goodwill is defined as the difference between the value of a business as a whole and the fair value...

Goodwill is defined as the Goodwill is defined as the difference between the value of difference between the value of a business as a whole and the a business as a whole and the fair value of its separable new fair value of its separable new assets.assets.Goodwill = Selling price as a going concern – Fair value of separate net assetsGoodwill = Selling price as a going concern – Fair value of separate net assets

= Selling price – (Assets –Liabilities)= Selling price – (Assets –Liabilities)

Value of business as a wholeValue of business as a whole Aggregate value of net assetsAggregate value of net assets>>

GoodwillGoodwill

Admission of new partnerAdmission of new partner Retirement of a partnerRetirement of a partner Change in profit-sharing ratioChange in profit-sharing ratio

Treated as in tangible fixed assetsTreated as in tangible fixed assets Written off immediatelyWritten off immediately

Goodwill account openedGoodwill account opened Goodwill account not openedGoodwill account not opened

• Reason for payment of goodwillReason 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 wil(1) A large number of regular customers who will continue to deal with the newl continue to deal with the new

owner.owner.• (2) The business has a good reputation.(2) The business has a good reputation.• (3) It has experienced, efficient and reliable emp(3) It has experienced, efficient and reliable emp

loyees.loyees.• (4) The business is situated in a good location.(4) The business is situated in a good location.• (5) It has good contacts with suppliers.(5) It has good contacts with suppliers.• (6)Well-known products(6)Well-known products• (7)The possession of favourable contracts.(7)The possession of favourable contracts. None of these advantage are available to compleNone of these advantage are available to comple

tely new businesses. For thistely new businesses. For this Reason, many people would decide to buy existiReason, many people would decide to buy existi

ng business and pay an amount forng business and pay an amount for Goodwill. Goodwill.

Existence of goodwillExistence of goodwill

Goodwill does not necessarily exist in a business. If the business has a

badreputation an inefficient labour force or other negative factors, the ow

nermay be unlikely to be paid for goodwi

ll on selling the business.

Goodwill Goodwill ︰︰ Average annualAverage annual sales / fees / profitssales / fees / profits over certain number of years over certain number of years XX a factor a factor

Average sales Average sales methodmethod

‧‧In many retail businesses, the In many retail businesses, the average yearly sales for the average yearly sales for the past few years are multiplied by past few years are multiplied by an agreed figure.an agreed figure. ‧ ‧ For instance, suppose it is For instance, suppose it is agreed that the goodwill should agreed that the goodwill should be three times thebe three times theAverage yearly sales for the last Average yearly sales for the last two years.two years.

•ExhibitExhibit

Year Year SalesSales

$$

• 2005 2005 140000140000

• 2006 2006 160000160000

Total Total 300000300000

==============

Average sales=$300000/2 = $150000Average sales=$300000/2 = $150000

Goodwill calculated=3 x $150000 = $450000 Goodwill calculated=3 x $150000 = $450000

Annual fees methodAnnual fees method

• Professional firms, such as Professional firms, such as accountants or lawyers, often accountants or lawyers, often use a method based on grossuse a method based on gross

annual income from fees, annual income from fees, before charging expenses.before charging expenses.

ExhibitExhibit 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 Year FeesFees

$$

• 2005 2005 180000 180000

• 2006 2006 220000220000 400000 400000 ==============

Average annual fees $400000/2 = $200000Average annual fees $400000/2 = $200000Goodwill calculated $200000 x 2,5 = Goodwill calculated $200000 x 2,5 = $500000$500000

Average net annual Average net annual profits methodprofits method

• Using this method, the average Using this method, the average net profits for a number of net profits for a number of years is multiplied by a years is multiplied by a States amount.States amount.

ExhibitExhibit Suppose goodwill is taken to be four times Suppose goodwill is taken to be four times the average net annual profits for the pastthe average net annual profits for the pastThree years.Three years.

