GOODWILL

Partnership Accounts

Definition

Goodwill is the value of the reputation of a company.

Goodwill Depends on Personal reputation of owners/management Reputation of goods /services= quality Peculiar advantage of the site of the business Peculiar advantage available with regards to sales or

supplies of materials Pantents, copyrights or trade marks owned by the firm

Valuation of goodwill

Goodwill is valued in the following cases: Change of profit sharing ratio New partner is admitted Partner retires or dies Business is sold

Opening Goodwill Account

Types NCA Dr Goodwill accCr Partners Capital Accounts in the Old

PSR

The recommended method is opening the Good will account method.

Valuation of goodwill

Average Profits Basis- Profits of the past few years are averaged and adjusted for any changes expected in the near future. The adjusted profits are multiplied by a factor eg 2, 3, or 4= the answer is the goodwill figure

Super Profits BasisInterest from Capital and Salaries of partners

are deducted from average profits what remains is Super Profits Multiplied by number of years purchase is agreed.

Valuation of goodwill

Capitalization MethodProfit/ Normal Return X 100 Eg 85 000/15 x100 = 566,666Deduct net assets from the figure then the answer is

goodwill.

Change in Profit Sharing Ratio by Old Partners or Introducing a New Partner A and B are partners sharing profits in the

ratio 3:1 if it is decided that in future both will be equal, what it means is that A is selling to B ¼ share of profits. B will pay to A an amount equal to ¼ of value of goodwill.

This means a partner is buying profits that belonged to another.

Goodwill and Partnership Accounts

Although goodwill is not normally entered in the books, partners own a share in the goodwill in proportion to the profit sharing ratio.

Change in PSR

A and B are partners sharing profits A3/4 and B1/4. The Capital accounts are A=90K and B30K. Its is decided that with effect from 1st Jan 2012 the PSR will be 5/8 and 3/8. The goodwill is valued at 2 years purchase price of average profits of the last 3 years which are 2008,42k;2009,39k;2010,45k.The capitals of the two partners should be proportionate to the psr. Calculate the new capital.

Change in PSR

A current Capital = 90K

A capital Account can be computed as follows: To change it to 5/8 it has to be 90k x 4/3 x 5/8=75k

¾-5/8=1/8 A will sell 1/8 of his goodwill to B which 90-75=15k.

Therefore A new capital account is 5/8x 120= 75k

Change in PSR

B gains in PSR= 3/8-1/4=1/8=

B new Capital Acc calculated as follows: At a PSR of 1/3 B has a Capital Acc of 30k his new capital should then be 30x4/3x3/8=45k

Admission of a New Partner

Finding out a new profit sharing ratio where a new partner is admitted and only the share of the new partners is mentioned in new psr. A and B are partners sharing profits and losses in the

ratio 5:3. They admit C and agree to give him 3/10 of the profits. Whats the new psr? - C share of 3/10 deduct from 1 and get 7/10.

Take the 7/10 and apply to old partners using the old psr.

A - 7/10 x 5/8= 35/80B-7/10 x 3/8= 21/80C 3/10 which is also 24/80

Admission of New Partner

Where the new partner buys shares from only one partner or from partners in different proportion.

A and B sharing profit in the ratio of 5:3 admit C and give him 3/10 of profits. IF C acquires his shares in the following proportion A gives 4/20 and B gives 2/20.Whats the new psr?- A =5/8-4/20= 17/40-B = 3/8-2/20=11/40- C= 3/8 or 12/40

Goodwill on Admission of New Partner

First we must establish whether the new partner is going to pay for the existing goodwill or not.

a. New Partners does not pay Dr Good will account /Credit Partners using the old PSR.

Goodwill

New Partners Chooses to Pay A) Pays directly to the partners at personal level and

no entries are captured in the partnership books.

B) New partner pays into the Partnership Account. No goodwill a/c. Dr Cash / Credit New Partners Capital Account Dr New Partners Capital Account and Credit Old

Partners using old PSR.

Revaluation of Partnership Assets

Assets are recorded in the partnership accounts at cost.

Overtime the value of assets will reflect the true market value.

Assets should be revalued to reflect their worth so that partners can get the true benefit or loss. Revaluation occurs when following happens

A new partner is admitted Partner leaves firm Partners change profit sharing ratio.

