Under this method the value of the firm is first determined based on the market capitalization rate using the following formula:
Average profit of the firm x 100
% of market rate of return
The above formula will give an estimate of the firm‟s value in the market. By subtracting the book value of the net assets (owners‟ equity/capital) of the firm from the above calculated value we shall get the amount of goodwill.
Suppose average profit of the firm is Rs. 45,000 and the market rate of return is 18% and the capital (net assets) of the firm is Rs. 200,000.
Then the good will of the firm will be calculated as under:
Goodwill = 45,000 / 18 x 100 = 250,000
= 250,000 -200,000
= Rs. 50,000
Goodwill Raised Scenario-1
When the incoming partner cannot bring cash as premium for goodwill
Here, the capital accounts of the old partners are artificially inflated towards the right of the
goodwill, without any cash contribution. The idea is that if the business were sold immediately after the admission of the new partner and the goodwill as well as other assets are realized at their book value, the old partners would automatically receive cash for their share of the goodwill since the amounts
attributable to them in respects of the goodwill are now included in their respective capital accounts.
In this case, goodwill account is to be raised in the books of account at its full value by debiting the goodwill account and crediting the old partners‟
capital accounts in old ratio.
Journal Entry
Goodwill A/c 135,000 A‟s capital A/c 81,000 B‟s capital A/c 54000 Working
A‟s share = 135,000 x 3/5 = 81,000 B‟s share = 135,000 x 2/5 = 54,000
Important Note
Following should be taken in to account when doing the above treatment for goodwill:
1. If goodwill already appears in the Balance Sheet which is equal to full value of goodwill so
calculated, then no entry is required to be passed.
2. If goodwill already appears in the Balance Sheet which is less than the full value of goodwill then goodwill is to be raised for the balance (full value of goodwill calculated less goodwill already
appearing in the Balance sheet)
3. If goodwill already appears in the Balance sheet which is more than the full value of goodwill, then excess goodwill is to be written off. The journal entry will be as under:
Old partners‟ capital accounts Dr Goodwill accounts Cr
(Being the value of the goodwill written down to its calculated value)
Goodwill Raised & Written-Off Scenario-2 When the incoming partner cannot bring anything as premium for goodwill but no goodwill is to appear in the books:
Since the value of the goodwill constantly changes and partners may not wish that an account should remain in the books, goodwill is raised in the books first and, thereafter it is written off. Advance
Financial Accounting (FIN-611) VU (C) Copyright Virtual University of Pakistan 94
Journal Entry (Goodwill raised) Goodwill A/c 135,000
A‟s capital A/c 81,000 B‟s capital A/c 54000
Journal Entry (Goodwill raised & written off ) A‟s capital A/c 67,500
B‟s capital A/c 45,000 C‟s capital A/c 22,500 Goodwill A/c 135,000 A’s benefit Goodwill Brought in Cash Scenario-3
When the required amount of premium for goodwill is brought in by the incoming partner and the money is retained in the business to increase the cash
resources:
In this situation, premium for goodwill is to be
shared by the old partners in the sacrificing ratio.
The sacrificing ratio is to be calculated by
deducting the new ratio from the old ratio for each partner. It should be noted that when the profit sharing ratio between the old partners does not
change as between themselves, this old profit sharing ratio is their sacrificing ratio.
Goodwill brought in cash Bank A/c 22,500
C‟s premium for goodwill A/c 22,500
Distribution of goodwill (sacrifice ratio) C‟s premium for goodwill A/c 22,500
A‟s capital A/c 13,500
B‟s capital A/c 9,000
A‟s share = 22,500 x 3/5 = 13,500
B‟s share = 22,500 x 2/5 = 9,000 Advance Financial Accounting (FIN-611) VU (C) Copyright Virtual
University of Pakistan 95
Goodwill Brought in Cash & Withdrawn Scenario-4 When the required amount of premium for goodwill is brought in by the new partners and this amount is immediately withdrawn by the old partners:
Goodwill brought in cash Bank A/c 22,500
C‟s premium for goodwill A/c 22,500
Distribution of goodwill (sacrifice ratio) C‟s premium for goodwill A/c 22,500
A‟s capital A/c 13,500 B‟s capital A/c 9,000 Goodwill withdrawn
A‟s capital A/c 13,500 B‟s capital A/c 9,000
Bank A/c 22,500 Advance Financial Accounting (FIN-611) VU (C) Copyright Virtual University of Pakistan 96
PARTNERSHIP ACCOUNTS (Cont.)
