Chapter 42

Goodwill for sole proprietors and

partnerships
Our amazing group members include:

• Hsu Yati Phyu  II BM 11

• Khaing Shwe Sin Win  II BM 15
• Khin Pa Pa Lwin  II BM 16
• Khin Thiri Myat Thu  II BM 17
• Myat Htoo Zaw  II BM 47
• Ei Kay Zin Aung  II BM 61
• Phone Myat  II BM 73
Table of contents
Here, we will talk about:
• A range of methods for arriving at the selling price of a business
• Calculating super profits
• Why goodwill exists
• Why goodwill has a monetary value
• Difference between purchased and non-purchased goodwill
• Calculating purchased goodwill
• Calculating adjustments needed when there is some form of change in a partnership
42.1 Nature of goodwill
How much would you ask as the total sale price of the business which has been running for some
years?
Buildings 225,000
Machinery 75,000
Accounts receivable 60,000
Inventory 40,000
400,000
If there are any liabilities, you would deduct from the total value of the assets to arrive at the value
of net assets.
If you sold off everything separately, you would expect to receive $400,000.
If you were running a successful business, would you be willing to sell it for the value of its net assets?

As the business is successful, there are buyers who will be willing to pay more than $400,000 net
asset value.
If someone bought it with $450,0000, the extra payment $50,000 would be goodwill.

Purchased Goodwill = Total price less value of net identifiable assets

• Goodwill is an intangible asset.

• It exists when the amount paid was greater than the value of the net assets.
• Goodwill represents value of reputation of the business at the time it was purchased.
42.2 Reasons for payment of goodwill
Some reasons why people are willing to buy an existing business

 The new owner will continue to deal with a large number of regular customers.
 A good reputation
 It has experienced, efficient and reliable employees.
 Situated in a good location
 It has good contacts with suppliers
 It has well-known brand names that have not been valued and included as assets.

These advantages are not available to completely new business.

42.3 Existence of goodwill
Goodwill exist depending on the business condition.
- If a business has a bad reputation, an inefficient labor force or other negative factors,
the owner would not be received for goodwill on selling the business.
- In the example in Section 42.1, goodwill was a positive figure of $50,000. If instead, it
had been the negative figure of $100,000.
42.4 Methods of calculating goodwill
 No single way of calculating goodwill.

 All that is certain is that the agreed price to be paid exceeds the value of the net assets and
that amount represents goodwill.

 Various methods are used to help buyer and seller come to an agreed figure for a business.

 Very often an industry or occupation has its own customary way of calculating goodwill.

Example: The average net annual profit for a specified past number of years multiplied by
an agreed number. This is often said to be x years’ purchase of the net profit.
Super-profit method
Super profits are what an accountant would call what is left of the net profits after allowances have been
made for (a) services of the proprietor and (b) the use of the capital

They are usually calculated as:

£ £
Annual net profits 80,000
Less (i) Remuneration proprietor would have earned for similar work 36,000
elsewhere
(ii) Interest that would have been earned if capital had been 7,000
elsewhere
(43,000)

Annual super profits 37,000

The annual super profits are then multiplied by a number agreed by seller and purchaser of the business
to arrive at the selling price.
42.5 Sole Proprietor’s books
 Goodwill is only entered in the sole proprietor’s accounts when it has been purchased.

 The existence of goodwill in the financial statement usually means that the business was
purchased as a going concern by the owner.

 That is, the owner didn’t start the business from scratch.

42.6 Partnership books

 The above concept does not apply for partnership; it is necessary to enter goodwill in partnership
businesses.

 Unless it has been agreed differently, partners own a share in the goodwill in the same ration in
which they share profits.

 This is true even if there is no goodwill account.

Changes in the ownership of goodwill
 The ownership of goodwill by partners changes in some way when:

a) Existing partners deciding to change profit and loss sharing ratio; or

b) A new partner being introduced; or
c) A partner retiring or dying

 The change may involve an adjustment in the books or cash passing from one partner to
another, so that the changes in ownership do not lead to a partner (partners) giving away their
share of ownership for nothing.
42.7 Change in profit sharing ratios of existing partners
• Sometimes the profit and loss sharing ratios have to be changed.
• Typical reasons are:
1. A partner may now not work as much as in the past, possibly because of old age or ill-
health.
2. A partner’s skills and ability may have changed, perhaps after attending a course or
following an illness.
New sharing ratio = 2 : 2 : 1
3. A partner may now be doing much more for the business than in the past.

E, F and G are in partnership, sharing profits and losses equally.

Old sharing ratio = 1 : 1 : 1
On 31 December 2016,
New sharing ratio = 2 : 2 : 1
On 31 December 2016, goodwill of this partnership is valued at £30,000.
Goodwill Adjustment
Partners’ Capital A/c
E F G E F G
£ £ £ £ £ £

Balance b/d 30,000 18,000 22,000

Goodwill with OLD ratio: £30,000 ( 1: 1: 1)  £10,000 for each partner

Goodwill with NEW ratio: £30,000 ( 2: 2: 1)

 £12,000 for E
 £12,000 for F
 £6,000 for G
(Working)
Goodwill A/c
£ £
Old Capital New Capital
E (30,000 * 1/3) 10,000 E (30,000 * 2/5) 12,000
F (30,000 * 1/3) 10,000 F (30,000 * 2/5) 12,000
G (30,000 * 1/3) 10,000 G (30,000 * 1/5) 6,000
30,000 30,000
Goodwill Adjustment
Partners’ Capital A/c
E F G E F G
£ £ £ £ £ £

