Goodwill in partnership accounts explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Goodwill is the extra value a firm has because of its name, customers and location, over and above its net assets. It matters in a partnership because the profit-sharing ratio changes when a partner joins, leaves or dies, and the partners who give up a share of future profit are entitled to be paid for it. This guide values one firm's goodwill three ways and then passes the adjusting entries through the capital accounts. Our partnership deed drafting team puts the valuation method and the treatment into the deed so that no dispute arises later.
Goodwill can be valued by average profit, super profit or capitalisation methods; the deed should say which. In the books, internally generated goodwill is not recognised as an asset (AS 26, paragraph 35); only goodwill that has been paid for is recorded. The usual practice is to adjust goodwill through the partners' capital accounts, with the gaining partners compensating the sacrificing ones, without raising a goodwill account.
What the standard says
AS 26, paragraph 35 says "Internally generated goodwill should not be recognised as an asset." Paragraph 36 explains that it is not an identifiable resource controlled by the enterprise that can be measured reliably at cost, and paragraph 37 adds that the gap between the market value of an enterprise and the carrying amount of its identifiable net assets cannot be treated as the cost of an intangible asset. A partnership firm that has built up its own goodwill therefore does not show it in the balance sheet. Our guide to AS 26 on intangible assets covers the rest of the standard. A valuation is still needed, but only to settle the money between partners; it is not an entry in the asset side. After dissolution, the Act deals with the sale of goodwill; see our post on section 55.
Three methods of valuation
| Method | Steps |
|---|---|
| Average profit | Take the average (simple or weighted) profit of past years, adjusted for abnormal items; multiply by an agreed number of years' purchase |
| Super profit | Super profit = average profit - normal profit (normal rate of return x capital employed); multiply super profit by the years' purchase |
| Capitalisation | Capitalise average profit at the normal rate to get the value of the firm; goodwill = this value - net assets. Equivalent to capitalising the super profit |
The number of years' purchase, the normal rate and the weights are matters of agreement or judgment; none is fixed by law.
Worked example: Hari, Mohan and Nair
The entity and all figures in this example are invented for illustration.
Hari, Mohan and Nair share profits 5:3:2. Net assets (capital employed) excluding goodwill are 10,00,000. The profits of the last five years, after adjusting abnormal items, are:
| Year | Profit | Weight | Product |
|---|---|---|---|
| 2021-22 | 1,80,000 | 1 | 1,80,000 |
| 2022-23 | 2,10,000 | 2 | 4,20,000 |
| 2023-24 | 2,40,000 | 3 | 7,20,000 |
| 2024-25 | 2,70,000 | 4 | 10,80,000 |
| 2025-26 | 3,00,000 | 5 | 15,00,000 |
| Total | 15 | 39,00,000 |
Weighted average profit = 39,00,000 / 15 = 2,60,000. (A simple average would be 12,00,000 / 5 = 2,40,000.) The normal rate of return of 20 per cent is an assumed rate, for arithmetic only.
| Method | Working | Goodwill |
|---|---|---|
| Average profit, 3 years' purchase | 2,60,000 x 3 | 7,80,000 |
| Super profit, 3 years' purchase | Normal profit 10,00,000 x 20% = 2,00,000; super profit 2,60,000 - 2,00,000 = 60,000; 60,000 x 3 | 1,80,000 |
| Capitalisation | Value of firm 2,60,000 / 20% = 13,00,000; less net assets 10,00,000 | 3,00,000 |
Check on the capitalisation method: capitalising the super profit gives the same figure, 60,000 / 20% = 3,00,000. The three methods give three different numbers, which shows why the deed must name one. The firm agrees to use the capitalisation figure of 3,00,000 in the two events below.
Event 1: admission of Pillai for a one-fifth share
Pillai is admitted for 1/5 share and brings his share of goodwill in cash. His share of goodwill is 3,00,000 x 1/5 = 60,000.
Ratios. Old partners share the remaining 4/5 in the old ratio 5:3:2: Hari 4/5 x 5/10 = 40/100; Mohan 24/100; Nair 16/100; Pillai 20/100. Sacrifice = old share - new share: Hari 50/100 - 40/100 = 10/100; Mohan 30/100 - 24/100 = 6/100; Nair 20/100 - 16/100 = 4/100. The sacrificing ratio is 10:6:4, which is 5:3:2.