Open a Revaluation Account

For Each assets showing a gain

SR and K are partners in a firm sahring profits and losses as SR 75% and K 25%On 1st April 2001 their Balance Sheet position was as given below:

Assets LiabilitiesPlant 28,000.00 Capital SR 50,000.00 Furniture 12,000.00 K 30,000.00 Stock 30,000.00 Debtors 10,000.00 Creditors 20,000.00 Cash at Bank 20,000.00

100,000.00 100,000.00

N is to join the partnership. He agrees to pay the partners 20,000.00 by way of Goodwill and introduces 1/2 of the combined capital of the two existing partnersafter depreciating Plant and Furniture at 20% and Stock at 10% and raising a provisionof 10% against debtors. The new partner is to be allowed 1/4 share of the profits of the firm.

Required: Record the transactions and draw a new Balance Sheet.

SR K N SR K NRevaluation 9,000.00 3,000.00 Capital 50,000.00 30,000.00 44,000.00

Goowill 15,000.00 5,000.00 Bal c/d 56,000.00 32,000.00 44,000.00

65,000.00 35,000.00 44,000.00 65,000.00 35,000.00 44,000.00

Revaluation ReservePlant 5,600.00 Furniture 2,400.00 stock 3,000.00 SR 9000debtors 1,000.00 K 3000

12,000.00 12000

Balance SheetAssets LiabilitiesGoodwill 20,000.00 Capital SR 56,000.00 Plant 22,400.00 K 32,000.00 Furniture 9,600.00 N 44,000.00 Stock 27,000.00 Creditors 20,000.00 Debtors 9,000.00 Cash at Bank 64,000.00

152,000.00 152,000.00

Alan, Bob and Charles are in partnership sharing profits and losses in the ratio 3:2:1 Below is the balance sheet of the partnership as at 30 June 2006.

Fixed Assets

Premises 90,000 Plant 37,000 Vehicles 15,000 Fixtures 2,000

144,000 Current Assets Stock 62,379 Debtors 34,980 Cash 760 98,119

Current LiabilitiesCreditors 19,036 Bank overdraft 4,200 (23,236)

Loan- Charles (28,000) 190,883

Capital Alan 85,000 Bob 65,000 Charles 35,000 185,000

Current AccountAlan 3,714 Bob (2,509) Charles 4,678 5,883

190,883

Notes

i) Charles decides to retire on 30 june 2006.ii Don is admitted as a partner the following day.iii Certain assets are revalued: Premises 120000, Plant 35000,stock 54179.iv Provision is to be made for doubtful debts in the sum of P3000v Goodwill is to be recorded in the books the day Charles retires, P42000. The partners do not wish to

mainatain a goodwill account so the amount is written back.vi Alan and Bob are to share are to share profits are before. Don is to have same profits as Bob.

Charles is to take his car at its book value of P3,900 in part payment. And the balance in cash except for20,000 which will be left in the loan account.

vii The partners in the new firm are to start on an equal footing as far as capital and current account are concerned. Don is to contribute cash to bring his capital and current account to same amount as the original partners from the old firm.

viii The original partner in the old firm who has the higher investment will draw out cash so that his capitaland current account balances equal those of his new partner.

REQUIREDa) Account for the above transactions , including goodwill and retiring partners accountsb) Balance Sheet of the partnership of Alan, Bob and Don as at 30 June 2006.

Solution

a) Premises 90,000.0 Premises 120,000.0 Plant 37,000.0 Plant 35,000.0 Stock 62,379.0 Stock 54,179.0 Provision for DB 3,000.0 Profit on RevaluationAlan 8,400.0 Bob 5,600.0 Charles 2,800.0

209,179.0 209,179.0

Goodwill AccountGoodwillCapital AccountsAlan 21000 Goodwill CancelBob 14000 Alan 3/7 18000Charles 7000 Bob 2/7 12000

Don 2/7 1200042000 42000

Revaluation Reserve Account

Capital AccountsAlan Bob Charles Don Alan Bob Charles Don

Goodwill 18,000 12,000 12,000 Balance b/d 85,000 65,000 35,000 Retirement Paid Out 42,000 Goodwill 21,000 14,000 7,000 Cash 21,000 Cash 79,000 Bal C/d 67,000 67,000

