Goodwill is defined as the difference
between the value of a business as a
whole and the fair value of its
separable new assets.
Goodwill = Selling price as a going concern – Fair value of separate net assets
= Selling price – (Assets –Liabilities)
Value of business as a whole
>
Aggregate value of net assets
Goodwill
Admission of new partner
Retirement of a partner
Treated as in tangible fixed assets
Goodwill account opened
Change in profit-sharing ratio
Written off immediately
Goodwill account not opened
• Reason for payment of goodwill
• In buying the an existing business
which has been established for some
time,
there may be quite a few possible
advantages.
• (1) A large number of regular customers who
will continue to deal with the new
owner.
• (2) The business has a good reputation.
• (3) It has experienced, efficient and reliable
employees.
• (4) The business is situated in a good location.
• (5) It has good contacts with suppliers.
• (6)Well-known products
• (7)The possession of favourable contracts.
None of these advantage are available to
completely new businesses. For this
Reason, many people would decide to buy
existing business and pay an amount for
Goodwill.
Goodwill ︰
Average annual sales / fees / profits over certain number of years X a factor
Existence of goodwill
Goodwill does not necessarily exist
in a business. If the business has
a bad
reputation an inefficient labour
force or other negative factors,
the owner
may be unlikely to be paid for
goodwill on selling the business.
Average sales method
‧In many retail businesses, the
average yearly sales for the past few
years are multiplied by an agreed figure.
‧ For instance, suppose it is agreed
that the goodwill should be three times
the
Average yearly sales for the last two
years.
• Exhibit
Year
Sales
$
• 2005
• 2006
Total
Average sales=$300000/2 = $150000
Goodwill calculated=3 x $150000 = $450000
140000
160000
300000
=======
Annual fees method
• Professional firms, such as
accountants or lawyers, often use a
method based on gross
annual income from fees, before
charging expenses.
Exhibit
A firm of accountants is selling its business. It
is asking a figure for goodwill which is 2.5 times
the average annual fees received for the last two
years.
• Year
• 2005
• 2006
Fees
$
180000
220000
400000
=======
Average annual fees $400000/2 = $200000
Goodwill calculated $200000 x 2,5 = $500000
Average net annual profits
method
• Using this method, the average net
profits for a number of years is
multiplied by a States amount.
Exhibit
Suppose goodwill is taken to be four times the
average net annual profits for the past
Three years.
•
Year
•
2004
• 2005
• 2006
•
Net profit
62000
69000
79000
210000
========
Average net annual profits $210000/3 = $70000
Goodwill calculated 4 x $70000 = 280000
Super profits method
• It may be argued, as in the
case of a sole trader, that
the net profits are not
‘ true profit ’. This is
because the net profit does
not reflect the following
circumstances.
• (1) Services of the proprietor. He has
worked in the business, but he has not
charged for such services. Any
drawings he makes are charged to a
capital account, not to the profit and
loss account.
• (2) The use of the money he has
invested in the business. If he had
invested his money elsewhere, he would
have earned interest or dividends on
such investments.
It is usually calculated as:
$
$
80000
Annual net profits
Less (1) Remuneration proprietor would have earned
for similar work elsewhere
20000
(2) Interest that would have been earned if capital
had been invested elsewhere
10000 30000
Annual super profits
50000
=======
The annual super profits are then
multiplied by a number agreed by the
seller and the purchaser of the
business.
Accounting for Goodwill in
Partnership
‧Any change in profit-sharing ratio means that the
ownership of the goodwill will also change.
‧In each of the following cases ，a change in the profitsharing ratio takes place and therefore goodwill
adjustments must be made︰
~ Admission of a new partner
~ Retirement of an old partner
~ Change of profit-sharing ratio between existing
partners
Admission of a New Partner
‧The new partner is required to pay for his share of the tangible
assets as well as the goodwill，according to the profit-sharing
ratio.Therefore goodwill must be revaluated.
(1) Goodwill Account Opened
‧Goodwill account will be shown in the Balance Sheets as
“Intangible Fixed Asset”.
