being loss on revaluation transferred to the partners’ capital accounts in their old ratio) | ||
Why it works. The increase in the value of that land did not happen on the day the partners signed a new agreement — it happened gradually over the years they were sharing 3:2:1. Recognising it now, in the old ratio, gives each partner exactly the share of the increase that accrued while he was entitled to it. Waiting until later would silently transfer part of A’s land appreciation to C.
Adjustment Through a Single Journal Entry — The Basket Rule
Many questions end with a sentence like this: “The partners do not want to record the goodwill, distribute the reserves or alter the book values of assets and liabilities. Pass a single journal entry to give effect to the above.” Students often panic here and start passing four entries and then reversing three of them. There is a much calmer way, and it is the one original idea I want you to carry out of this chapter.
So tip all of them into one basket:
Basket = Goodwill + Reserves + Accumulated Profit − Accumulated Loss + Revaluation Profit − Revaluation Loss
Then move one number:
Amount = Basket × Sacrificing (or Gaining) Share
Entry: Gaining Partner’s Capital A/c Dr. To Sacrificing Partner’s Capital A/c
One basket, one multiplication, one entry. That is the entire technique.
It works because each of those items is being shared in the old ratio and then implicitly re-shared in the new ratio. The net movement for any partner is always (old share − new share) × item. Since the fraction is the same for every item, you can add the items up first and multiply once at the end. Distributive law, nothing more.
Step 1 — sacrifice and gain. A sacrifices 1/6, B nil, C gains 1/6.
Step 2 — fill the basket.
Goodwill 90,000 + General Reserve 36,000 + Revaluation Profit 54,000 = ₹ 1,80,000
Step 3 — one multiplication. 1,80,000 × 1/6 = ₹ 30,000
Step 4 — the entry.
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| C’s Capital A/c Dr. | 30,000 | |
| To A’s Capital A/c | 30,000 | |
| (Being adjustment for goodwill, general reserve and revaluation profit on change in profit-sharing ratio, without altering the books) | ||
Goodwill ₹ 90,000 — old ratio: A 45,000, B 30,000, C 15,000. New ratio: 30,000 each. Difference: A +15,000, B nil, C −15,000.
General Reserve ₹ 36,000 — old: A 18,000, B 12,000, C 6,000. New: 12,000 each. Difference: A +6,000, B nil, C −6,000.
Revaluation Profit ₹ 54,000 — old: A 27,000, B 18,000, C 9,000. New: 18,000 each. Difference: A +9,000, B nil, C −9,000.
Totals: A + (15,000 + 6,000 + 9,000) = +₹ 30,000; B nil; C − (15,000 + 6,000 + 9,000) = −₹ 30,000
Identical to the one-line basket answer. Nine multiplications replaced by one.
Step 1. X sacrifices 3/10, Y nil, Z gains 3/10.
Step 2 — fill the basket, watching the signs.
1,50,000 (goodwill) + 60,000 (reserve) − 20,000 (accumulated loss) − 30,000 (revaluation loss) = ₹ 1,60,000
Step 3. 1,60,000 × 3/10 = ₹ 48,000
Step 4.
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| Z’s Capital A/c Dr. | 48,000 | |
| To X’s Capital A/c | 48,000 | |
| (Being single adjusting entry passed for goodwill, reserves, accumulated loss and revaluation loss on change in profit-sharing ratio) | ||
Practice Worksheet
Ten original questions covering every method and every entry on this page. Cover the answers, work each one on paper, and only then open the accordion. Getting a question wrong after a real attempt teaches you far more than reading a solved one.
Q1. The profits of Tanvi Traders for four years were ₹ 62,000, ₹ 78,000, ₹ 85,000 and ₹ 95,000. Calculate goodwill at 3 years’ purchase of the average profit.
Show Answer
Average profit = 3,20,000 ÷ 4 = ₹ 80,000
Goodwill = 80,000 × 3 = ₹ 2,40,000
Q2. Profits of Mehul & Co. were: 2022-23 ₹ 1,10,000; 2023-24 ₹ 1,30,000; 2024-25 ₹ 1,52,000. On checking you find that the 2023-24 profit includes an abnormal gain of ₹ 20,000, the 2024-25 profit is after charging a loss by theft of ₹ 12,000, and rent of ₹ 18,000 per year for a partner’s premises has not been charged in any year. Calculate goodwill at 2 years’ purchase of the average profit.
Show Answer
2023-24: 1,30,000 − 20,000 − 18,000 = ₹ 92,000
2024-25: 1,52,000 + 12,000 − 18,000 = ₹ 1,46,000
Total = ₹ 3,30,000; Average = 3,30,000 ÷ 3 = ₹ 1,10,000
Goodwill = 1,10,000 × 2 = ₹ 2,20,000
Q3. Profits of Sanya & Sons were ₹ 84,000, ₹ 96,000 and ₹ 1,14,000 for three successive years. Weights of 1, 2 and 3 are to be used. Calculate goodwill at 2 years’ purchase of the weighted average profit.