Questions
Laiquee, Imran and Ishtiaq are in partnership. They shared profit in the ratio 2:5:3. It is decided to admit Amir. Amir will bring Rs. 4,000 cash into the business for capital. It is agreed that goodwill was worth Rs. 10,000, but that is not to be brought into business record. The new profit sharing ratio is to be 3:4:2:1.
The balance sheet before Amir was introduced as a new partner was as follow:
Assets (Rs.) Less Creditors 3,500 Net Assets 12,000 Capital (Rs.)
Laiquee 3,000 Imran 5,000 Ishtiaq 4,000
12,000
After the admission of Amir Assets are revalued:
Assets (Rs.) Building 10,000 Machinery 2,500 Stock 1,800 Required:
1. Record necessary accounting entries 2. Prepare capital Accounts
3. Post admission balance sheet
Questions
Two partners A & B were sharing profit ratio 3:2. “A”
gets salary of Rs. 2,800 per annum. After six months, C was admitted as a new partner and shared profit 1/5. According to new profit sharing ratio, A and B will get equal share. The new profit ratio is 2:2:1.
C will also get salary Rs. 2,400 per annum.
• Total sales Rs. 160,000
• Sales of first six months Rs. 96,000
• Sales of next six months Rs. 64,000
Required: Distribute Rs. 19,000 profit among partners.
Retirement of Partner
Issues Relating to Retiring Partner Step 1. Calculation of goodwill
Step 2. Revaluation of goodwill/raise the goodwill Step 3. Revaluation of net assets
Step 4. Preparation of partner's capital account Step 5.Transfer of retiring partner‟s capital account into his loan account
Step 6. Make part payment or full payment of his loan account (depending upon the cash availability)
Step 7. Prepare post retirement balance sheet Let us understand the accounting treatment by retiring Laiquee (Solved Question # 1):
Total Profit Distribution:
Transfer capital account to loan account Retiring partner capital A/c
Retiring partner Loan A/c
Transfer Laiquee‟s capital account to loan account Laiquee‟s capital A/c 5,260
Laiquee‟s loan A/c 5,260 Part payment of Laiquee loan
Laiquee‟s loan A/c 2,000 Cash A/c 2,000
“Hire Purchase”
Definition: The hire purchase system is a system under which the purchase is paid in number of installments as soon as the contract is entered into and the first installment is paid the hire purchaser acquires position (not the owner ship) of the goods. After the payment of the final installment the hire purchaser becomes the full fledged owner of the goods. So long as he does not become the owner, the installments paid by him are considered to be the payments for hire. In case the hire purchaser fails to pay any particular installment, the seller or vendor can take away the goods, and the installments already paid become forfeited. Thus, the essential features of a hire purchase system are
a. The position of goods (not the owner ship) is transferred to the hire purchaser the goods remains the property of seller until the buyer as paid the entire installments.
If default is made by the hire purchaser in payments, the seller can take away the goods.
b. The hire purchaser is not forced to complete the whole transactions. If he so desires, the hire purchase agreement may be cancelled and the goods returned, but he will forfeit the installments he has paid.
c. The hire purchaser is responsible for keeping the goods in good condition so long as they remain the property of the seller.
d. As the seller retains the ownership of goods he must get them insured against loss or damage.
It‟s the system, under which the purchase price has to pay by the purchaser in a number of periodical installments which easily resembles the hire purchase system, is called installments purchase system.
Hire Purchase Installment Purchase
The purchaser obtains the possession of the obtains the delivery of it and begins to use.
In the vender system the vender can not re-
QUESTIONS SOLVED FOR PRACTICS FROM GIVEN BOOKS