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. Please compare and contrast these methodologies in the formation of a partnership. Feel free to use examples.

Answer 1

Ans-

Bonus method

Bonus method refers to the historical cost concept that is used to analyze the cost. The bonus method ultimately acknowledges the increase in the value of assets by giving a bonus either to the original or new partners.

Goodwill method

The goodwill method recognizes an asset implied by a transaction rather than recognizing an asset that was actually purchased. During the early times, goodwill was recognized only when purchased so that more objective measure of its value will be established.

The goodwill method always results in a greater amount of total partnership capital because of the recognition of write-ups.

Goodwill method states that interest on invested capital will be higher.

Example to explain the situation

Assumption

The goodwill traceable to the original partners, A and B, was allocated as 40% to A and 60% to B.

Result

In this, the result of capital balance will be different from that of the bonus method that has been used originally.

A similar result may occur when a new partner’s interest in profits is different from the partner’s initial interest in capital.