Change in Profit Sharing Ratio
There is a requirement for a valuation of goodwill whenever there is a change in the profit-sharing ratio of the current partners since this initiates the necessity for the valuation.
When the profit-sharing ratio is adjusted, one of the partners will benefit financially while the other will suffer a loss. As a consequence of this, the partner who benefits from the new ratio is obligated to make up for the other partner’s loss.
In terms of the share of profit, the partner who is profiting may choose to buy his share of profits from any one or two other partners, depending on the circumstances. It is possible for the partners who sell the shares to make sacrifices in amounts that are equal or unequal. Always in proportion to the degree of the sacrifice made, the quantity of goodwill that is credited to the partner or partners from whom the gaining partner purchases his share of the business.
To accomplish this goal with the journal entry, one partner’s capital account will be debited with the proportionate share of goodwill, and the capital account or accounts of the other partners will be credited with the same amount. The partner who gains will be the one who benefits from this transaction.