Goodwill in the Accounts

Author(s): Richard N. Owens

Source: The University Journal of Business , May, 1923, Vol. 1, No. 3 (May, 1923), pp.
282-299
Published by: The University of Chicago Press

Stable URL: https://www.jstor.org/stable/2354868

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 GOODWILL IN THE ACCOUNTS

I. DEFINITION AND NATURE OF GOODWILL

Goodwill is made up of numerous elements and is therefore

rather difficult to define in concise terms. Many definitions
appear in both legal and accounting literature, and these vary
according to the particular phase of goodwill which the writer
wishes to emphasize. One of the oldest definitions of goodwill
is that of Lord Elton, given in a case at bar in England more
than a hundred years ago. He said: " Goodwill is nothing more
than the probability that the customers will resort to the old
place." This definition has been criticised by accountants and
others because it connects goodwill with the idea of place.
However, the definition was given in a case involving goodwill
in the business of a wagoner and was satisfactory as applied to
that business.
Another definition given by an English court is as follows:
Goodwill must mean every advantage that has been acquired by the old
firm in carrying on its business, whether connected with the premises in
which the business was previously carried on, or with the name of the late
firm, or with any other matter carrying with it the benefit of the business.,

This definition appears to be broad enough to be fairly

satisfactory, and it is, in fact, quoted with approval by account-
ants.
Another legal definition which is an attempt to cover the whole
meaning of goodwill is that of Chief Justice Story, the American
jurist. He defines goodwill as:
The advantage or benefit which is acquired by an establishment beyond
the mere value of the capital, stock, funds, or property employed therein, in
consequence of the general public patronage and encouragement which it
receives from constant and habitual customers on account of its local
position or common celebrity, or reputation for skill, or affluence, or punctual-
ity, or from any other accidental circumstances and necessities or even
from partialities or prejudices.2

x Esquerre, Applied Theory of Accounts, p. 244.

2 C. L. Cleminson in The Accountant, June 8, 1907, p. 784.
282

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 GOODWILL IN THE ACCOUNTS 283

This definition appears to be satisfactory to accountants.

Although there are many legal practices that the accountants
do not approve of, the present legal attitude towards goodwill
is not one of them. We turn now to notice how some accountants
define goodwill.
Cole' states that goodwill is that value which a "properly
informed and properly equipped person would pay as premium
for the old business rather than start a new one with similar
assets." Paton and Stevenson2 define goodwill as "the capital-
ized value of the excess income which a particular firm is able to
realize over a normal enterprise in the same industry and having
the same capital investment." Kester3 states that goodwill
includes "every advantage connected with location, premises,
personality, and name." These definitions are essentially not
at variance with each other. Rogers4, representing the point
of view of the advertising man, says: " The collective friendliness
of individuals is goodwill. It is that which makes tomorrow's
business more than an accident. It is the reasonable expectation
of future patronage based on past satisfactory dealings." From
these definitions it will be seen that there are several elements
of goodwill, the most important of which are (i) locality, (2)
reputation, (3) individuality of the owner, and (4) business
connections.
Goodwill is closely related to certain other intangible assets.
The amounts listed on the balance sheet or in the accounts for
such items as trade-names, trade-marks, and patents probably
include an estimate for goodwill. A trade-name, for example,
would have. no value unless the company has an element of
goodwill. The name is merely the device which enables the
customer to identify the article, but the customer desires to
identify and secure the article because of the goodwill of the firm.
The means of identification of business establishments are the
things to which goodwill attaches and which make for contined
business. Similarly with regard to patents, the amount which a
I Fundamentals of Accounting, p. 367. 2 Principles of Accounting, p. 535.
3 Accounting Theory and Practice Volume II, p. 33I.
4 Goodwill, Trade Marks, and Unfair Trading, p. I2.

