1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern –...

46
1 Partnership Accounting for goodwill

Transcript of 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern –...

Page 1: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

1

Partnership

Accounting for goodwill

Page 2: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

2

Goodwill

Goodwill = Selling price as a going concern – Fair value of separate net assets

Goodwill = Selling price – (Assets – Liabilities)

Page 3: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

3

Goodwill Buyer may be willing to pay more for a business as a going

concern because of:

- Good location- Good customer relations- Good reputation- Well-known products- Experienced and efficient employees and management team- Good relation with suppliers

Page 4: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

4

Types of Goodwill Inherent Goodwill Purchased Goodwill

Page 5: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

5

Inherent Goodwill• Goodwill generated internally because of the above

advantages• Inherent goodwill is only an estimation. Therefore, it should

not be brought into the books, and no accounting entry is required

Page 6: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

6

Purchased Goodwill•It is the goodwill generated during the acquisition of a business•It is the difference between the selling price of a business as a going concern and the total value of its separable net assets•It can be treated as an intangible fixed asset.•Some companies may write it off immediately against reserves, or amortized through the profit and loss account over its useful economic life

Page 7: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

7

Calculation of Goodwill Subjective Judgement Average Sales/Fees/Profits Method Super Profit Method

Page 8: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

8

Subject Judgement Estimate the value of goodwill with reference

to some intangible factors and according to their professional judgement

Page 9: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

9

Average Sales/Fees/Profit Method It can be calculated on gross average or

weight average

Goodwill = Average annual sales/fees/profits over a stated number of years * a factorThe factor is usually stated as a certain number of years’ purchase of the average sales/fees/profits

Page 10: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

10

Example 1

Page 11: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

11

Year Annual Sales$

1995 100000 1996 200000 1997 300000

(a) Goodwill is valued at 3 years’ purchase of the average annual sales of the past3 years:

Average annual sales = ($100000+200000+300000 ) /3 = $200000

Goodwill = $200000 X3 = $600000

Page 12: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

12

(b) Goodwill is valued at the 3 years’ purchase of the weighted average of the annual sales of the past 3 years

Weighted average annual sales = (100000 x 1 + 200000 x 2 + 300000 x 3)

1+2+3 = 1400000 6 = 233333 (Calculation to the nearest dollar)

Page 13: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

13

Super Profit Method A business with goodwill is expected to be

able to earn more profit than a business without goodwill

The extra profit earned is called the super profit

Statement Calculating Super Profit

Average annual net profit X

Less: Reasonable remuneration to the owner X

Reasonable return on the capital employed in the

tangible assets X X

Super profit X

Page 14: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

14

Example 2

Page 15: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

15

Chan is leaving the partnership, and goodwill is to be revalued at 3 years’ purchase of the super profit. The expected rate of return on net tangible assets is 10 %, after paying a management fee of $500. The calculation of the super profit is to be based on the average profits of the last four years.

Net profit from 1994-1997 is $5000, $6500, $6500, $7000

Expected return on net tangible assets = Net tangible assets * 10%. Expected return is $5000.

Page 16: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

16

AnswerStatement Calculating Super Profit

$ $Average net profit(5000+6500+6500+7000)/4 6250Less: Management fee 500

Expected rate of returnon net tangible assets 5000 5500

Super profit 750

Goodwill= $750 X 3 = $2250

Page 17: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

17

Accounting for Goodwill in Partnership

Page 18: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

18

Accounting for goodwill in partnership Only purchased goodwill is to be brought into the

accounts. In sole trader’s accounts, goodwill is to be recognized and recorded in the books only if the business is acquired as a going concern

In partnerships, however, goodwill is brought into the books whenever there is a change in the partnership such as: Admission of a new partner Retirement of an old partner Change of the profit-sharing ratio

Page 19: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

19

Each partner has a share of the profit-sharing ratio. At a change in the partnership, goodwill must be taken into account and shared among the existing partners, according to the existing profit-sharing ratio

Page 20: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

20

Goodwill on the admission of a new partner

Page 21: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

21

Goodwill on the 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

On the admission of a new partner, goodwill must be revalued

However, not all business keep a goodwill account in their books. Goodwill adjustments can be done: Goodwill account opened Goodwill account not opened

