Module 2- Preparation of Financial Statements

Changes in Ownership Structure

 Partnership

Part 1-Goodwill

Goodwill is the extra amount that the purchaser is willing to pay over and above the total value
of the assets if sold separately. The amount of goodwill is the difference between the purchase
price of the business and the fair market value price of the tangible assets obtained in the
purchase. We evaluate goodwill on the admission of a new partner, death of a partner, retirement
of a partner and change in profit sharing ratio.

Average Annual Profits Method to Value Goodwill

Under this method, the average price for an agreed number of years is calculated to arrive at the
profit for a typical year. Goodwill is then estimated to be worth a certain number of years’
purchase of the average profit.

 Admission of New Partner

If a new partner is admitted, we have to qualify the amount of goodwill. A special term called
“premium on goodwill” is used to refer to the extra amount over the normal contribution if there
is no goodwill. From the premium that a new partner must pay and his own share of profits, we
can calculate the full value of the firm’s goodwill.

E.g. Ben and Jerry are partners sharing profits and losses equally. Charles wants to join the
partnership. Before admitting Charles, they value the goodwill of the firm to be $10 000. The
new profit sharing ratio is 3:3:2. Calculate the premium on goodwill Charles must pay.

Goodwill = 10 000
Charles’ share of goodwill = 2/8 x 10 000 = 2500
Premium= $2500

When goodwill is recorded in the books – DR. Goodwill a/c CR. Old partners’ capital a/c

e.g. X and Z are partners sharing profit and losses 2:1. They admit Y as a partner and the new
ratio is 2:1:1. Goodwill is worth $900.
Journal Entry to record admission of Y:

Details Debit Credit

Goodwill 900  
Capital X   600
Capital Z   300
Record of old partners' share of goodwill on    
admission of Y    
     

Goodwill account:

Goodwill A/c
Capital X (2/3) 600 Balance c/d 900
Capital Z (1/3) 300    
  900   900
Balance b/d 900    
       

Where goodwill is not recorded in the books- Calculate goodwill, DR. Goodwill & CR. old
ratio, DR. old and new partners’ capital a/c & CR. Goodwill a/c (new ratio)

Journal entries & ledger a/c to record admission of Y:

Details Debit Credit

Capital Y 225  
Capital X   150
Capital Z   75
Goodwill adjustment on admission of Y    
     

Goodwill a/c:

Goodwill A/c
Capital X (2/3) 600 Capital X (2/4) 450
Capital Z (1/3) 300 Capital Z (1/4) 225
    Capital Y(1/4) 225
  900   900
       
Death or Retirement of a Partner

When a partner dies or retires, all accounts belonging to him must be closed and transferred to
his capital a/c so that the amt. owed by or to him is calculated.

For example check page 82-83