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284 THE UNIVERSITY JOURNAL OF BUSINESS

concern pays for a patent may contain a large element fo

will. This fact would make considerable difference in the
of the company when the question of depreciation of the
is considered.
It cannot be denied that goodwill is a real asset in many cases.
Many corporations carry a large item of goodwill in the accounts.
The Shredded Wheat Company, for example, has had its goodwill
valued at $8,500,000, while the publishers of Webster's dictionary
are said to value the word Webster at $i,ooo,ooo. The Royal
Baking Powder Company in I9I2 carried goodwill at
$I2,000,000,' while the Coca Cola Company carries goodwill and
formulae at about twice that amount. Esquerre2 defends the
policy of carrying goodwill on the books for value, saying that
"there is no other asset of a concern the sale of which would be
so effective in bringing operations to an end."
Goodwill is property, in the view of the courts, but it is
inseparable from the business. In the case of Commissioners
of Inland Revenue v. Miller (i9oi), the court said: " Goodwill is
inseparable from the business to which it adds value, and exists
where the business is carried on." In another case, a deceased
partner had by his will bequeathed the goodwill of a business to
a person who was not a member of the firm. It was held that
the testator could not so separate the goodwill from the business
and that the legacy was invalid.3
In the same way, the assignment of a trade name in gross
and apart from any business is not allowed at law, since this
practice would lead to the deception of the consumer. The same
reasoning applies to a trade mark, which cannot be assigned
independently of the manufacture of the goods to which it
relates. If the trade-name or the trade-mark has come to
designate in the mind of the consumer, some place of origin or
manufacture, the sale of the name or mark without the like
transfer of the business would confuse and deceive the consumer.4
I C. Bartle, The Accountant, May, I919, p. 2I5.
2 Applied Theory of Accounts, p. 245. 3 Dicksee, Goodwill, p. 36.
4 The most complete discussion of the legal phases is in Dicksee's, Goodwill,
Its Treatment in Accounts.

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 GOODWILL IN THE ACCOUNTS 285

Goodwill may be real or personal property, according to the

circumstances. If attached to a public house which is owned
by a sole trader, the goodwill is real property. A business
has been held to be so linked to the premises where it is carried
on that if the premises are compulsorily purchased the business
must be paid for as well as the premises. But if the premises
are the property of a partnership, they are in equity considered
as personal property.
The sale of a business carries with it the entire goodwill,
even though the word is not used in the transaction, and if it
carries the goodwill, it passes also the property in a trade name
or trade-mark used in the business, although it may not be
specifically mentioned.
The law recognizes the right of a trader to compensation for
a loss of goodwill. Where a trader is compelled to vacate his
premises by reason of the lands being taken under statutory
power, he is entitled to compensation for the disturbance to the
extent of any diminution or extinction of his goodwill in conse-
quence of the removal. This compensation is quite apart from
any payment due for loss or damage to stock, fixtures, or other
assets.'

II. ACQUISITION OF GOODWILL

Goodwill may be acquired by advertising, or by purchase of

a business which has an established trade. Each of these methods
will be considered.
Accountants differ on the question of whether it is ever
advisable to capitalize advertising as goodwill, though most of
them condemn the practice. Esquerre2 says: "There does not
seem to be a valid objection to the charging of operating short-
comings of what might be called the probation period of a newly
established business, to an account which would record the cost
of obtaining the goodwill of the community." Kester,3 while
agreeing that the value is somewhat speculative, says that

I Dawson, Cyclopaedia of Accounting, Volume III, p. 207.

2 Applied Theory of Accounts, p. 248.
3 Accounting Theory and Practice, Volume II, p. 334.

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286 THE UNIVERSITY JOURNAL OF BUSINESS

"where handled carefully and with conservati

be put on the books by capitalizing a part of the advertising.
The trouble is, as Kester points out, the plan is not likely to be
carried out carefully and with conservatism. Dicksee' also
states that certain advertising expenses may be capitalized when
a new business is being started, and the editor of The AccountantP
similarly approves of the practice under some circumstances.
The plan is followed by some companies for the purpose of
increasing the capital stock and decreasing the dividend rate,
but with the exception noted above, most accountants think
it improper to capitalize advertising as goodwill.
Most accountants do not approve of capitalizing any advertis-
ing as goodwill. Hatfield states his objections as follows:
Human nature is so incurably optimistic when it comes to estimating
one's own possessions. The boy's jackknife, the citizen's fatherland, the
man's children are in normal cases a little better than similar possessions
of any one else.

