Partnership

Accounting for goodwill

Goodwill
Goodwill = Selling price as a going concern Fair value of separate net assets Goodwill = Selling price (Assets Liabilities)

Goodwill

Buyer ay be willing to pay concern because of!

ore for a business as a going

" " " " " "

Good location Good custo er relations Good reputation #ell"$nown products %&perienced and efficient e ployees and Good relation with suppliers

anage ent tea

'ypes of Goodwill

(nherent Goodwill Purchased Goodwill

(nherent Goodwill
) )

Goodwill generated internally because of the above advantages (nherent goodwill is only an esti ation* 'herefore+ it should not be brought into the boo$s+ and no accounting entry is re,uired

Purchased Goodwill
)(t is the goodwill generated during the ac,uisition of a business )(t is the difference between the selling price of a business as a going concern and the total value of its separable net assets )(t can be treated as an intangible fi&ed asset. )So e co panies ay write it off i ediately against reserves+ or a orti-ed through the profit and loss account over its useful econo ic life

.alculation of Goodwill

Sub/ective 0udge ent Average Sales1Fees1Profits 2ethod Super Profit 2ethod

Sub/ect 0udge ent

%sti ate the value of goodwill with reference to so e intangible factors and according to their professional /udge ent

Average Sales1Fees1Profit 2ethod

(t can be calculated on gross average or weight average Goodwill = Average annual sales1fees1profits over a stated nu ber of years 3 a factor
The factor is usually stated as a certain number of years purchase of the average sales/fees/profits

%&a ple 4

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5ear 4778 477: 477<

Annual Sales 6 499999 ;99999 =99999

(a) Goodwill is valued at = years purchase of the average annual sales of the past = years! Average annual sales = (6499999>;99999>=99999 ) 1= = 6;99999 Goodwill = 6;99999 ?= = 6:99999
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(b) Goodwill is valued at the = years purchase of the weighted average of the annual sales of the past = years #eighted average annual sales = (499999 & 4 > ;99999 & ; > =99999 & =) 4>;>= = 4@99999 : = ;===== (.alculation to the nearest dollar)

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Super Profit 2ethod

A business with goodwill is e&pected to be able to earn ore profit than a business without goodwill 'he e&tra profit earned is called the super profit
Statement Calculating Super Profit Average annual net profit Less! Aeasonable re uneration to the owner Aeasonable return on the capital e ployed in the tangible assets Super profit ? ? ?
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? ?

%&a ple ;

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.han is leaving the partnership+ and goodwill is to be revalued at = years purchase of the super profit* 'he e&pected rate of return on net tangible assets is 49 B+ after paying a anage ent fee of 6899* 'he calculation of the super profit is to be based on the average profits of the last four years* Cet profit fro 477@"477< is 68999+ 6:899+ 6:899+ 6<999 %&pected return on net tangible assets = Cet tangible assets 3 49B* %&pected return is 68999*
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Answer State ent .alculating Super Profit 6 Average net profit (8999>:899>:899><999)1@ Less! 2anage ent fee 899 %&pected rate of return on net tangible assets 8999 Super profit Goodwill= 6<89 ? = = 6;;89

6 :;89 8899 <89

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Accounting for Goodwill in

Partnership

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Accounting for goodwill in partnership

Dnly purchased goodwill is to be brought into the accounts* (n sole traders accounts+ goodwill is to be recogni-ed and recorded in the boo$s only if the business is ac,uired as a going concern (n partnerships+ however+ goodwill is brought into the boo$s whenever there is a change in the partnership such as!

Ad ission of a new partner Aetire ent of an old partner .hange of the profit"sharing ratio
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%ach partner has a share of the profit"sharing ratio* At a change in the partnership+ goodwill ust be ta$en into account and shared a ong the e&isting partners+ according to the e&isting profit"sharing ratio

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Goodwill on the ad ission of a new partner

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Goodwill on the ad ission of a new partner

'he new partner is re,uired to pay for his share of the tangible assets as well as the goodwill+ according to the profit"sharing ratio Dn the ad ission of a new partner+ goodwill ust be revalued Eowever+ not all business $eep a goodwill account in their boo$s* Goodwill ad/ust ents can be done!