• Year Net profit• 2004 62000• 2005 69000 • 2006 79000• 210000 ======== Average net annual profits $210000/3 = $70000

Goodwill calculated 4 x $70000 = 280000

Super profits Super profits methodmethod

• It may be argued, as in It may be argued, as in the case of a sole the case of a sole trader, that the net trader, that the net profits are not ‘ true profits are not ‘ true profit ’. This is profit ’. This is because the net profit because the net profit does not reflect the does not reflect the following following circumstances.circumstances.

• (1) Services of the proprietor. (1) Services of the proprietor. He has worked in the business, He has worked in the business, but he has not charged for such but he has not charged for such services. Any drawings he makes services. Any drawings he makes are charged to a capital are charged to a capital account, not to the profit and account, not to the profit and loss account.loss account.

• (2) The use of the money he has (2) The use of the money he has invested in the business. If he invested in the business. If he had invested his money had invested his money elsewhere, he would have earned elsewhere, he would have earned interest or dividends on such interest or dividends on such investments.investments.

It is usually calculated as:It is usually calculated as:

$ $$ $

Annual net profits 80000Annual net profits 80000

Less (1) Remuneration proprietor would have earnedLess (1) Remuneration proprietor would have earned

for similar work elsewhere 20000for similar work elsewhere 20000

(2) Interest that would have been earned if capital(2) Interest that would have been earned if capital

had been invested elsewhere had been invested elsewhere 10000 10000 30000 30000

Annual super profits 50000Annual super profits 50000

==============

The annual super profits are The annual super profits are then multiplied by a number then multiplied by a number agreed by the seller and the agreed by the seller and the purchaser of the business. purchaser of the business.

Accounting for Goodwill in PartnersAccounting for Goodwill in Partnershiphip

‧‧Any change in profit-sharing ratio means that the ownersAny change in profit-sharing ratio means that the ownership of the goodwill will also change.hip of the goodwill will also change.

‧‧In each of the following cases In each of the following cases ，， a change in the profia change in the profit-sharing ratio takes place and therefore goodwill adjustmt-sharing ratio takes place and therefore goodwill adjustments must be madeents must be made ︰︰

~~ Admission of a new partner Admission of a new partner

~~ Retirement of an old partner Retirement of an old partner

~~ Change of profit-sharing ratio between existing Change of profit-sharing ratio between existing

partnerspartners

Admission of a New PartnerAdmission of a New Partner‧‧The new partner is required to pay for his share of the tangiblThe new partner is required to pay for his share of the tangible assets as well as the goodwille assets as well as the goodwill ，， according to the profit-shariaccording to the profit-sharing ratio.Therefore goodwill must be revaluated.ng ratio.Therefore goodwill must be revaluated.

(1)(1) Goodwill Account OpenedGoodwill Account Opened

‧‧Goodwill account will be shown in the Balance Sheets as Goodwill account will be shown in the Balance Sheets as “Intangible Fixed Asset”.“Intangible Fixed Asset”.

‧‧Accounting entriesAccounting entries ︰︰

Dr-Goodwill AccountDr-Goodwill Account With the value of With the value of goodwillgoodwill

Cr-Capital Cr-Capital Accounts(old Accounts(old partners onlypartners only

With their share of With their share of goodwill in old goodwill in old

ratioratio

(2)Goodwill Account Not Opened(2)Goodwill Account Not Opened

‧‧Goodwill account will not be shown in the Goodwill account will not be shown in the Balance Sheet.Balance Sheet.

‧‧Accounting entriesAccounting entries︰︰Dr-Goodwill Dr-Goodwill AccountAccount

Cr-Capital Cr-Capital Accounts(old Accounts(old partners onlypartners only

Share goodwill among Share goodwill among all partners in the all partners in the old profit-sharing old profit-sharing ratio.ratio.

Dr-Capital Dr-Capital Accounts(all Accounts(all partner)partner)

Cr-Goodwill Cr-Goodwill AccountAccount

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

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

Retirement of a partnerRetirement of a partner

(1)Goodwill Account Opened(1)Goodwill Account Opened

Dr-Goodwill AccountDr-Goodwill Account

Cr-Capital Account(all Cr-Capital Account(all Partners) Partners)

oror

Cr-Goodwill AccountCr-Goodwill Account

With the increase in the With the increase in the value of goodwillvalue of goodwill ，， shared shared in the old ratio.in the old ratio.