It has also been pointed out that to set up an item of goodwill

merely because income is anticipated in the future may cause
dividends to be paid improperly with the consequent embarrass-
ment of the company. The conservatism of accountants in
refusing to sanction the placing of goodwill on the books in this
manner, is justifiable.
Approval of the capitalizing of advertising as goodwill
would open the door to many questionable practices. Goodwill
as an asset has been brought somewhat into disrepute because
some have used it to cover up a discount on stock, or a stock
bonus, or perhaps a capital loss. The use of goodwill in this way
is uniformly condemned by accountants, and rightly so. At
least one writer on corporation finance, however, approves of
the practice of watering stock. Hastings Lyon3 says: " Watered
stock can take a very useful and entirely proper part in corpora-
tion finance through affording further means of effecting divisions
and recombinations of the incidents of ownership." This can
be done, he says, by giving bonus stock to the underwriters
I Goodwill, p. 8i.
2 October 29, i9io, also February 28, I914. 3 Corporation Finance, p. 88.

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 GOODWILL IN THE ACCOUNTS 287

which may be an economical transaction for the corporation.

He does not state how the watered stock would appear on the
books, whether as inflated asset values or as fictitious goodwill;
but either practice would be condemned by accountants who
maintain that the books should reflect transactions as truthfully
as possible.
Although accountants generally do not approve of capitalizing
advertising or of putting a fictitious goodwill on the books, they
are agreed that goodwill should be put. on the books when it is
acquired by the purchase of an established business and a sum
is paid for the business in excesss of its net worth. It is, no doubt,
inconsistent to say that the purchaser may put an item of goodwill
on the books when it was improper for the vendor to do so before
the sale, but the reasons, for this attitude have already been
indicated.
Goodwill may be acquired by one firm from another in several
ways. If the goodwill is attached to the premises and the
premises are mortgaged, the goodwill goes with the mortgage.
Likewise the transfer of such property by bequest would carry
the goodwill with it. The sale of the business or property would
in most cases include the goodwill. When goodwill is tranferred
by sale in bankruptcy proceedings, the value of the goodwill
is not as great as where sold by a willing seller. The bankrupt
has more freedom with regard to competition in the future than
a willing seller would have.
The nature of the rights acquired by the purchase of goodwill
may be indicated. In case goodwill cannot be separated from
the premises, the purchaser would usually have the right to
possession of the old business premises and the old stock. He
would have the right to carry on the old business and to represent
that it is the old business that is being carried on. This would
include the sole right to use the old trade or firm name, the right
to the exclusive use of trade marks, and the right to receive the
benefits of agreements in restraint of trade entered into by the
assignor. To be legal, such agreements must be (i) only partial
and not too indefinite in their duration, (2) made for a considera-
tion, and (3) not unreasonable as to subject matter. If any

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288 THE UNIVERSITY JOURNAL OF BUSINESS