Page 22: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

22

Goodwill account opened The 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

Dr Goodwill account

Cr Capital account ( old partners only

With the value of goodwill

With their share of goodwill in old ratio

Dr Goodwill account

Cr Capital account ( old partner

With the increase in the value of goodwill, share in the old ratio

Dr Capital account (old partner)

Cr Goodwill account

With the decrease in the value of goodwill, share in the old artio

Page 23: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

23

Goodwill account not opened Goodwill is intangible in nature. It cannot be disposed of

separately. Therefore, some businesses prefer not to maintain a goodwill account

The new partner may be required to pay extra cash, or have his capital balance reduced, for his share of goodwill

Dr Goodwill account

Cr Capital account (old partners only)

Share goodwill among old partners in old profit-sharing ratio

Dr Capital account ( all partners)

Cr Goodwill account

Written off goodwill among all partners in the new profit-sharing ratio

Page 24: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

24

Example 3

Page 25: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

25

Chan and Wong were partners sharing profits and losses equally.

On 1 January 1998, they admitted Lee as a new partner who was required to introduce $600 as capital. The profits are now to be shared among Chan, Wong and Lee equally.

Goodwill is valued at $300. The balance sheet before the admission of the new partner is shown as follows:

Chan and WongBalance Sheet as at 31 December 1997

Assets 1,200 Capital Chan 600 Wong 600

1,200 1,200

Page 26: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

26

Goodwill account openedGoodwill

Capital: Chan (1/2) 150 Wong (1/2) 150

300 300

Capital

Chan Wong Lee Chan Wong Lee

Balance c/f 750 750 600 Goodwill 150 150

Cash 600

750 750 600 750 750 600

Balance c/f 300

Balance b/f 600 600

Page 27: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

27

Goodwill account openedBalance Sheet as at 31 December 1998

AssetsGoodwill 300

CapitalChan 750

Other Assets (1,200 + 600) 1,800 Wong 750Lee 600

2,100 2,100New capital balance

Page 28: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

28

Goodwill account not opened CapitalChan Wong Lee Chan Wong Lee

Goodwill : new ratio 100 100 100

Goodwill: old ratio 150 150Cash 600

750 750 600 750 750 600

Balance c/f 650 650 500

Balance b/f 600 600

Before admission After admission

Partner Old ratio Share of goodwill

New ratio Share of goodwill

Gain/loss

Chan 1/2 $150 1/3 $100 $50 loss

Wong 1/2 $150 1/3 $100 $50 loss

Lee 1/3 $100 $100 gain

$300 $300

Page 29: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

29

Goodwill account not openedBalance Sheet as at 31 December 1998

Assets CapitalChan 650Wong 650Lee 500

1,800 1,800

Assets (1,200 + 600) 1,800

Page 30: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

30

Goodwill on the Retirement of a Partner

Page 31: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

31

Goodwill on the Retirement of a Partner When a partner wants to withdraw from a partnership, the

partnership should revalue all the assets which belongs to the leaving partner in order to compute the total amount of money that he can withdraw from the partnership

Goodwill adjustment should be calculated in order to compensate the leaving partner

Page 32: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

32

Example 4

Page 33: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

33

Ho, Tang and Lau were partners sharing profits and losses equally.

On 31 December 1997, Lau left the partnership. The other two partners agreed to share profits and losses equally.

The goodwill is revalued at $10,000. Lau received cash from the partnership for the amount due to him on 31 December 1997.