With the decrease in the With the decrease in the value of goodwillvalue of goodwill ，， shared shared in the old ratioin the old ratio

Dr-Current Account(leaving Dr-Current Account(leaving partner)partner)

Cr-Capital Account(leaving Cr-Capital Account(leaving partner) partner) oror

Dr-Capital Account(leaving Dr-Capital Account(leaving partner)partner)

Cr-Current Account(leaving Cr-Current Account(leaving partner)partner)

Transfer the balance in the Transfer the balance in the current account of the current account of the leaving partner to the leaving partner to the

capital account.capital account.


Cr-Cash / Bank / LoanCr-Cash / Bank / Loan

Cash paid to leaving Cash paid to leaving partner or the leaving partner or the leaving partner or the leaving partner or the leaving partner retains the balance partner retains the balance as a loan to the firm.as a loan to the firm.



Cr-Capital Account(all Cr-Capital Account(all Partners)Partners)

With the increase in the With the increase in the value of goodwillvalue of goodwill ，， shared shared in the old ratio.in the old ratio.

Dr-Capital Dr-Capital Account(remaining partner)Account(remaining partner)

Cr-Goodwill AccountCr-Goodwill Account

Write off the goodwillWrite off the goodwill ，， in in new ratio.new ratio.

Dr-Current Account(leaving Dr-Current Account(leaving partner)partner)

Cr-Capital Account(leaving Cr-Capital Account(leaving partner) partner) oror


Cr-Current Account(leaving Cr-Current Account(leaving partner)partner)

Transfer the balance in the Transfer the balance in the current account of the current account of the leaving partner to the leaving partner to the

capital account.capital account.


Cr-Cash / Bank / LoanCr-Cash / Bank / Loan

Cash paid to leaving Cash paid to leaving partner or the leaving partner or the leaving partner or the leaving partner or the leaving partner retains the balance partner retains the balance as a loan to the firm.as a loan to the firm.

Change in the Profit-sharing RatioChange in the Profit-sharing Ratio

(1)Goodwill Account Opened(1)Goodwill Account Opened


Cr-Capital Cr-Capital Account(all Account(all partners)partners)

With the increase With the increase in the value of in the value of goodwillgoodwill，， shared in shared in the old ratio.the old ratio.



Cr-Capital Cr-Capital Account(all Account(all partners)partners)

With the increase With the increase in the value of in the value of goodwillgoodwill，， shared in shared in the old ratio.the old ratio.

Dr-Capital AccountsDr-Capital Accounts

Cr-Goodwill AccountCr-Goodwill AccountWrite off the Write off the goodwillgoodwill，， in new in new ratio.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

Cr-Revaluation

Revaluation XXXRevaluation XXX

AssetsAssets RevaluationRevaluation

Assets XXXAssets XXX

With decrease in value of assets

Dr-Revaluation

Cr-Assets

Assets XXX

Revaluation 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 XXX

Bad Debts

Provision for Bad Debts

Revaluation XXX

With profit on revaluation

(shared among partners, according to the old profit-sharing ratio)

Dr=Revaluation

Cr-Capital

Revaluation

XXXX XXX

XXXX XXX

Bal B/d:

Partner A XX

Partner B XX

XXXX XXX

XXXX XXX

Capital

A B

Profit on XX XX

revaluation

With loss on revaluation

(shared among partners, according to the old profit sharing ratio)

Dr-Capital

Cr-Revaluation

Capital Revaluation

A B

Loss on XX XX

revaluation

XXXX XXX

XXXX XXX

Share loss:

Partner A XX

Partner B XX

6A6A 鐘兆康鐘兆康6A6A 王志勇王志勇6A6A 余玉君余玉君

goodwill is defined as the difference between the value of a business as a whole and the fair value...

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