previous owner has made agreements binding himself with regard

to competition, these constitute a part of the goodwill, and the
purchaser of the goodwill gets the benefit of any unexpired
portion of such agreements. The purchaser has the right to
solicit the customers of the old firm and to have the books of
the firm.
The rights of the purchaser of the business are subject to
certain rights of the vendor. The vendor has the right of freedom
from liability under any contracts entered into by the new busi-
ness; so that in the interests of the vendor, the purchaser cannot
use the old name in such a manner as to render the vendor liable
for any debts incurred by the purchaser in the old name. The
vendor can be restrained from continuing to trade in his own
name if it can be shown (i) that he is attempting to deceive the
public into the belief that he is still the owner of the old business,
or (2) that it is impossible so to trade without misleading the
public. Subject to these restrictions the vendor has a right to
engage in business and to use his name, but he cannot set up
another business under any name which might lead people to
infer that he was still carrying on the old business. Nor can
the vendor personally or by circular solicit the customers of the
former business and so deteriorate the value of the goodwill he
has sold. But unless otherwise agreed, the vendor of the
goodwill may set up a new business and advertise the fact,
provided he does not attempt to move under cover of his former
position or avail himself of his special knowledge of his old
customers to regain that which he has parted with for value.'
In brief, the vendor (unless under special agreement) can set up
business even next door to the old place and may state to the
public his connection with the old firm, but he cannot use the
firm name or a name sufficiently like it to deceive the public
nor can he solicit privately or by letter, the customers who were
habitual dealers with the old firm, but should the old customers
come to trade with him without solicitation, he can then solicit
them to continue so to trade.
' Adapted from S. S. Dawson, Cydopaedia of Accounting, Vol. III, p. 198.
2 C. Bartle, The Accountant, March Is, I9I9, p. 214.

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 GOODWILL IN THE ACCOUNTS 289

An English case, the decision of which depended upon the

question of the nature of goodwill, was that in which a partner-
ship agreement had been made that the goodwill on dissolution
should go to one of the partners. The other partner, before the
time for the dissolution of the partnership, employed a clerk to
copy the names of the customers of the firm. He intended to
set up a rival business after the firm was dissolved and to use
the names in soliciting customers. The court granted an
injunction against the use of this information, on the ground
that a partner who sold or otherwise disposed of the goodwill
of his business had no right to use any special information he
may have gained from the business.' His position becomes the
same as that of any other outsider.
If a bankrupt is forced to sell his business, none of the restric-
tions regarding competition and solicitation of old customers
apply, since the sale is not voluntary on the part of the bankrupt.
However, if the debtor assigns his property for the benefit of
creditors and the trustee sells the goodwill of the debtor's busi-
ness, the debtor is not an involuntary party to the sale and the
usual restrictions regarding competition apply. In at least one
English case, where a trustee under a deed of assignment for the
benefit of creditors sold the goodwill of the debtor's business,
the estate was held responsible for damage done to a purchaser
as a result of subsequent canvassing by the debtor of the cus-
tomers of the business which had been sold.2
In order to protect himself against the rights of the vendor
of the goodwill, the purchaser should enter into an agreement
with the vendor expressly restraining the vendor from competing
against or otherwise acting so as to deteriorate the business he
is selling. Otherwise the purchaser has to rely upon the general
provisions of the law relative to goodwill. In any case, however,
the purchaser of goodwill is justified in placing the asset on the
books at the price paid for it.
It sometimes happens that a new company which is just
starting business but has not had time to build up an established
I Wm. Hunter, The Accountant, April 6, I90I, p. 437.
2 S. S. Dawson, Cyclopaedia of Accounting, Vol. III, p. i99.

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290 THE UNIVERSITY JOURNAL OF BUSINESS

