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Goodwill is defined as the difference between the value of a business as a whole and the fair value of its separable new assets. Goodwill = Selling.

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Presentation on theme: "Goodwill is defined as the difference between the value of a business as a whole and the fair value of its separable new assets. Goodwill = Selling."— Presentation transcript:

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3 Goodwill is defined as the difference between the value of a business as a whole and the fair value of its separable new assets. Goodwill = Selling price as a going concern – Fair value of separate net assets = Selling price – (Assets –Liabilities) = Selling price – (Assets –Liabilities)

4 Value of business as a whole Aggregate value of net assets > Goodwill Admission of new partner Retirement of a partner Change in profit-sharing ratio Treated as in tangible fixed assets Written off immediately Goodwill account opened Goodwill account not opened

5 Reason for payment of goodwillReason for payment of goodwill In buying the an existing business which has been established for some time, there may be quite a few possible advantages.

6 (1) A large number of regular customers who will continue to deal with the new(1) A large number of regular customers who will continue to deal with the new owner. owner. (2) The business has a good reputation.(2) The business has a good reputation. (3) It has experienced, efficient and reliable employees.(3) It has experienced, efficient and reliable employees. (4) The business is situated in a good location.(4) The business is situated in a good location. (5) It has good contacts with suppliers.(5) It has good contacts with suppliers. (6)Well-known products(6)Well-known products (7)The possession of favourable contracts.(7)The possession of favourable contracts. None of these advantage are available to completely new businesses. For this None of these advantage are available to completely new businesses. For this Reason, many people would decide to buy existing business and pay an amount for Reason, many people would decide to buy existing business and pay an amount for Goodwill. Goodwill.

7 Existence of goodwill Goodwill does not necessarily exist in a business. If the business has a bad reputation an inefficient labour force or other negative factors, the owner may be unlikely to be paid for goodwill on selling the business. Goodwill ︰ Average annual sales / fees / profits over certain number of years X a factor

8 Average sales method ‧ In many retail businesses, the average yearly sales for the past few years are multiplied by an agreed figure. ‧ For instance, suppose it is agreed that the goodwill should be three times the Average yearly sales for the last two years.

9 ExhibitExhibit Year Sales Year Sales $ Total Total ======= ======= Average sales=$300000/2 = $ Goodwill calculated=3 x $ = $450000

10 Annual fees method Professional firms, such as accountants or lawyers, often use a method based on grossProfessional firms, such as accountants or lawyers, often use a method based on gross annual income from fees, before charging expenses. annual income from fees, before charging expenses.

11 Exhibit Exhibit A firm of accountants is selling its business. It is asking a figure for goodwill which is 2.5 times the average annual fees received for the last two years. Year FeesYear Fees $ ======= ======= Average annual fees $400000/2 = $ Average annual fees $400000/2 = $ Goodwill calculated $ x 2,5 = $500000

12 Average net annual profits method Using this method, the average net profits for a number of years is multiplied by a States amount.Using this method, the average net profits for a number of years is multiplied by a States amount.

13 Exhibit Suppose goodwill is taken to be four times the average net annual profits for the past Three years. Year Net profit ======== Average net annual profits $210000/3 = $70000 Goodwill calculated 4 x $70000 =

14 Super profits method Super profits method It may be argued, as in the case of a sole trader, that the net profits are not ‘ true profit ’. This is because the net profit does not reflect the following circumstances.It may be argued, as in the case of a sole trader, that the net profits are not ‘ true profit ’. This is because the net profit does not reflect the following circumstances.

15 (1) Services of the proprietor. He has worked in the business, but he has not charged for such services. Any drawings he makes are charged to a capital account, not to the profit and loss account.(1) Services of the proprietor. He has worked in the business, but he has not charged for such services. Any drawings he makes are charged to a capital account, not to the profit and loss account. (2) The use of the money he has invested in the business. If he had invested his money elsewhere, he would have earned interest or dividends on such investments.(2) The use of the money he has invested in the business. If he had invested his money elsewhere, he would have earned interest or dividends on such investments.

16 It is usually calculated as: It is usually calculated as: $ $ $ $ Annual net profits Less (1) Remuneration proprietor would have earned for similar work elsewhere for similar work elsewhere (2) Interest that would have been earned if capital (2) Interest that would have been earned if capital had been invested elsewhere had been invested elsewhere Annual super profits ======= ======= The annual super profits are then multiplied by a number agreed by the seller and the purchaser of the business.