Goodwill account opened Goodwill account not opened

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Goodwill account opened

'he value of the goodwill will be credited to the old partners capital accounts+ which represents an increase in the resources they own+ while the new partner will not have a share of the goodwill
Fr Goodwill account .r .apital account ( old partners only Fr Goodwill account .r .apital account ( old partner Fr .apital account (old partner) .r Goodwill account #ith the value of goodwill #ith their share of goodwill in old ratio #ith the increase in the value of goodwill+ share in the old ratio #ith the decrease in the value of goodwill+ share in the old artio

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Goodwill account not opened

Goodwill is intangible in nature* (t cannot be disposed of separately* 'herefore+ so e businesses prefer not to aintain a goodwill account 'he new partner ay be re,uired to pay e&tra cash+ or have his capital balance reduced+ for his share of goodwill

Fr Goodwill account Share goodwill a ong old partners in old .r .apital account (old profit"sharing ratio partners only) Fr .apital account ( all #ritten off goodwill a ong all partners partners) in the new profit"sharing ratio .r Goodwill account 23

%&a ple =

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.han and #ong were partners sharing profits and losses e,ually* Dn 4 0anuary 477G+ they ad itted Lee as a new partner who was re,uired to introduce 6:99 as capital* 'he profits are now to be shared a ong .han+ #ong and Lee e,ually* Goodwill is valued at 6=99* 'he balance sheet before the ad ission of the new partner is shown as follows!
Chan and Wong Balance heet a! at 31 "ece#$er 1997

A!!et!

1%2&&

Ca'ital Chan Wong

6&& 6&& 1%2&&

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1%2&&

Goodwill account opened

.apital! .han (41;) Wong (1)2* Goodwill 489 Balance c1f 15& 3&&
Ca'ital Chan Balance c)f 75& Wong 75& +ee 6&& Chan Wong +ee

=99 3&&

Balance b1f
,oodwill Ca!h

:99
15& 75&

:99
15& 6&& 75& 6&&

75&

75&

6&&

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Goodwill account opened

Balance Sheet as at =4 Fece ber 477G
A!!et! ,oodwill -ther A!!et! (1%2&& . 6&&* 3&& 1%8&& 2%1&& Ca'ital Chan Wong +ee Cew capital balance 75& 75& 6&& 2%1&&

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Goodwill account not Ca'ital opened

Chan ,oodwill / new ratio Balance c)f 1&& 65& 75& Wong 1&& 65& 75& +ee Chan Wong +ee

Balance b1f
1&& 5&& 6&&

:99

:99
15& 75& 6&& 6&&

,oodwill/ old ratio 15& Ca!h 75&

Before ad ission Partner .han #ong Lee 6=99 Dld ratio 41; 41; Share of goodwill 6489 6489

After ad ission Cew ratio 41= 41= 41= Share of goodwill 6499 6499 6499 6=99 Gain1loss 689 loss 689 loss 6499 gain
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Goodwill account not opened

Balance Sheet as at =4 Fece ber 477G
A!!et! A!!et! (1%2&& . 6&&* 1%8&& Ca'ital Chan Wong +ee 65& 65& 5&& 1%8&&

1%8&&

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Goodwill on the Aetire ent of a Partner

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Goodwill on the Aetire ent of a Partner

#hen a partner wants to withdraw fro a partnership+ the partnership should revalue all the assets which belongs to the leaving partner in order to co pute the total a ount of oney that he can withdraw fro the partnership Goodwill ad/ust ent should be calculated in order to co pensate the leaving partner

31

%&a ple @

32

Eo+ 'ang and Lau were partners sharing profits and losses e,ually* Dn =4 Fece ber 477<+ Lau left the partnership* 'he other two partners agreed to share profits and losses e,ually* 'he goodwill is revalued at 649+999* Lau received cash fro the partnership for the a ount due to hi on =4 Fece ber 477<* 'he balance sheet before Laus retire ent is shown as follows! 0o% 1ang and +au
Balance heet a! at 31 "ece#$er 1997 1%&&& 41%&&& 42%&&& Ca'ital 0o 1ang +au 14%&&& 14%&&& 14%&&& 42%&&&
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,oodwill -ther A!!et!