business, is bought out by another concern which pays more

than the net worth of the business.- More frequently, perhaps,
is the case of a partnership which admits a new partner on
condition that he pay more than his share of the assets would
indicate. In either case, there would be an element of goodwill
to be set up on the books. But since, by assumption, the business
has no established trade, the question arises as to whether
there is a real element of goodwill in the accounting sense.
Seymour Walton' contends that this is speculation- on future
possibilities rather than a payment for goodwill, and he says
it is a mistake to call it goodwill. However, since there is no other
term by which it may be called in the accounts, and since it is
something for which money has been paid, the best practice seems
to be the one at present employed, namely, showing it as goodwill.
A somewhat different case is that where a holding company
purchases the stock of competing concerns to consolidate them,
paying more therefor than the net worth alone would justify.
It seems a misnomer to call this element goodwill, for the antici-
pated earning power may not be due to any established business
and it may have no justification in past profits. The anticipated
earnings are to come from the elimination of competition and the
substitution of monopoly control. Kester2 calls this "dormant
or latent" goodwill, saying that it signifies the excess earning
power that would exist if it were not for the inharmonious
working of the various parts of the organization and other
similar handicaps which the new management will remove.
In consolidated statements, there is an element of goodwill
to represent an amount paid for the stock of the subsidiary in
excess of the book value. In the eliminations made on the
consolidated statement, the capital and its share of surplus will
be eliminated on the credit side, and a corresponding amount
will be eliminated on the debit side as a subtraction from the
stock investment. If this does not eliminate all of the stock
investment, the remainder will be carried as the asset goodwill.3
,,Journal of Accountancy, May, I9I9, p. 379.
2 Accounting Theory and Practice, Volume II, p. 331.
3 Finney, Consolidated Statements.

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 GOODWILL IN THE ACCOUNTS 29I

This may not be goodwill in the true sense and may represent
secret reserves or any number of other factors, but it is best
shown as goodwill.
If the purchase price of the stock is less than the book value
as shown by the balance sheet, it may be assumed that the balance
sheet figures are inflated, and such a discount may be credited
to the goodwill account on the consolidated balance sheet. In
addition, the goodwill account on the consolidated statement
would include the various items of goodwill which appeared
on the balance sheets of the underlying companies at the time
they were taken over.,
At least two legal cases may be referred to with regard to
recording goodwill on the books. In the litigation between the
City of New York and the Consolidated Gas Company of that
city, the Supreme Court of the United States rendered a decision
to the effect that in determining whether or not a legislative
rate was reasonable, goodwill could not be included as an asset.
Goodwill may not, therefore, be considered as an asset by a public
utility.
In the case of Barrow v. Hematite Steel Company, an English
case decided in igoo, an application was made to the court for
permission to reduce the capital of the corporation on the ground
that part of the capital had been lost. In that case, the court
said: "As to goodwill, it is no doubt true that the company
never has entered goodwill as an asset. For the purposes of the
company as a going concern there never was a necessity of doing
this, but nevertheless, any goodwill must be regarded as an
available asset for purposes of a reduction petition."3

III. VALUATION OF GOODWILL

The question of how to value goodwill arises when goodwill

is to be placed on the books for the purpose of issuing stock and
thereby reducing the rate of return on the investment, also when
the goodwill is to be disposed of. Since accountants do not
I Gilman, Principles of Accounting, p. 40I.
2 Greendlinger, Financial and Business Statements, p. 123.
3 Dicksee, Goodwill, p. 59.

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292 THE UNIVERSITY JOURNAL OF BUSINESS

approve of putting goodwill on the books unless it has been

purchased, the discussion will be limited to valuation for purposes
of purchase or sale. The question would, therefore, arise
when a business is sold or when a new partner is to be admitted
to a partnership.
Aside from the question, merely of how much profits have
been earned in past periods, a number of other factors must be
considered. There is, for example, the question of how much
skilled supervision is necessary for the maintenance of the
business, and in a professional firm the personal element may be
the main factor in the earning of profits. The probable con-
tinuity of the business is very important. This would depend
upon the present age of the business, the attitude the present
proprietors will take when they leave the business, the probability
of the present proprietors becoming competitors, the nature of
the business and its product, whether luxury or necessity,
competitive or monopoly, the tenure of the premises and whether
the lease can be renewed, the number and character of the
customers, and any special advantages which the business may
have enjoyed in the past, such as in purchasing. There may be
unusual factors in past periods which would have to be eliminated,
such as war profits, or failure of present proprietors to keep up
repairs.
A careful audit should be made before a business is purchased
to see that all expenses are charged and profit is accurately
stated. The following are a few of the respects in which profits
might be overstated:
I. No rent charged. If the building is to go with the business,
of course, this would not have any effect.
2. Salaries of partners or managers may be too low.
3. Bad debts and depreciation may not be charged off, or the
allowance may be inadequate.
4. Sales may be falsified near the close of the period and before
the transfer takes place.
5. Assets may be written up to create a fictitious profit.
6. Inventions may be overvalued.
7. Repairs may be neglected.
8. Expenses may have been capitalized.

