Accounting for goodwillnotes by

Osei Benjamin Mireku (ICAG)

phlixter@aol.com

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

Goodwill = Selling price – (Assets – Liabilities)

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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

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Inherent Goodwill Purchased Goodwill

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• 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

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•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

Subjective Judgement Average Sales/Fees/Profits Method Super Profit Method

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Estimate the value of goodwill with reference to some intangible factors and according to their professional judgement

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It can be calculated on gross average or weight averageGoodwill = Average annual sales/fees/profits over a stated number of years * a factor

The factor is usually stated as a certain number of years’ purchase of the average sales/fees/profits

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All questions are welcomed through email only.

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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

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(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)

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

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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

All questions are welcomed through email only.

Phlixter@aol.com

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Ben 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.

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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

All questions are welcomed through email only.

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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:o Admission of a new partnero Retirement of an old partnero Change of the profit-sharing ratio

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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

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The mind is not a vessel to be filled but a fire to be ignited

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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:o Goodwill account openedo Goodwill account not opened

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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

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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

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

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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

Don’t limit yourself. Many people limit themselves to what they think

they can do. You can go as far as your mind lets you. What you believe, you can achieve.

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Klotey and Elorm were partners sharing profits and losses equally.

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

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

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Chan and WongBalance Sheet as at 31 December 1997

Assets 1,200 Capital Klotey 600 Elorm 600

1,200 1,200

Goodwill

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Capital: Klotey (1/2) 150 Elorm (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

Balance Sheet as at 31 December 1998

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AssetsGoodwill 300

CapitalKlotey 750

Other Assets (1,200 + 600) 1,800 Elorm 750Ben 600

2,100 2,100New capital balance

Before admission After admission

Partner Old ratio Share of goodwill

New ratio Share of goodwill

Gain/loss

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

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

Ben 1/3 $100 $100 gain

$300 $300 28

CapitalKlotey Elorm Ben Klotey Elorm Ben

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

Balance Sheet as at 31 December 1998

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Assets CapitalKlotey 650Elorm 650Ben 500

1,800 1,800

Assets (1,200 + 600) 1,800

Education is what survives when what has been learned has

been forgotten.

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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

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Education costs money, but then so does ignorance.

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Fafa, Eli and Awotwe were partners sharing profits and losses equally.

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

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

The balance sheet before Awotwe’s retirement is shown as follows:

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Fafa, Eli and AwotweBalance Sheet as at 31 December 1997

Goodwill 1,000 Capital Fafa 14,000 Eli 14,000

Other Assets 41,000

Awotwe 14,00042,000 42,000

Balance b/f 1,000

o Fafa Eli Awotwe Fafa Eli Awotwe

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Capital

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

17,000 17,000 17,000

Capital: Fafa (1/3) 3,000Eli (1/3) 3,000Awotwe (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

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Fafa and EliBalance Sheet as at 31 December 1998

Goodwill 1,000 Capital Fafa 17,000 Eli 17,000

Other Assets (41000-17000) 24,000

34,000 34,000

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Capital

Fafa Eli Awotwe Fafa Eli AwotweBank 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

Fafa and EliBalance Sheet as at 31 December 1998

Assets (41,000 – 17,000) 24,000 Capital: Fafa 12,000 Eli 12,000

24,000 24,000

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

Treat people as if they were what they ought to be, and you help them become what they are capable of becoming

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.

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Optimism is the faith that leads to achievement; nothing can be done

without hope and confidence.

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Bless, Grace and Eyi 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:

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Bless, Grace and EyiBalance Sheet as at 31 December 1997

Goodwill 1,000 Capital: Bless 30,000 Grace 30,000

80,000 80,000

Other Assets 79,000 Eyi 20,000

GoodwillBalance b/f 1,000

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Capital

Bless Grace Eyi Bless Grace Eyi

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

33,000 33,000 22,000

Capital: Bless (3/8) 3,000Grace (3/8) 3,000Eyi (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

Balance Sheet as at 31 December 1998

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Goodwill 9,000 CapitalBless 33,000Grace 33,000Eyi 22,000

Other Assets 79,000

88,000 88,000

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Capital

Bless Grace Eyi Bless Grace Eyi

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

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Bless, Grace & EyiBalance Sheet as at 31 December 1998

Assets 79,000 Capital: Bless 30,000 Grace 30,000

79,000 79,000 Eyi 19,000

Elorm and Ben were in partnership. They shared profits and losses in ratio of 3:2 On 1 January 2001, they decided to admit Klotey. 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. Klotey 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 Klotey is as follows:Assets 110,000 Capital : Elorm 65,000Cash 25,000 Ben 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 Klotey.

Valuation of Goodwill :

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

1 + 2 + 3 + 4

57,000