Goodwill account opened

Goodwill Balance b1f
Ca'ital/ 0o (1)3* 1ang (1)3* +au (1)3* 3%&&& 3%&&& 3%&&& 4+999

Balance c1f

49+999

9%&&& 1&%&&& Ca'ital

1&%&&&

0o Ban2 Balance c)f

1ang

+au 17%&&&

0o Balance $)f ,oodwill

1ang

+au

17%&&& 17%&&& 17%&&& 17%&&& 17%&&&

14%&&& 14%&&& 14%&&& 3%&&& 3%&&& 3%&&& 17%&&& 17%&&& 17%&&&

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0o and 1ang Balance heet a! at 31 "ece#$er 1998 ,oodwill -ther A!!et! (41&&&317&&&* 1%&&& 24%&&& 34%&&& Ca'ital 0o 1ang 17%&&& 17%&&& 34%&&&

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Goodwill account not opened

Ca'ital Ban2 ,oodwill/ new ratio Balance c)f 0o 1ang +au 17%&&& Balance $)f ,oodwill / old ratio 0o 1ang +au 14%&&& 14%&&& 14%&&& 3%&&& 3%&&& 3%&&& 5%&&& 5%&&& 12%&&& 12%&&& 17%&&& 17%&&& 17%&&& 0o and 1ang Balance heet a! at 31 "ece#$er 1998 A!!et! (41%&&& 17%&&&* 24%&&& Ca'ital/ 0o 1ang 24%&&&

17%&&& 17%&&& 17%&&&

12%&&& 12%&&& 24%&&&

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Goodwill on a change in the profit"sharing ratio

Goodwill on a change in the profit" sharing ratio

#hen there is a change in the profit"sharing ratio+ the value of goodwill should also be re" assessed+ so as to ascertain the a ount of resources a partner has to give up ( in ter s of a reduction in the relative capital balance) for the gain in his share of profits1loss*

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%&a ple 8

39

5ip+ .how and Au are partners in a trading fir and share profits and losses in the ratio =!=!;* Dn =4 Fece ber 477<+ they wanted to change the profit" sharing ratio to 4!4!4* 'he goodwill is revalued at 67+999* 'he fir s balance sheet on =4 Fece ber 477< was!
4i'% Chow and Au Balance heet a! at 31 "ece#$er 1997 1%&&& Ca'ital/ 4i' 79%&&& Chow Au 8&%&&&

,oodwill -ther A!!et!

3&%&&& 3&%&&& 2&%&&& 8&%&&&

4&

Goodwill account opened

Goodwill Balance b1f
Ca'ital/ 4i' (3)8* Chow (3)8* Au (2)8* 3%&&& 3%&&& 2%&&& 4+999

Balance c1f

7+999

8%&&& 9%&&& Ca'ital 9%&&&

4i' Balance c)f

Chow

Au Balance $)f ,oodwill

33%&&& 33%&&& 22%&&&

4i' Chow Au 3&%&&& 3&%&&& 2&%&&& 3%&&& 3%&&& 2%&&&

33%&&& 33%&&& 22%&&&

33%&&& 33%&&& 22%&&&

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Goodwill account opened

Balance Sheet as at =4 Fece ber 477G
,oodwill -ther A!!et! 9%&&& 79%&&& Ca'ital 4i' Chow Au 33%&&& 33%&&& 22%&&& 88%&&&

88%&&&

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Goodwill account not opened

Ca'ital 4i' ,oodwill/ new ratio Balance c)f Chow Au Balance $)f ,oodwill/ old ratio 4i' Chow Au 3%&&& 3%&&& 3%&&& 3&%&&& 3&%&&& 19%&&& 33%&&& 33%&&& 22%&&& 3&%&&& 3&%&&& 2&%&&& 3%&&& 3%&&& 2%&&&

33%&&& 33%&&& 22%&&&

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A!!et!

4i'% Chow 5 Au Balance heet a! at 31 "ece#$er 1998 79%&&& Ca'ital/ 4i' Chow Au 79%&&&

3&%&&& 3&%&&& 19%&&& 79%&&&

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.indy and .andy were in partnership* 'hey shared profits and losses in ratio of =!; Dn 4 0anuary ;994+ they decided to ad it 0oe* Goodwill is valued at one years purchase of the average annual profits (weighted average) of the past four years* Goodwill is not to be brought into the partnerships boo$* 0oe brought 6@9+999 cash into the business for capital* Co e&tra cash is paid for goodwill* 'he new profit"sharing ratio is =!;!4* 'he balance sheet as at =4 Fece ber;999 before the ad ission of 0oe is as follows! Assets 449+999 .apital ! .indy :8+999 .ash ;8+999 .andy <9+999 Annual net profits for 477< to ;999 were 6;8+999+6@9+999+ 6<8+999 and 6:9+999 respectively* Aecord the above change in the partnership in the partners capital accounts in colu nar for + and show the balance sheet after the ad ission of 0oe*

Haluation of Goodwill ! ;8+999 &4 > @9+999&; > <8+999 &= > :9+999 & @ 4 > ; > = > @ 8<+999