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 GOODWILL IN THE ACCOUNTS 293

The question of how long a period should be used in the

valuation of goodwill on the basis of profits is also important.
One year seems not to be enough since it does not establish the
usual profits and gives too much chance for error because of the
unusual conditions that may exist during that one year. On the
other hand, if too many years are used, the early years have too
much influence. This would be true whether profits are increas-
ing or decreasing. The usual period in England is three to
five years. In the United States many concerns have used only
one year as the basis.'
There are two methods of valuing goodwill for purposes
of purchase and sale: (i) Number of year's purchase of the profits,
and (2) the excess profits method. The first method involves
the agreement between buyer and seller with regard to the
number of years purchase at which the goodwill is to be valued.
The amount to be paid for goodwill is found by multiplying the
average profits by the number of years purchase. The number
of years purchase varies from one to fifteen.2
A slightly different method of arriving at the value of goodwill
by`the number of year's purchase, is given by Dicksee.3 Accord-
ing to this method, the basis of the number of year's purchase
is the average net profits, less interest on the average capital
employed. This amount is then multiplied by the number of
year's purchase agreed upon. The number of years will vary
in different industries, and in different businesses, but the follow-
ing is suggested by Dicksee as applying to his method:
Business Years
Wholesale and retail business ....................... I to 5
Manufacturing concern ......................... I to 4
Professional concern ......................... I to 3
Newspapers and quasi-monopolies .................. I to IO

The excess profits method consists in the finding of the excess

profits which the concern is making and capitalizing it at an
agreed interest rate. The excess profits are found by taking
the average profits of the concern in question, from which are

' Hatfield, Modern Accounting, p. iii.

2 Kester, Accounting Theory and Practice, Vol. II, p. 334.
3 Goodwill, p. 7I.

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294 THE UNIVERSITY JOURNAL OF BUSINESS

subtracted the profits which the same concern would make on

its capitalization, if it earned the same percentage that is usually
expected in that line of business. For example, if the usual
profits in that industry are io per cent, multiply the net worth
of the business by io per cent. This gives the profits which the
concern may reasonably expect. Subtract this amount from the
average which it actually does earn, and the remainder is its
excess profits. Capitalize the excess profits at an agreed rate,
IO per cent, 15 per cent, or 50 per cent, and you have the value
of the goodwill. The rate is a matter for buyer and seller to
decide.
A variation of this method consists of capitalizing the average
net profits, and subtracting from that amount the actual net
worth of the business. This gives the same result, provided
the same interest rate is used.

IV. DEPRECIATION OF GOODWILL

Whether or not goodwill, when once placed on the books,

should gradually be written off is a question about which there
has been a great deal of argument but no agreement. From the
point of view of expediency, if goodwill does depreciate, it means
that profits are less and there will probably be no surplus to
write goodwill off against. If goodwill does not depreciate,
profits will be large but there will not be the necessity for writing
off the goodwill. The problem has been tersely stated by one
writer: "If you can afford to write off goodwill, you need not
do so; but if you cannot afford to do so, then you must."
If the stockholder invests in a company which purchases
goodwill, he does so in the expectation of profits. If the profits
are used to write off goodwill, then the stockholder is deprived
of the very profits which the goodwill gave him the right to expect.
On the other hand, it is argued that goodwill represents capital-
ized super-profits, and such profits cannot be permanent because
of the nature of competition and the possibility of new inventions
or new products appearing on the market.
Among the American writers opposed to writing down the
goodwill are Cole, Kester, and Esquerre, while in favor of such

