Question

When two or more individuals come together to form a partnership, the assets that they bring with them into the partnership may be disproportionate. In this event, the assignment of capital may be based on the bonus method or the goodwill method.

Give an example of both the bonus method and goodwill method.

Answer 1

Bonus Accounting Method: Under this method, the new partner’s investment may or may not equal the book value of the capital interest that has been purchased. If it exceeds the book value of the capital interest, then the difference, which is referred to as a bonus, will be distributed to the old partners. If the investment made by the new partner is less than the book value of the capital interest that has been purchased, then the bonus will be allocated to that new partner.

Goodwill Accounting Method: Under this method, when the new partner makes an investment that is not equal to the book value of the capital interest that has been purchased, then that difference is recorded as an intangible asset called goodwill. When goodwill arises, a goodwill account is created, and a debit entry is made for goodwill. Credit entries are then made in the capital accounts of the old partners. The share that each partner gets is based on their old profit and loss sharing ratios.