The premium of 60,000 is shared in the sacrificing ratio: Hari 30,000; Mohan 18,000; Nair 12,000.
| Particulars | Debit | Credit |
|---|---|---|
| Bank A/c Dr | 60,000 | |
| To Hari's capital A/c | 30,000 | |
| To Mohan's capital A/c | 18,000 | |
| To Nair's capital A/c | 12,000 | |
| (Pillai's share of goodwill, credited to the sacrificing partners) | ||
| Total | 60,000 | 60,000 |
No goodwill account is opened. If Pillai could not pay in cash, the entry would debit his current account and, if the partners agreed, the amount would be settled later.
Event 2: retirement of Nair
Take the original firm again. Nair retires, and Hari and Mohan continue sharing in 5:3. Nair's share of goodwill = 3,00,000 x 2/10 = 60,000.
Gaining ratio = new share - old share. Hari 5/8 - 5/10 = 25/40 - 20/40 = 5/40; Mohan 3/8 - 3/10 = 15/40 - 12/40 = 3/40. The gaining ratio is 5:3. Hari pays 60,000 x 5/8 = 37,500 and Mohan 60,000 x 3/8 = 22,500.
| Particulars | Debit | Credit |
|---|---|---|
| Hari's capital A/c Dr | 37,500 | |
| Mohan's capital A/c Dr | 22,500 | |
| To Nair's capital A/c | 60,000 | |
| (Nair's share of goodwill, borne by the gaining partners) | ||
| Total | 60,000 | 60,000 |
The amount due to Nair, including this credit, is then settled in cash or as a loan; see our companion article on retirement of a partner.
Event 3: death of a partner
If Nair had died instead, the entry is identical, except that the credit goes to the account of the deceased partner, from which the executors are paid. The deed may value goodwill differently on death. See death of a partner.
Check for all events. Admission: debit 60,000 = credit 30,000 + 18,000 + 12,000 = 60,000. Retirement: debits 37,500 + 22,500 = 60,000 = credit 60,000. In each, the entries net to nil across the capital accounts or are covered by the cash brought in, so total capital and net assets change only by the cash received.
When a goodwill account is raised
Goodwill is shown as an asset only when it has been bought for a price, for example when a firm buys a business. Where the partners agree to raise one temporarily, they write it off in their old ratio immediately after the change. The method above avoids that step and leaves no unrecognised asset in the books.
Common mistakes
- Raising goodwill on the asset side for internally generated goodwill, contrary to AS 26, paragraph 35.
- Using the old ratio when the sacrificing ratio is different.
- Mixing the gaining and sacrificing ratios in retirement and admission.
- Ignoring abnormal items when working the average profit.
- Using different methods in the same firm at different events, without the deed saying so.
Need help with goodwill clauses and adjustments?
If your deed does not name a goodwill method or you are admitting or retiring a partner, we can value goodwill and draft the adjusting entries and the clause. Our partnership deed drafting service covers valuation terms, new ratios and settlement of dues.
Key takeaways
- Goodwill is valued by average profit, super profit or capitalisation; the three give different results.
- Internally generated goodwill is not recognised as an asset (AS 26, paragraph 35).
- On admission, the premium is shared by the sacrificing partners in the sacrificing ratio.
- On retirement or death, the gaining partners compensate in the gaining ratio.
- Adjust through capital accounts and raise no goodwill account.
Read next
- Admission of a partner: accounting
- Retirement of a partner: accounting
- Goodwill valuation in partnership: methods and treatment
- Section 55: sale of goodwill after dissolution
Disclaimer: Based on the Accounting Standards issued by the Institute of Chartered Accountants of India as on 1 April 2025, the Companies (Accounting Standards) Rules, 2021 as amended up to G.S.R. 169(E) of 10 March 2026, the Companies Act, 2013 and the ICAI guidance named in the article, as consulted on 4 October 2026. The worked example uses invented figures. Later amendments should be checked on icai.org and mca.gov.in. This article is general information, not legal advice; check the official text before acting.