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 GOODWILL IN THE ACCOUNTS 295

practice are Hatfield, and Paton and Stevenson. Among the

English accountants, Child, Cooper, Guthrie, and Pixley are
among those who favor a writing off of goodwill. Dicksee,
Caldicott, Garcke and Fells, and James argue that it may be
continued at its original figure regardless of changes in its value.
Esquerre rises in defense of goodwill:
Why goodwill, having been acquired at a cost which is sometimes con-
siderable, and constituting in some instances the only truly valuable asset
of a concern, should be outlawed and sentenced to gradual expulsion from
respectable books, is one of the perplexing puzzles which accounting offers
to students. Accountants who never would permit the reduction of a
physical asset by the estimated amount of depreciation which it may or
may not have suffered during a given period, have no scruples at all when
it comes to goodwill. There is no apparent reason why so-called conserva-
tism should demand the writing off of an asset to the detriment of the very
profits which its purchase gave right to expect.'

Hatfield's position is that the "tendency of goodwill is to

depreciate and the safest policy is to make provision for a reserve
to offset the item of goodwill in the accounts. 12 Dicksee argues
that goodwill does not depreciate, though it is liable to fluctua-
tions. Since the amount of goodwill in the balance sheet is not
supposed to represent either the maximum or the minimum
to the concern, no one is deceived by its retention in the accounts.
There is, therefore, no reason for writing it off.
It seems reasonable that goodwill may be retained in the
accounts at the price paid for it, unless the excess earnings are
due to patent rights or copyrights which will expire. Ordinarily,
however, there is only the argument of conservatism in favor of
depreciating goodwill.
The view that goodwill need not be written off has been upheld
by the courts. In the case of Wilmer v. McNacmara (English
case, i895), it was held that even though the goodwill had actually
declined in value, it was not necessary to charge the shrinkage
against profits. The decision was based on the conception that
goodwill is fixed capital, and a decline in the value of fixed
capital need not be taken into account in determining profits.3
x Applied Theory of Accounts, p. 248.
2 Modern Accounting, p. 144. 3 Hatfield, Modern Accounting, p. ii6.

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296 THE UNIVERSITY JOURNAL OF BUSINESS

Dicksee in his book on goodwill argues that if a company

has legitimately placed goodwill on the books by purchase and
afterwards writes it off against surplus, it thereby creates a
secret reserve. Seymour Walton replies to this argument by
saying that no one is deceived by writing off goodwill. "Absence
of the building from the accounts would imply that the company
did not own one, and a secret reserve might thereby be created,
but this cannot apply to goodwill."' Even those writers who
believe that goodwill does not necessarily depreciate are likely
to agree with Walton on this point.

V. SHOWING THE GOODWILL ON THE BALANCE SHEET

It is held by some writers that goodwill ought to be shown on

the balance sheet as a deduction from surplus. The goodwill,
however, is a real asset and it ought not to be shown at all unless
it has been paid for; and if the company has paid for the goodwill,
there seems to be no logical reason why it should not appear
among the other assets. If it is shown among the assets, there
if the further question of whether it should be included among
the fixed assets or shown with the other intangibles, namely,
patents, trade-marks, and organization expenses. Since goodwill
is closely related to patents, trade-marks, and trade-names, it
would seem more logical to include it with the other intangible
assets, and this is true whether or not it is to be written off the
books.
VI. GOODWILL IN A PARTNERSHIP

The treatment of goodwill in partnership accounts is some-

what different from its treatments in the accounts of a corpora-
tion. Goodwill is usually not carried in the accounts of a
partnership, but it is important when (i) the business is sold,
(2) a part of the business is sold, (3) a new partner is admitted,
(4) a partner retires, and (5) a partner dies. Goodwill is common
property, and upon dissolution each of the. partners has a right
to have the goodwill sold or brought into the accounts for all
the partners. Pending the sale of the goodwill, the partners
I Journal of Accountancy, July, igi7, p. 64.

