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ADMISSION OF PARTNERS, GOODWILL AND REVALUATION OF ASSETS

Financial Accounting

ADMISSION OF NEW PARTNERS

This occurs when a new partner is admitted into an existing partnership business. The reasons for such admission usually are: expiration of old partnership agreement, to inject in more fund, bring in a specialist, death of an old partner, etc.

However, it will be unfair to the  existing partners for a new person to come in and take part in the established prosperous business without any reward  to the old partners. This compensation to the old partners is goodwill.

 

GOODWILL ON ADMISSION OF A PARTNER

Definition of Goodwill: Goodwill is the benefit and advantage attached to an old established business as a result of its good name, efficient management good connection, good location, etc which make it to earn more profit.

 

REASONS FOR PAYMENT FOR GOODWILL

Thus, a partner of an existing business or an incoming partner will be induced to pay for goodwill because of:

  • quality of goods and services (ii) favourable business location  (iii) efficient and loyal work force  (iv) efficient management  (v) possession of monopoly power  (vi) patents and trade marks  (vii) successful research and development  (viii) good public image, etc.

 

TREATMENT OF GOODWILL

Then goodwill will be brought into the business. This will be dealt with as follows:

  1. Raising and retaining Goodwill account in the books: Here, the value of goodwill is debited to goodwill account and credited to the capital accounts in the partners old profit and loss sharing ratio.

 

In partners’ OLD P & L sharing ratio

Accounting Entries: Dr. Goodwill A/c

Cr. Partners capital A/c

 

Any cash introduced by the new partner as capital, Dr Cash A/c; Cr. Capital A/c

 

  1. Goodwill is written off: If the business does not desire to retain the goodwill in the books, it will be necessary to write it off to the capital account of the partners in their NEW P&L sharing ratio
In partners NEW P&L sharing ratio

Accounting Entries – goodwill written off

Dr. Capital A/c; Cr. Goodwill A/c

 

EXAMPLE:

A and B are Partners who share profit equally. They decide to admit C by agreement, goodwill valued at N60,000 is to be introduced into the books. C is required to provide capital equal to that of B after he has been credited with his share of goodwill. The new profit sharing ratio is to be 4:3:3 to A, B and C respectively.

The partner’s balance sheet before the admission of C is as follows

Balance sheet

Capital: A               80,000                   Building                  80,000

B               40,000                   Motor Vehicle                   30,000

Furniture                40,000

Creditors                30,000                   Cash                      20,000

Other liabilities       20,000

170,000                                              170,000

 

Prepare the following:

  1. Journal and Ledger entries for the admission of C if goodwill account is to be retained.
  2. The new balance sheet as a result of admission of C and the retention of goodwill account.
  3. Journal and Ledger entries for the admission of C if goodwill account is not retained.
  4. New balance sheet showing C admission and goodwill not retained.

 

Solution

  1. Journal entries – goodwill account retained

 

JOURNAL

Debit                     Credit

Good will Account                                          60,000

Capital Account –  A                                                                             30,000

—  B                                                                    30,000

Being goodwill introduced and shared based

on old profit sharing ratio

Cash Account                                                          70,000

Capital Account C                                                                       70,000

Being capital contributed by C

 

Note: Since B’s capital was N40,000 before the goodwill of N30,000, then B’s capital will now be N70,000. Hence, C must contribute same amount as stated in the question.

Ledger – goodwill account retained

Goodwill Account

N                                                       N

Capital: A               30,000

B               30,000                   Bal c/d                   60,000

60,000                                                60,000

Bal b/d                   60,000

Capital Account

  A B C   A B C
 

 

 

Bal c/d

N

 

 

110,000

110,000

N

 

 

70,000

70,000

N

 

 

70,000

70,000

 

Bal b/d

Cash

Goodwill

 

Bal b/d

N

80,000

30,000

110,000

110,000

N

40,000

30,000

70,000

70,000

N

 

70,000

70,000

70,000

 

Cash Account

NN

Bal b/d                   20,000

capital                    70,000                   Bal c/d                   90,000