The balance sheet before Lau’s retirement is shown as follows: Ho, Tang and Lau

Balance Sheet as at 31 December 1997

Goodwill 1,000 Capital Ho 14,000 Tang 14,000

Other Assets 41,000

Lau 14,00042,000 42,000

Page 34: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

34

Goodwill account openedGoodwill

Balance b/f 1,000

Capital

Ho Tang Lau Ho Tang Lau

Balance b/f 14,000 14,000 14,000Goodwill 3,000 3,000 3,000

17,000 17,000 17,000

Capital: Ho (1/3) 3,000Tang (1/3) 3,000 Lau (1/3) 3,000 9,000

10,000 10,000

Balance c/f 17,000 17,000

17,000 17,000 17,000

Bank 17,000

Balance c/f 10,000

Page 35: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

35

Ho and TangBalance Sheet as at 31 December 1998

Goodwill 1,000 Capital Ho 17,000 Tang 17,000

Other Assets (41000-17000) 24,000

34,000 34,000

Page 36: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

36

Goodwill account not opened Capital

Ho Tang Lau Ho Tang LauBank 17,000

Goodwill :old ratio 3,000 3,000 3,000

17,000 17,000 17,000

Balance c/f 12,000 12,000

17,000 17,000 17,000

Goodwill: new ratio 5,000 5,000

Ho and TangBalance Sheet as at 31 December 1998

Assets (41,000 – 17,000) 24,000 Capital: Ho 12,000 Tang 12,000

24,000 24,000

Balance b/f 14,000 14,000 14,000

Page 37: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

Goodwill on a change in the profit-sharing ratio

Page 38: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

38

Goodwill on a change in the profit-sharing ratio When there is a change in the profit-sharing

ratio, the value of goodwill should also be re-assessed, so as to ascertain the amount of resources a partner has to give up ( in terms of a reduction in the relative capital balance) for the gain in his share of profits/loss.

Page 39: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

39

Example 5

Page 40: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

40

Yip, Chow and Au are partners in a trading firm and share profits and losses in the ratio 3:3:2.

On 31 December 1997, they wanted to change the profit-sharing ratio to 1:1:1.

The goodwill is revalued at $9,000. The firm’s balance sheet on 31 December 1997 was:

Yip, Chow and AuBalance Sheet as at 31 December 1997

Goodwill 1,000 Capital: Yip 30,000 Chow 30,000

80,000 80,000

Other Assets 79,000 Au 20,000

Page 41: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

41

Goodwill account openedGoodwill

Balance b/f 1,000

Capital

Yip Chow Au Yip Chow Au

Balance c/f 33,000 33,000 22,000Goodwill 3,000 3,000 2,000

33,000 33,000 22,000

Capital: Yip (3/8) 3,000Chow (3/8) 3,000Au (2/8) 2,000 8,000

9,000 9,000

33,000 33,000 22,000

Balance b/f 30,000 30,000 20,000

Balance c/f 9,000

Page 42: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

42

Goodwill account openedBalance Sheet as at 31 December 1998

Goodwill 9,000 CapitalYip 33,000Chow 33,000Au 22,000

Other Assets 79,000

88,000 88,000

Page 43: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

43

Goodwill account not opened Capital

Yip Chow Au Yip Chow Au

Balance b/f 30,000 30,000 20,000Goodwill: old ratio 3,000 3,000 2,000

33,000 33,000 22,000

Balance c/f 30,000 30,000 19,000

33,000 33,000 22,000

Goodwill:new ratio 3,000 3,000 3,000

Page 44: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

44

Yip, Chow & AuBalance Sheet as at 31 December 1998

Assets 79,000 Capital: Yip 30,000 Chow 30,000

79,000 79,000 Au 19,000

Page 45: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

Cindy and Candy were in partnership. They shared profits and losses in ratio of 3:2 On 1 January 2001, they decided to admit Joe. Goodwill is valued at one year’s purchase of the average annual profits (weighted average) of the past four years. Goodwill is not to be brought into the partnership’s book. Joe brought $40,000 cash into the business for capital. No extra cash is paid for goodwill. The new profit-sharing ratio is 3:2:1.

The balance sheet as at 31 December2000 before the admission of Joe is as follows:Assets 110,000 Capital : Cindy 65,000Cash 25,000 Candy 70,000

Annual net profits for 1997 to 2000 were $25,000,$40,000, $75,000 and $60,000 respectively.

Record the above change in the partnership in the partners’ capital accounts in columnar form, and show the balance sheet after the admission of Joe.

Page 46: 1 Partnership Accounting for goodwill. 2 Goodwill Goodwill = Selling price as a going concern – Fair value of separate net assets Goodwill = Selling price.

Valuation of Goodwill :

25,000 x1 + 40,000x2 + 75,000 x3 + 60,000 x 4

1 + 2 + 3 + 4

57,000