Goodwill 12,000 12,000 6,000 Balance b/d 30,000 18,000 22,000

(NEW ratio)
Goodwill 10,000 10,000 10,000
(OLD ratio)
Balance c/d 28,000 16,000 26,000

40,000 28,000 32,000 40,000 28,000 32,000

42.8 Admission of New Partners
New partners may be admitted, usually for
one of two reasons
1. As an extra partner, either because the
firm has grown or because someone is
needed with different skills.
2. To replace partners who are leaving the
firm. This might be because of retirement
or death of a partner.
42.9 Goodwill on admission of new partners
The new partner will be entitled to a share in the profits, normally,
also to the same share of the value of goodwill. It is correct to charge
the new partner for taking over that share of the goodwill.
Creation of goodwill(old ratio) Goodwill written off(new ratio)
Goodwill A/C – Dr Goodwill A/C- Cr
Capital A/C –Cr Capital A/C - Dr
42.10 Goodwill adjustment when new partners
are admitted
This calculation is done in four stage
1. Show value of goodwill divided between old partners in the old profit
and loss sharing ratios. (Goodwill A/C Dr, partners’ capital A/C Cr)
2. Then show value of goodwill divided between partners ( including new
partner ) in the new profit and loss ratio.( Goodwill A/C Cr, Partners
capital A/C Dr)
3. Goodwill gain shown : charge these partners for the gain.
4. Goodwill loss shown : give these partners an allowance for their
losses.
Example: A and B are in partnership, sharing profits and losses equally. C is admitted
as a new partner. The three partners will share profits and losses one-third each.
Total goodwill is valued at $60000.
Stage 1 Stage 2 Stage 3

Partners Old profit Share of New profit Share of Gain of Loss Adjustment
shares goodwill shares goodwill needed

A 1/2 30000 1/3 20000 10000 Cr A

(loss) capital

B 1/2 30000 1/3 20000 10000 Cr B

(loss) Capital

C 1/3 20000 20000 Dr C

(gain) capital

60000 60000
D and E are in partnership sharing one-half each. A new partner F is admitted.
Profit will now be shared D one-fifth, and E and F two-fifth each. D and E, therefore,
have not kept their shares equal to each other. Goodwill is valued at $60000.

Stage 1 Stage 2 Stage 3

Partners Old profit Share of New profit Share of Gain or loss Adjustment
shares goodwill shares goodwill needed
D 1/2 30000 1/5 12000 18000 Cr D
(loss) Capital
E 1/2 30000 2/5 24000 6000 Cr E
(loss) Capital
F - 2/5 24000 24000 Dr F
(gain) capital
60000 60000
42.11 Accounting entries for goodwill
adjustments
These depend on how the partners wish to arrange the adjustment. Three
methods are usually used:
1. Cash is paid by the new partner privately to the old partners for his/her
share of the goodwill. No goodwill account is to be opened.
2. Cash is paid by the new partner into the business bank account for
his/her share of the goodwill. No goodwill account is to be opened.
Assume that the capital balances before F was admitted were D £50,000,
E £50,000, and F was to pay in £50,000 as capital plus £24,000 for
goodwill. The debit entry is to the bank account. The entries in the
capital accounts are:
3. Goodwill account to be opened. No extra cash to be paid in by the
new partner for goodwill.
The action required is:
 Debit goodwill account: with total value of goodwill;
 Credit capitals of old partners: with their shares of goodwill in old
profit sharing ratios.
 42.12 Where new partners pay for share of goodwill
 In the second case, £24,000 was paid for goodwill by
the new partner. Total goodwill at that time was
£60,000. The profit share of the new partner is 2/5. If
you divide £24,000 by 2/5 you get £60,000.
Therefore, if you didn't know that the total goodwill
was £60,000 you can calculate it by dividing the
amount a new partner pays for goodwill by that new
partner's profit sharing ratio.

• Unless otherwise agreed, the assumption is that the total value of goodwill is directly
proportionate to the amount paid by the new partner for the share of profit the new partner will
receive in future. If a new partner pays £12,000 for a one-fifth share of future profits, goodwill is
taken to be £60,000. A sum of £18,000 for a one-quarter share of future profits would,
therefore, be taken to imply a total value of £72,000 for goodwill.
42.13 Goodwill on withdrawal or death of partners

This depends on whether or not a goodwill

account exists.

If there was no goodwill account

If no goodwill account already existed the partnership goodwill should be valued because the out-
going partner is entitled to his/her share of its value. This value is entered in double entry accounts:
• Debit goodwill account with valuation.
• Credit each old partner's capital account in profit sharing ratios.
 
If a goodwill account exists
 
1. If a goodwill account exists with the correct valuation of goodwill entered in it, no
further action is needed.
2. If the valuation in the goodwill account needs to be changed, the following will apply:
 

Goodwill undervalued:
Debit increase needed to goodwill account.
Credit increase to old partners' capital accounts in their old profit sharing ratios.

Goodwill overvalued:
Debit reduction to old partners' capital accounts in their old profit sharing ratios.
Credit reduction needed to goodwill account.
Thank you for your
attention.

BYE ~