17 Accounting for Goodwill in Partnership ‧ Any change in profit-sharing ratio means that the ownership of the goodwill will also change. ‧ In each of the following cases , a change in the profit-sharing ratio takes place and therefore goodwill adjustments must be made ︰ ~ Admission of a new partner ~ Admission of a new partner ~ Retirement of an old partner ~ Retirement of an old partner ~ Change of profit-sharing ratio between existing ~ Change of profit-sharing ratio between existing partners partners

18 Admission of a New Partner ‧ The new partner is required to pay for his share of the tangible assets as well as the goodwill , according to the profit-sharing ratio.Therefore goodwill must be revaluated. (1)Goodwill Account Opened ‧ Goodwill account will be shown in the Balance Sheets as “Intangible Fixed Asset”. ‧ Accounting entries ︰ Dr-Goodwill Account With the value of goodwill Cr-Capital Accounts(old partners only With their share of goodwill in old ratio

19 (2)Goodwill Account Not Opened ‧ Goodwill account will not be shown in the Balance Sheet. ‧ Accounting entries ︰ Dr-Goodwill Account Cr-Capital Accounts(old partners only Share goodwill among all partners in the old profit- sharing ratio. Dr-Capital Accounts(all partner) Cr-Goodwill Account Write off goodwill among all partners in the new profit- sharing ratio. ‧ The new partner may be required to pay extra cash , or have his capital balance reduced , for his share of goodwill.

20 Retirement of a partner (1)Goodwill Account Opened Dr-Goodwill Account Cr-Capital Account(all Partners) or Cr-Goodwill Account With the increase in the value of goodwill , shared in the old ratio. With the decrease in the value of goodwill , shared in the old ratio Dr-Current Account(leaving partner) Cr-Capital Account(leaving partner) or Dr-Capital Account(leaving partner) Cr-Current Account(leaving partner) Transfer the balance in the current account of the leaving partner to the capital account. Dr-Capital Account(leaving partner) Cr-Cash / Bank / Loan Cash paid to leaving partner or the leaving partner or the leaving partner retains the balance as a loan to the firm.

21 (2)Goodwill Account Not Opened Dr-Goodwill Account Cr-Capital Account(all Partners) With the increase in the value of goodwill , shared in the old ratio. Dr-Capital Account(remaining partner) Cr-Goodwill Account Write off the goodwill , in new ratio. Dr-Current Account(leaving partner) Cr-Capital Account(leaving partner) or Dr-Capital Account(leaving partner) Cr-Current Account(leaving partner) Transfer the balance in the current account of the leaving partner to the capital account. Dr-Capital Account(leaving partner) Cr-Cash / Bank / Loan Cash paid to leaving partner or the leaving partner or the leaving partner retains the balance as a loan to the firm.

22 Change in the Profit-sharing Ratio (1)Goodwill Account Opened Dr-Goodwill Account Cr-Capital Account(all partners) With the increase in the value of goodwill , shared in the old ratio. (2)Goodwill Account Not Opened Dr-Goodwill Account Cr-Capital Account(all partners) With the increase in the value of goodwill , shared in the old ratio. Dr-Capital Accounts Cr-Goodwill Account Write off the goodwill , in new ratio.

23 Revaluation of assets

24 Chang of partnership --Admission of new partners --Retirement of partners --Change in profit-sharing ratio Revaluation of asset

25 Introduction In the changes of a partner, admission or retirement of a partner, the assets and liabilities may be revalued to reflect the fair value of the business. Ant profits or losses on revaluation are normally entered in the partners’ capital account according to the profit sharing ratio before Change.

26 Accounting for a Revaluation

27 With increase in value of assets Dr-Assets Cr- Revaluation Revaluation XXX Assets Revaluation Assets XXX

28 With decrease in value of assets Dr-Revaluation Cr-Assets Assets XXX Revaluation Assets Revaluation XXX

29 With provision for depreciation on revalued assets Dr-Provision for depreciation Cr-Revaluation Provision for depreciation Revaluation XXX Revaluation Depreciation XXX

30 With increase in provision for bad debt Dr-Revaluation Cr-Provision for Bad Debts Revaluation Provision for XXX Bad Debts Provision for Bad Debts Revaluation XXX

31 With profit on revaluation (shared among partners, according to the old profit- sharing ratio) Dr=Revaluation Cr-Capital Revaluation XXXX XXX Bal B/d: Partner A XX Partner B XX XXXX XXX Capital A B Profit on XX XX revaluation

32 With loss on revaluation (shared among partners, according to the old profit sharing ratio) Dr-Capital Cr-Revaluation Capital Revaluation A B Loss on XX XX revaluation XXXX XXX Share loss: Partner A XX Partner B XX

33 6A 鐘兆康 6A 王志勇 6A 余玉君


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