‧Accounting entries︰
Dr-Goodwill Account
Cr-Capital Accounts(old
partners only
With the value of
goodwill
With their share of
goodwill in old ratio
(2)Goodwill Account Not Opened
‧Goodwill account will not be shown in the Balance
Sheet.
‧Accounting entries︰
Dr-Goodwill Account
Cr-Capital
Accounts(old partners
only
Dr-Capital
Accounts(all partner)
Cr-Goodwill Account
Share goodwill among all
partners in the old
profit-sharing ratio.
Write off goodwill among
all partners in the new
profit-sharing ratio.
‧The new partner may be required to pay extra cash，or
have his capital balance reduced，for his share of
goodwill.
Retirement of a partner
(1)Goodwill Account Opened
Dr-Goodwill Account
With the increase in the value
Cr-Capital Account(all Partners) of goodwill，shared in the old
ratio.
or
Cr-Goodwill Account
With the decrease in the value
of goodwill，shared in the old
ratio
Dr-Current Account(leaving
partner)
Cr-Capital Account(leaving
partner) or
Dr-Capital Account(leaving
partner)
Cr-Current Account(leaving
partner)
Dr-Capital Account(leaving
Transfer the balance in the
current account of the leaving
partner to the capital account.
Cash paid to leaving partner or
(2)Goodwill Account Not Opened
Dr-Goodwill Account
With the increase in the value
Cr-Capital Account(all Partners) of goodwill，shared in the old
ratio.
Write off the goodwill，in new
Dr-Capital Account(remaining
partner)
ratio.
Cr-Goodwill Account
Dr-Current Account(leaving
partner)
Cr-Capital Account(leaving
partner) or
Dr-Capital Account(leaving
partner)
Cr-Current Account(leaving
partner)
Dr-Capital Account(leaving
partner)
Transfer the balance in the
current account of the leaving
partner to the capital account.
Cash paid to leaving partner or
the leaving partner or the
Change in the Profit-sharing Ratio
(1)Goodwill Account Opened
Dr-Goodwill Account
Cr-Capital Account(all
partners)
With the increase in
the value of goodwill，
shared in the old ratio.
(2)Goodwill Account Not Opened
Dr-Goodwill Account
Cr-Capital Account(all
partners)
With the increase in
the value of goodwill，
shared in the old ratio.
Dr-Capital Accounts
Cr-Goodwill Account
Write off the goodwill，
in new ratio.
Revaluation of assets
Chang of partnership
--Admission of new partners
--Retirement of partners
--Change in profit-sharing ratio
Revaluation of asset
Introduction
In the changes of a partner, admission or retirement of a partner,
the assets and liabilities may be revalued to reflect the fair value
of the business.
Ant profits or losses on revaluation are normally entered in the
partners’ capital account according to the profit sharing ratio before
Change.
Accounting for a Revaluation
With increase in value of assets
Dr-Assets
CrRevaluation
Assets
Revaluation XXX
Revaluation
Assets
XXX
With decrease in value of assets
Dr-Revaluation
Cr-Assets
Revaluation
Assets
XXX
Assets
Revaluation
XXX
With provision for depreciation on revalued assets
Dr-Provision for depreciation
Cr-Revaluation
Provision for
depreciation
Revaluation XXX
Revaluation
Depreciation
XXX
With increase in provision for bad debt
Dr-Revaluation
Cr-Provision for Bad Debts
Revaluation
Provision for Bad Debts
Revaluation
Provision for
Bad Debts
XXX
XXX
With profit on revaluation
(shared among partners, according to the old profitsharing ratio)
Dr=Revaluation
Cr-Capital
Revaluation
XXXX
XXX
XXXX
XXX
Bal B/d:
Partner A
XX
Partner B
XX
Capital
XXXX
XXX
XXXX
XXX
A
Profit on
revaluation
B
XX XX
With loss on revaluation
(shared among partners, according to the old
profit sharing ratio)
Dr-Capital
Cr-Revaluation
Revaluation
Capital
Loss on
A
B
XXXX
XXX
Share loss:
XX
XX
XXXX
XXX
Partner A
XX
Partner B
XX
revaluation
6A 鐘兆康
6A 王志勇
6A 余玉君