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Partnership
 

Partnership

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about partner ship firm, ADMISSION OF PARTNER, DEATH, OR DISSOLUTION OF FIRM

about partner ship firm, ADMISSION OF PARTNER, DEATH, OR DISSOLUTION OF FIRM

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    Partnership Partnership Presentation Transcript

    • PartnershipAccounting for goodwill 1
    • GoodwillGoodwill = Selling price as a going concern – Fair value of separate net assetsGoodwill = Selling price – (Assets – Liabilities) 2
    • 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 3
    • Types of Goodwill Inherent Goodwill Purchased Goodwill 4
    • 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 5
    • Purchased Goodwill•It is the goodwill generated during the acquisition of abusiness•It is the difference between the selling price of a business asa 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 againstreserves, or amortized through the profit and loss accountover its useful economic life 6
    • Calculation of Goodwill Subjective Judgement Average Sales/Fees/Profits Method Super Profit Method 7
    • Subject Judgement Estimate the value of goodwill with reference to some intangible factors and according to their professional judgement 8
    • 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 factor The factor is usually stated as a certain number of years’ purchase of the average sales/fees/profits 9
    • Example 1 10
    • Year Annual Sales $ 1995 100000 1996 200000 1997 300000(a) Goodwill is valued at 3 years’ purchase of the average annual sales of the past 3 years: Average annual sales = ($100000+200000+300000 ) /3 = $200000 Goodwill = $200000 X3 = $600000 11
    • (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) 12
    • 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 13 Super profit X
    • Example 2 14
    •  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. 15
    • AnswerStatement Calculating Super Profit $ $Average net profit(5000+6500+6500+7000)/4 6250Less: Management fee 500 Expected rate of return on net tangible assets 5000 5500Super profit 750Goodwill= $750 X 3 = $2250 16
    • Accounting for Goodwill in Partnership 17
    • 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 18
    •  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 19
    • Goodwill on the admission of a new partner 20
    • Goodwill on the admission of a newpartner 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 21
    • 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 With the value of goodwill Cr Capital account ( old partners With their share of goodwill in old only ratio Dr Goodwill account With the increase in the value of Cr Capital account ( old partner goodwill, share in the old ratio Dr Capital account (old partner) With the decrease in the value of Cr Goodwill account goodwill, share in the old artio 22
    • 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 goodwillDr Goodwill account Share goodwill among old partners in oldCr Capital account (old profit-sharing ratiopartners only)Dr Capital account ( all Written off goodwill among all partnerspartners) in the new profit-sharing ratioCr Goodwill account 23
    • Example 3 24
    •  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 Wong Balance Sheet as at 31 December 1997Assets 1,200 Capital Chan 600 Wong 600 1,200 1,200 25
    • Goodwill account opened Goodwill Capital: Chan (1/2) 150 Balance c/f 300 Wong (1/2) 150 300 300 Capital Chan Wong Lee Chan Wong LeeBalance c/f 750 750 600 Balance b/f 600 600 Goodwill 150 150 Cash 600 750 750 600 750 750 600 26
    • Goodwill account opened Balance Sheet as at 31 December 1998Assets CapitalGoodwill 300 Chan 750Other Assets (1,200 + 600) 1,800 Wong 750 Lee New capital balance 600 2,100 2,100 27