106,000 79,000 42,000 12,000 106,000 79,000 42,000 79,000

Current AccountsAlan Bob Charles Don Alan Bob Charles Don

Bal b/d 2,509 Balance b/d 3,714 4,678 Retirement 7,478 Revaluation Profit 8,400 5,600 2,800 Cash 9,023 Cash 3,091 Bal C/d 3,091 3,091 3,091

12,114 5,600 7,478 3,091 12,114 5,600 7,478 3,091

Charles Retirement AccountCar 3,900 Capital 42,000 Cash 53,578 Current 7,478 Balance c/d 20,000 Loan 28,000

77,478 77,478

Bank AccountDon Capital 79,000 bal b/d 4,200 Don Current 3,091 Retirement Charles 53,578 Balance c/d 5,710 Repaid Alan- Capital 21,000

Repaid Alan- Current A 9,023 87,801 87,801

Partnership Dissolution

What happens at dissolution; Assets are sold Liabilities are paid out. Partners are paid advances or loans extended to the

partnership Partners are paid the current and capital account.

Disposal of Assets and Payment of Obligations

Where partners buy assets or take over assets the amount is charged to the capital account.

Close all asset account to the realization account. Cr Asset Dr Realization Account.

For Liabilities: Dr Liabilities Cr Bank

Costs of dissolution Dr Realization Acc Cr Bank

Example

X,Y and Z have been in partnership for several years, sharing profits and losses in the ratio 3:2:1. Their last statement of financial position which was prepared on 31st October 2012 is as follows;Statement of Financial Position of X, Y and Z October 2012.

Example cont..Non Current Assets

At Cost 20,000.00 Less Depr (6,000.00)

14,000.00 Current Assets Inventory 5,000.00 Debtors 21,000.00

26,000.00 Total Assets 40,000.00

Current liabilitiesBank 13,000.00 Creditors 17,000.00

30,000.00 Total Liabilities 30,000.00

CapitlaX 4,000.00 Y 4,000.00 Z 2,000.00

10,000.00 40,000.00

Example…contDespite making good profit during recent years they had become increasily dependent on one credit customer, Smithson and in order to retain his custom they had gradually increased his credit limit until he owed the partnership P18, 000.It has now been discovered that Smithson is insolvent and that he is unlikely to repay any of the money owed by him to the partnership. Reluctantly X, Y and Z have agreed to dissolve the partnership on the following terms:

a) Inventory to be sold to Nelson P4000.00 b) Non- current Assets will be sold for P8000 except for certain items with a book value of

P5000.00 which will be taken over by X at a value of P7000.00 c) All debtors ,excerpt for Smithson will pay their balances in full. d) The discount on creditors is 500, cost of dissolution is 800 and Z is unable to meet his liability to

the partnership out of his personal funds. Required:

a) The Realisation Account b) Capital Accounts of the partners recording the dissolution.

Solution

Non current Asets 14,000.00 Bank Non Current assets 8,000.00 Inventory 5,000.00 X : Non current assets 7,000.00 Debtors 21,000.00 Bank Inventory 4,000.00 Bank Dissoltion Costs 800.00 Bank Debtors 3,000.00

Discount on Creditors 500.00 X 9,150.00 Y 6,100.00 Z 3,050.00

40,800.00 40,800.00

Realisation Account

SolutionCapital Accounts

X Y Z X Y ZNon C/ A take over 7,000.00 Balance b/d 4,000.00 4,000.00 2,000.00 Loss shared 9,150.00 6,100.00 3,050.00 Deficiency sharedDeficiency 525.00 525.00 X 525.00

Y 525.00 Bank to settle 12,675.00 2,625.00

16,675.00 6,625.00 3,050.00 16,675.00 6,625.00 3,050.00

Bank Account

Realisation Account Balance b/d 13,000.00 Non -CA 8,000.00 Accounts Payable 16,500.00 Inventory 4,000.00 Realisation Costs 800.00 Accounts Receivable 3,000.00 Capital X 12,675.00 Y 2,625.00

30,300.00 30,300.00