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 GOODWILL IN THE ACCOUNTS 297

should not conduct themselves as to any way affect the value of

the common property. If the goodwill is sold or brought into
the accounts, the surviving partners have the right to compete
against the buyer. The right of the partners to compete is
subject to the general limitations already discussed. This right
of the partners considerably reduces the value of the goodwill
if it does not destroy it altogether.
The mere fact that there is no item of goodwill in the accounts
does not of itself deprive a retiring partner or representative of a
deceased partner of his due share of the value of the goodwill.
If there is nothing expressly to the contrary in the articles of
partnership, or the annual accounts are not made the basis of
the final account, goodwill must be brought in when the final
account is made. Two legal cases are in point. In the case of
Stewart v. Gladstone (England, i879), the partnership articles
provided that a yearly general account should be taken of
"stocks, moneys, debts, and other effects," and that a fair
valuation whould be made of everything susceptible of valuation.
The court held that this did not include goodwill and the retiring
partner was not entitled to anything for goodwill.
In the case of David v. Matthews (England, i899), the partner-
ship articles provided that "in the case of death of one of the
partners, a general account shall be made of all effects and
securities of whatsoever nature, and the value of such effects
and securities be estimated as at the date of such decease."
This was held to include goodwill, the goodwill to be valued as
if it were sold and subject to the usual rights of the other partners
to compete with the old business.' Goodwill has also been
held to be included in the term "assets of the business. 12
When a partner is admitted and a payment made by the new
partner on account of goodwill, the accounts may be handled
in several ways according to the agreement made. One way
would be to set up the account for goodwill on the books before
the new partner is admitted, crediting the amount to the old
I C. Bartle, The Accountant, May, I9I9, p. 2i6.
2 Dicksee, Goodwill, p. 39.

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298 THE UNIVERSITY.JOURNAL OF BUSINESS

partner's accounts in the proportion in which they share profits.

Another way would be for the incoming partner to pay in an
extra amount of cash, to be credited to the accounts of the old
partners. Another way would be for the new partner to pay a
specified sum to the old partners outside the business, the cash
becoming their own. Whichever way is employed should be
agreed upon in very definite terms so that there can be no
misunderstanding.
In like manner when a partner retires and is paid his share
of goodwill by the others, the fund may be paid out of the
business or by additional funds advanced by the other partners.
In either case an item of goodwill might be set up on the books.
It is the contention of Dicksee' that goodwill should be got
rid of from partnership accounts as soon as possible. He would
set it up when a new partner is admitted on terms relative to
goodwill, but he would write it off according to the profit sharing
ratio as soon as the new partner is admitted. He, would also
set up the account of goodwill when a partner retires, but this
also he would write off as soon as possible after the readjustment
is made. His reason is that it is possible to write off the goodwill
against the partners' capital accounts, while in the case of a
corporation, its would be possible to write off the goodwill only
is case the surplus is sufficiently large. It is difficult, however,
to reconcile this view with his other argument that goodwill
does not depreciate and need not be written off in the case of
corporation accounts. The fact that payment is received for a
share of goodwill in the case of an incoming partner, or made to
an outgoing partner, indicates that there is a real value to the
goodwill of the partnership. If the view is accepted that goodwill
does not depreciate, it seems more logical to retain it on the books
of the partnership.
Goodwill as an asset has been used to conceal questionable
practices. It has been used to cover up trade losses, discount
on stock sold, deferred charges, organization expenses, pure stock
watering, and similar deficiencies. For this reason, goodwill
I Ibid., p. 8o.

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 GOODWILL IN THE ACCOUNTS 299

has come to be looked upon as a doubtful asset, and according

to present practice it is rightly a signal for further investigation.
When used according to correct practices, it is a real asset and
should be so considered. If corporations could be induced to
follow the principles here laid down for the handling of goodwill
in the accounts, goodwill would come to mean something more
than a shield for mismanagement.
RICoAWD N. OwENs
UNIVERSITY OF CHICAGO

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