Goodwill and Change in Profit Sharing Ratio Class 12 Notes

Goodwill is an intangible value of a company that comes from things like having a good reputation, loyal customers, talented employees, valuable brands, and patents. Here are the notes of this chapter.

Goodwill

Goodwill is nothing more than the popularity that the old customer will resort to the old place.

Types of Goodwill

There are two types of Goodwill:
1) Self Generated Goodwill
2) Purchased Goodwill

Self Generated Goodwill

It is internally generated goodwill that arises from several characteristics that an ongoing business has.

Note: As per AS-26(intangible assets), self-generated goodwill is not to be shown in books of accounts because consideration in money or money’s worth is not paid for it.

Purchased Goodwill

It is goodwill that is acquired by making a payment in cash or kind.

For Example, when a business is purchased and purchase consideration is more than the value of net assets, the difference amount is the value of purchased goodwill.

Methods of Calculating Goodwill

There are mainly three methods of calculating goodwill:
1) Average Profit Method
2) Super Profit Method
3) Capitalisation Method

Average Profit Method

Goodwill = Average Profit * Number of years purchased

Average Profit = Total amt. of profit/Total number of years

Important Things to Note

• If there is any abnormal income/gain in any year, it should be deducted from the net profit of that particular year.
• If there is any abnormal loss in any year, it will be added back to the net profit of that particular year.
• Income from investment is treated as an abnormal income as it is received from outside the business.
• If there is any increasing or decreasing trend in profits then the weighted average profit method is used instead of the simple average profit method.

Goodwill = Weighted Average Profit * No. of years purchased

Weighted Average Profit = Sum of Profits/ Sum of Weights

Adjustment of Stock

• If closing stock is overvalued it shows that profit is also overvalued. To rectify this, profits need to be reduced.
• If closing stock is undervalued, it shows that profit is also undervalued. To rectify it, profits need to be added back.
• If opening stock is overvalued it shows that profit is undervalued. To rectify this, profit needs to be added back.
• If the opening stock is undervalued, it shows that profit is overvalued. To rectify this, profit needs to be reduced.

Super Profit Method

Goodwill = Super profit * No. of years purchased

Super Profit = Average Profit – Normal Profit

Normal Profit = Capital Employed * Normal Rate of Return/ 100

Capital Employed = Assets – Liabilities
or
Total Capital + Reserves & Surplus

Capitalisation Method

a) Capitalisation of Average Profits

Goodwill = Capitalised Value – Capital Employed

Capitalized Value = Average Profit * 100/Normal Rate of Return

Capital Employed = Assets – Liabilities
or
Total Capital + Reserves & Surplus

b) Capitalisation of Super Profits

Goodwill = Super Profits * 100/Normal Rate of Return

Super Profit = Average Profit – Normal Profit

Accounting Treatment of Goodwill, Reserves & Accumulated Profits & Losses in Case of Change in PSR

1) Accounting Treatment of Goodwill

Gaining Partner’s Capital A/c Dr.
To Sacrificing Partner’s Capital A/c

2) For Profits and Reserves

WCR A/c Dr.
IFR A/c Dr.
Reserve A/c Dr.
P&L A/c (credit bal.) Dr.
To old partner’s Capital/Current A/c

3) For Accumulated Losses

Old Partner’s Capital/Current A/c Dr.
To P&L A/c (debit bal.)
To Deferred Rev. Exp. A/c

Treatment of Goodwill

If there is an existing goodwill in books, it should be written off between all partners in their old profit-sharing ratio. The Journal entry will be;

All Partner’s Capital/Current A/c Dr.
To Goodwill A/c

For the current value of goodwill, gaining partners will compensate the share of goodwill to sacrificing partners. The journal entry will be;

Gaining Partner’s Capital/Current A/c Dr.
To Sacrificing Partner’s Capital/Current A/c

Fundamental of Partnership Notes Class 12

Accounting Treatment when the assets and liabilities are not to be shown at their altered values

In this case, rather than preparing a revaluation A/c, we will make a statement showing the profit or loss that arises on A/c of change in the value of assets and liabilities and pass entry of net effect.

Gaining Partner’s Capital/Current A/c Dr.
To Sacrificing Partner’s Capital/Current A/c

Working Note

Revaluation A/c

Revaluation A/c is prepared to ascertain the profit or loss on revaluation of assets and liabilities at the time of reconstitution of the firm.

Nature of Revaluation A/c is Nominal A/c.

Revaluation A/c

Distribute the profit/loss between old partners in their old profit-sharing ratio.

In case of Profit:
Revaluation A/c Dr.
To Old Partner’s Capital/Current A/c (Old Ratio)

In case of Loss:
Old Partner’s Capital/Current A/c Dr.
To Revaluation A/c (Old Ratio)