Show Answer
Total of products = ₹ 6,18,000; total of weights = 6
Weighted average profit = 6,18,000 ÷ 6 = ₹ 1,03,000
Goodwill = 1,03,000 × 2 = ₹ 2,06,000
Q4. A firm has capital employed of ₹ 5,00,000 and the normal rate of return is 14%. Its average maintainable profit is ₹ 1,00,000. Calculate goodwill at 3 years’ purchase of the super profit.
Show Answer
Super profit = 1,00,000 − 70,000 = ₹ 30,000
Goodwill = 30,000 × 3 = ₹ 90,000
Q5. The average profit of a firm is ₹ 96,000 and the normal rate of return is 12%. The net assets of the firm are ₹ 7,00,000. Calculate goodwill by the capitalisation of average profit method.
Show Answer
Goodwill = 8,00,000 − 7,00,000 = ₹ 1,00,000
Q6. A firm has capital employed of ₹ 4,50,000, a normal rate of return of 16% and an average maintainable profit of ₹ 1,08,000. Calculate goodwill by the capitalisation of super profit method, and verify it using the capitalisation of average profit method.
Show Answer
Super profit = 1,08,000 − 72,000 = ₹ 36,000
Goodwill = 36,000 × 100 ÷ 16 = ₹ 2,25,000
Verification: Capitalised value = 1,08,000 × 100 ÷ 16 = ₹ 6,75,000; Goodwill = 6,75,000 − 4,50,000 = ₹ 2,25,000. The two methods agree.
Q7. L, M and N share profits in the ratio 4:3:2. They decide to share profits 2:3:4 in future. Goodwill of the firm is valued at ₹ 1,08,000. Calculate the sacrificing and gaining shares and pass the necessary journal entry.
Show Answer
M: 3/9 − 3/9 = nil
N: 2/9 − 4/9 = −2/9, that is 2/9 gain
Amount = 1,08,000 × 2/9 = ₹ 24,000
N’s Capital A/c Dr. ₹ 24,000
To L’s Capital A/c ₹ 24,000
(Being adjustment for goodwill on change in profit-sharing ratio)
Q8. P and Q share profits in the ratio 5:3 and decide to share equally. Goodwill of the firm is valued at ₹ 1,28,000 and is not to appear in the books. Pass the journal entry.
Show Answer
Q: 3/8 − 4/8 = −1/8, that is 1/8 gain
Amount = 1,28,000 × 1/8 = ₹ 16,000
Q’s Capital A/c Dr. ₹ 16,000
To P’s Capital A/c ₹ 16,000
(Being adjustment for goodwill on change in profit-sharing ratio)
Q9. R, S and T share profits 5:3:2 and are changing their ratio. Their books show a General Reserve of ₹ 72,000, a credit balance in the Profit and Loss Account of ₹ 18,000, and Deferred Revenue Expenditure of ₹ 15,000. All are to be distributed. Show the net amount credited to each partner.
Show Answer
Deferred revenue expenditure ₹ 15,000 debited 5:3:2 → R ₹ 7,500, S ₹ 4,500, T ₹ 3,000
Net credit — R ₹ 37,500; S ₹ 22,500; T ₹ 15,000
Check: 37,500 : 22,500 : 15,000 reduces to 5:3:2. Correct.
Q10. D, E and F share profits 5:3:2 and change to an equal ratio. On that date: Goodwill is valued at ₹ 1,20,000; General Reserve stands at ₹ 60,000; revaluation of assets and liabilities shows a profit of ₹ 30,000. None of this is to be recorded in the books. Pass a single journal entry using the Basket Rule.
Show Answer
D: 5/10 − 1/3 = 15/30 − 10/30 = 5/30 sacrifice
E: 3/10 − 1/3 = 9/30 − 10/30 = −1/30, that is 1/30 gain
F: 2/10 − 1/3 = 6/30 − 10/30 = −4/30, that is 4/30 gain
Check: sacrifice 5/30 = gains 1/30 + 4/30. Correct.
Step 2 — the basket. 1,20,000 + 60,000 + 30,000 = ₹ 2,10,000
Step 3 — amounts.
D credited: 2,10,000 × 5/30 = ₹ 35,000
E debited: 2,10,000 × 1/30 = ₹ 7,000
F debited: 2,10,000 × 4/30 = ₹ 28,000
Check: 7,000 + 28,000 = 35,000. Correct.
E’s Capital A/c Dr. ₹ 7,000
F’s Capital A/c Dr. ₹ 28,000
To D’s Capital A/c ₹ 35,000
(Being single adjusting entry for goodwill, general reserve and revaluation profit on change in profit-sharing ratio)
Continue Learning
You now have both halves of this chapter in one place. The natural next step is Admission of a Partner, where the same sacrificing ratio reappears — except that a new partner brings cash in from outside. After that, Retirement or Death of a Partner uses the gaining ratio in the mirror image of everything you learned here. The Basket Rule you picked up today will carry into both.
Kaizen closing line: you do not need to master this chapter tonight. Just aim for one more correct answer than yesterday — one more sacrifice fraction found without hesitating, one more journal entry written without checking which partner to debit. Ten such small days and this chapter belongs to you.