Lesson Notes By Weeks and Term - Senior Secondary 2

Term: 2^nd Term

Week: 4

Class: Senior Secondary School 2

Age: 16 years

Duration: 40 minutes of 2 periods each

Date:       

Subject:      Financial accounting

Topic:-       Partnership account IV

SPECIFIC OBJECTIVES: At the end of the lesson, pupils should be able to

1. Give reasons for the admission of new partners
2. Explain goodwill and its valuations

INSTRUCTIONAL TECHNIQUES: Identification, explanation, questions and answers, demonstration, videos from source

INSTRUCTIONAL MATERIALS: Videos, loud speaker, textbook, pictures

INSTRUCTIONAL PROCEDURES

PERIOD 1-2

PRESENTATION	TEACHER’S ACTIVITY	STUDENT’S ACTIVITY
STEP 1 INTRODUCTION	The teacher reviews the previous lesson on partnership account	Students pay attention
STEP 2 EXPLANATION	She gives reasons for the admission of new partners	Students pay attention and participates
STEP 3 DEMONSTRATION	She explains goodwill and its valuations.	Students pay attention and participate
STEP 4 NOTE TAKING	The teacher writes a summarized note on the board	The students copy the note in their books

 

NOTE

PARTNERSHIP ACCOUNT

A business firm seeks new partners with business expansion being one of

the driving motives. A new partner can be admitted into the firm with the

consent of all the existing partners, unless otherwise agreed upon.

With the admission of a new partner, there is a reconstitution of the

partnership firm and all the partners get into a new agreement for carrying

out the business of the firm. 

The following conditions led to the addition of a new partner:

1. When the firm is in an expansion mode and requires fresh capital.
2. When the new partners possess expertise which can be beneficial for the business expansion of the firm.
3. When the partner in question is a person of reputation and adds goodwill to the firm.

 

The following adjustments need to be made at the time of admission of a

new partner

1. Calculating the new profit-sharing ratio along with the sacrificing ratio.
2. Accounting for goodwill.
3. Revaluation of assets and liabilities.
4. Adjustment of capital as per new profit-sharing ratio.

 

With the admission of a new associate, the partnership enterprise is

restructured and a new agreement is entered into; to carry on the trading

concern of the enterprise. A newly added partner obtains 2 primary rights in

the enterprise:

• Right to share the assets of the partnership firm
• Right to share the profits of the partnership firm

 

GOODWILL AND ITS VALUATIONS

Goodwill is an intangible asset associated with the purchase of one

company by another. Specifically, goodwill is recorded in a situation in

which the purchase price is higher than the sum of the fair value of all

visible solid assets and intangible assets purchased in the acquisition and

the liabilities assumed in the process. The value of a company’s brand

name, solid customer base, good customer relations, good employee

relations, and any patents or proprietary technology represent some

examples of goodwill.

 

Goodwill Meaning in Accounting

Goodwill arises when a company acquires another entire business. The

amount of goodwill is the cost to purchase the business minus the fair

market value of the tangible assets, the intangible assets that can be

identified, and the liabilities obtained in the purchase.

 

How to Calculate Goodwill

To calculate goodwill, we should take the purchase price of a company and

subtract the fair market value of identifiable assets and liabilities.

 

Goodwill Formula: 

Goodwill = P−(A+L)

where,

P = Purchase price of the target company

A = Fair market value of assets

L = Fair market value of liabilities

 

Types of Goodwill

There are two distinct types:

• Purchased: Purchased goodwill is the difference between the value paid for an enterprise as a going concern and the sum of its assets less the sum of its liabilities, each item of which has been separately identified and valued.
• Inherent: It is the value of the business in excess of the fair value of its separable net assets. It is referred to as internally generated goodwill, and it arises over a period of time due to the good reputation of a business. It can also be called as self-generated or non-purchased goodwill.

For example, suppose you are selling an outstanding product or providing

excellent service consistently. In that case, there is a high chance of an

increase in goodwill.

 

Goodwill Accounting Treatment

There are five types of accounting treatment of goodwill at the time of

admission of a new partner:

• When the amount of goodwill is brought in cash and not recorded in books.
• When the new partner brings his share of goodwill in cash and is retained in business.
• When the new partner does not bring his share of goodwill in cash.
• When goodwill already exists in the books.
• When goodwill is raised at its full value.

 

Goodwill Example

To put it in a simple term, a Company named ABC’s assets minus liabilities

is ₹10 crores, and another company purchases the company ABC for ₹15

crores, the premium value following the acquisition is ₹5 crores. This ₹5

crores will be included on the acquirer’s balance sheet as goodwill. It is

also recorded when the purchase price of the target company is higher

than the debt that is assumed.

 

Factors Affecting Goodwill

The following factors have an impact on the goodwill, which are:

1. Location of the business: A business which is located in a suitable location will have a more favourable chance of higher goodwill than a business located in a remote location.
2. Quality of goods and services:  A business which is providing a higher quality of goods and services stands a great chance of earning more goodwill than competitors who provide inferior goods and services.
3. Efficiency of management: An efficient management results in increase in profit of the business which enhances the goodwill of the business.
4. Business Risk: A business having lesser risk has a better chance of creating goodwill than a high-risk business.
5. Nature of business:It means the type of products that business deals with, the level of competition in the market, demand for the products and the regulations impacting the business. A business having a favourable outcome in all these areas will have a greater goodwill.
6. Favourable Contracts: A firm will enjoy a higher goodwill if it has access to favourable contracts for sale of products.
7. Possession of trade mark and patents: Firms that have patents and trademarks will enjoy monopoly in the market, which will contribute to the increase in the goodwill of the firm.
8. Capital: A firm with a higher return on investment along with lesser capital investment will be considered by buyers as more profitable and having more goodwill.

 

Need for Valuation of Goodwill

• The difference in the profit-sharing ratio (PSR) amongst the existing partners
• Admission of a new partner
• Retirement of a partner
• Death of a partner
• Dissolution of an enterprise involving the sale of the business as a trading concern
• Consolidation of partnership firms

 

Methods of Valuation of Goodwill

The significant methodologies of valuation are mentioned:

• Average Profits Method
• Super Profits Method
• Capitalisation Method

Treatment of Goodwill in the Admission of a Partner

 

Adjustment of Capital and Change in Profit Sharing Ratio Among Existing Partners

Few significant points which require observation during the admission of a new partner are mentioned below:

1. Sacrificing ratio
2. New profit-sharing ratio
3. Revaluation of assets and Reassessment of liabilities
4. Valuation and adjustment of goodwill
5. Adjustment of partners’ capitals
6. Distribution of accumulated profits (reserves

 

EVALUATION:    1. Give reasons for the admission of new partners

2. Define goodwill
3. Discuss the valuations of goodwill

CLASSWORK: As in evaluation

CONCLUSION: The teacher commends the students positively