    • Goodwill account not opened Capital Chan Wong Lee Chan Wong LeeGoodwill : Balance b/f 600 600new ratio 100 100 100 Goodwill: old ratio 150 150Balance c/f 650 650 500 Cash 600 750 750 600 750 750 600 Before admission After admission Partner Old ratio Share of New ratio Share of Gain/loss goodwill goodwill 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 28
    • Goodwill account not opened Balance Sheet as at 31 December 1998Assets CapitalAssets (1,200 + 600) 1,800 Chan 650 Wong 650 Lee 500 1,800 1,800 29
    • Goodwill on theRetirement of a Partner 30
    • Goodwill on the Retirement of aPartner 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 31
    • Example 4 32
    •  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 1997Goodwill 1,000 CapitalOther Assets 41,000 Ho 14,000 Tang 14,000 Lau 14,000 42,000 42,000 33
    • Goodwill account opened Goodwill Balance b/f 1,000 Balance c/f 10,000 Capital: Ho (1/3) 3,000 Tang (1/3) 3,000 Lau (1/3) 3,000 9,000 10,000 10,000 Capital Ho Tang Lau Ho Tang Lau Bank 17,000 Balance b/f 14,000 14,000 14,000Balance c/f 17,000 17,000 Goodwill 3,000 3,000 3,000 17,000 17,000 17,000 17,000 17,000 17,000 34
    • Ho and Tang Balance Sheet as at 31 December 1998Goodwill 1,000 CapitalOther Assets Ho 17,000(41000-17000) 24,000 Tang 17,000 34,000 34,000 35
    • Goodwill account not opened Capital Ho Tang Lau Ho Tang LauBank 17,000 Balance b/f 14,000 14,000 14,000Goodwill:new ratio 5,000 5,000 Goodwill :Balance c/f 12,000 12,000 old ratio 3,000 3,000 3,000 17,000 17,000 17,000 17,000 17,000 17,000 Ho and Tang Balance Sheet as at 31 December 1998Assets (41,000 – 17,000) 24,000 Capital: Ho 12,000 Tang 12,000 24,000 24,000 36
    • Goodwill on a change in the profit-sharing ratio
    • 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. 38
    • Example 5 39
    •  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 Au Balance Sheet as at 31 December 1997Goodwill 1,000 Capital: Yip 30,000Other Assets 79,000 Chow 30,000 Au 20,000 80,000 80,000 40
    • Goodwill account opened Goodwill Balance b/f 1,000 Balance c/f 9,000 Capital: Yip (3/8) 3,000 Chow (3/8) 3,000 Au (2/8) 2,000 8,000 9,000 9,000 Capital Yip Chow Au Yip Chow Au Balance b/f 30,000 30,000 20,000Balance c/f 33,000 33,000 22,000 Goodwill 3,000 3,000 2,000 33,000 33,000 22,000 33,000 33,000 22,000 41
    • Goodwill account opened Balance Sheet as at 31 December 1998Goodwill 9,000 CapitalOther Assets 79,000 Yip 33,000 Chow 33,000 Au 22,000 88,000 88,000 42
    • Goodwill account not opened Capital Yip Chow Au Yip Chow AuGoodwill: Balance b/f 30,000 30,000 20,000new ratio 3,000 3,000 3,000 Goodwill: Balance c/f 30,000 30,000 19,000 old ratio 3,000 3,000 2,000 33,000 33,000 22,000 33,000 33,000 22,000 43
    • Yip, Chow & Au Balance Sheet as at 31 December 1998Assets 79,000 Capital: Yip 30,000 Chow 30,000 Au 19,000 79,000 79,000 44
    • Cindy and Candy were in partnership. They shared profits and lossesin ratio of 3:2 On 1 January 2001, they decided to admit Joe.Goodwill is valued at one year’s purchase of the average annualprofits (weighted average) of the past four years. Goodwill is not tobe brought into the partnership’s book. Joe brought $40,000 cashinto the business for capital. No extra cash is paid for goodwill. Thenew profit-sharing ratio is 3:2:1.The balance sheet as at 31 December2000 before the admission ofJoe is as follows:Assets 110,000 Capital : Cindy 65,000Cash 25,000 Candy 70,000Annual net profits for 1997 to 2000 were $25,000,$40,000, $75,000and $60,000 respectively.Record the above change in the partnership in the partners’ capitalaccounts in columnar form, and show the balance sheet after theadmission of Joe.
    • Valuation of Goodwill :25,000 x1 + 40,000x2 + 75,000 x3 + 60,000 x 4 1 + 2 + 3 + 4 57,000