Accounts Class 12th (Ch.2 Changing the Profit Sharing Ratio among the existing Partner's) Part 1

Accounts (Ch.2 Changing the Profit Sharing Ratio among the existing Partner's) Part 1

Meaning of Goodwill - Goodwill means 'Good Name' or 'Reputation' earned by the firm through the hard work and honesty of its owners.

According to Lord Elden - "Goodwill is nothing more than the probability that the old customers resort (appeal) to old place".

It is the monetary value of that invisible power which attracts the customers.

Nature of Goodwill

1.It is intangible asset because it cannot be seen and touched.

2.All the assets can be separately sold but goodwill cannot be.

3.Goodwill has no separate existance while other assets have.

4.It is valued only when the entire business is sold.

5.It is an extra earning capacity of the business.

6.It is liable to constant fluctuation.

7.It is difficult to know the exact value of asset.

Factors affecting the Goodwill :- 

1. Favourable location of business.

2.Efficient Management.

3.Market Situation - Monopoly.

4.Good relation with customers.

5.Good quality of product.

6.Reasonable Prices.

7.After sales services.

8.Consumer Satisfaction.

9.Advantage of Patients , Copyright , Licences etc.

10.Excess to supplies.

11.Favourable contract.

Types of Goodwill :-

1.Dog Goodwill.

2.Cat Goodwill.

3.Rat Goodwill.

Need for the valuation of Goodwill :-

1.When the entire business is sold out (Purchases).

2.On the reconstitution of the partnership firm.

a)Change is profit sharing ration among the existing partner.

b)Admission of a new partner.

c)Retirement / Death of a partner.

d)Amalgmation of the partnership firms.

Classification of Goodwill :-

Purchased Goodwill.

a)It is the goodwill that is aquired by making the payment.

b)Such goodwill arises by the purchased of entire business.

c)Since a consideration value is paid for such goodwill , so it will be recorded into the books of accounts.

d)It is shown in the Assets side of Balance Sheet.

e)It is amortized (written off) over its useful economic life.

Identity of Purchased Goodwill :-

1.Goodwill will appears in the book Rs.5000.

2.Non - Purchased Goodwill / Self Generated Goodwill.

Goodwill does not appear in the books:-

Non Purchased Goodwill

a)It is internally generated goodwill.

b)It arises from the no. of factors such as efficient management , good quality product , favourable location etc.

c)No considerate value is paid for such goodwill.

d)It will not shown in the books of accounts.

(Special Note - As per A.S. 26 , internally generate goodwill is not to be recognized as an asset).

 Methods of the valuation of Goodwill :-

1.Average Profit Method - "Simple Average Profit Method" or "Past Profit Method"

FORMULA - Goodwill - Average / Actual Profit X No. of Year Purchased

A)Average / Actual Profit :-

Total Profit for all the Years
Total no. of years of which
profit or losses are given.

Average / Actual Profit is also called Average Maintainable Profit in future.

>No. of year's purchased - No. of year purchased means for how many years the firm will earn the same amount of profit after change in ownership.

For the valuation of goodwill we need the profit through the operating (normal) activities of the business.

>Operating (Normal) Profit - Profit during year + Abnormal losses - Abnormal incomes - Normal expense during the year + Normal incomes during the year.

*Abnormal Losses - Loss by Fire /  Loss by Theft / Loss by Accident / Loss on sale of Fixed Asset / Interest on Loan / Donation and Charity etc.

*Abnormal Incomes - Profit on sale of Fixed Asset / Rent Receives from Tenant / Interest on Investment / Dividend receives on Shares / Incomes through Lottery or Speculation.

*Normal Expenses - Salaries to Partners / Managerial Cost.

B)Weighted Average Profit Method - 

Formula :- Goodwill - Weighted Average Profit X No. of Years Purchased

a)Weighted Average Profit - Sum of Product
                                              Sum of Weight

b)Product - Profit X Weight

c)Weight - Importance of the given year's profit.

2.Super Profit Method :-

Goodwill - Super profit X No. of year purchased

a)Super Profit - Actual / Average Profit - Normal Profit.

b)Normal Profit - Capital Invested X Normal Rate of Return.

c)Capital Invested (Net Assets / Capital Employed).

*Assets - Liabilities or Sum of Partner's Capital + Reserves or Profit - Debit Balance of P&L A/c.

3.Capitalization Method :- 

a)Capitalized Average Profit Method.

Goodwill - Capitalized Average Profit - Actual Capital Employed.

Capitalized Average Profit - Average Profit X       100                          
                                                                             Normal Rate of Return

                                                                     

Actual Capital Employed - Assets - Liabilities

b)Capitalized Super Profit Method.

Goodwill - Super Profit X         100                          
                                               Normal Rate of Return

Reconstitution of the Partnership Firm

When an existing agreement comes to an end a new agreement comes into existence an the firm continuous is called Reconstitution Firm.

A Firm is Reconstituted when there is a :- 

a)Change in the Changing the Profit Sharing Ratio among the existing Partner's.

b)Admission of a Partner.

c)Retirement / Death of a Partner.

d)Amalgmation of two Partnership Firm (But it is not included in Syllabus.).

Change in the Changing the Profit Sharing Ratio among the existing Partner's.

Change in the Changing the Profit Sharing Ratio means change in ratio in which profit or loss of the firm is shared by the partner's.

                    A : B : C

Old Ratio     3 : 2  : 1

New Ratio   1  :1  : 1

The partner's decide to change in ratio due to :- 

1.Change in capital contribution.

2.Change in participation in the managerial activities.

Adjustment on the change in Ratio "Existing Partner's".

a)Calculate the sacrificing and gaining ratio.

b)Valuation and Accounting treatment of goodwill.

c)Accounting treatment of reserves profit & losses.

d)Accounting treatment of the revaluation of Assets & Reassesment of Liabilities.

e)Adjustment of Partner's Capital A/c.

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