90,000                                                90,000

Bal b/d                   90,000

A, B and C

Balance Sheet

          N               N                 N
Goodwill 60,000
Fixed Assets
Building 80,000
Furniture 40,000
Motor vehicle 30,000 150,000
210,000
Current asset
Cash 90,000
Current liabilities
Creditors 30,000
Other liabilities 20,000 50,000
Net current asset 40,000
250,000
Financed by
Capital account
A 110,000
B 70,000
C 70,000
250,000

Journal entries – goodwill account not retained 

JOURNAL

Debit Credit
N  N
Goodwill Account 60,000
Capital – A 30,000
             B 30,000
Being creation of goodwill as agreed on
Admission of C
Cash account 70,000
Capital Account – C 70,000
Being Capital contributed  by C
Capital Account – A 24,000
                         B 18,000
                         C 18,000
Goodwill Account 60,000
Being goodwill written off using new
Profit sharing ratio

 

Cash Account

N                                                       N

Bal b/d                   20,000

C’s – Capital           70,000                   Bal c/d                   90,000

90,000                                                90,000

Bal b/d                   90,000

 

Goodwill Account

Capital Account – A           30,000         Capital Account – A           24,000

Capital Account – B           30,000         Capital Account – B           18,000

Capital Account – C           18,000

60,000                                                60,000

 

Capital Account

  A B C   A B C
  N N N N N N N
Goodwill

Bal c/d

24,000

86,000

 

110,000

18,000

52,000

 

70,000

18,000

52,000

 

70,000

Bal b/d

Cash

Goodwill

 

Bal b/d

80,000

30,000

110,000

86,000

40,000

30,000

70,000

52,000

70,000

70,000

52,000

A, B and C

Balance Sheet

Capital Account: Fixed Assets
  N N
A 86,000 Building 80,000
B 52,000 Furniture 40,000
C 52,000 Motor vehicle 30,000
190,000 150,000
Current liabilities Current asset
Creditors 30,000 Cash 90,000
Other liabilities 20,000
240,000 240,000

 

EVALUATION

  1. Explain the term Goodwill.
  2. List five circumstances that can give rise to the valuation of goodwill in partnership accounts.

 

REVALUATION OF ASSETS ON ADMISSION OF A NEW PARTNER INTO A PARTNERSHIP

The assets of a partnership should be revalued to show their current value in any of the following circumstances: (i) admission of a partner (ii) retirement of a partner (iii) changes occur in P & L sharing ratio of partners.

 

ACCOUNTING ENTRIES 

  • Open a Revaluation A/c;
    1. Assets A/c; Cr. Revaluation A/c with increase in value of asset
    2. Assets A/c; Dr. Revaluation A/c with reduction in value of assets.
    3. Revaluation A/c; Cr. Liabilities A/c with increase in value of liabilities
    4. Revaluation A/c; Dr. liabilities with reduction in the value of liabilities
  1. If Goodwill is introduced

Dr. Goodwill A/c; Cr Revaluation A/c with the amount of the Goodwill

  1. Transfer of profit on revaluation to the old partners capital account: 

Dr. Revaluation A/c in the old P & L sharing ratio

Cr. Capital A/c in the P & L sharing ratio

  1. Transfer of loss on revaluation

Cr. Revaluation A./c in the P & L sharing ratio

Dr. Capital A/c in the P & L sharing ration

  1. Goodwill to be written off

Cr. Goodwill A/c in the NEW P & L sharing ration

Dr. Capital A/c in the P & L sharing ratio

In revaluation of assets, the following accounts will be prepared.

  1. Revaluation Capital accounts of partners c. Balance sheet

 

Example

S & O are in partnership, sharing profits and losses equally. On 1/1/1995 they decided to admit J, who would be entitled to one quarter of any future profits, the balance being shared equally between S and O.

The financial position of the business before the admission of J was a follows:-

Freehold premises: N75, 000, Fixtures and fittings: N26, 000, Stock in trade: N105, 000 Debtors: N45, 000, Cash in hand: N12, 640, Creditors: N58, 940.

Additional information:

  1. It is agreed to value and retain goodwill at N30,000, b. Revalue the other assets as follows: Freehold premise: N100,000, Fixtures and fittings: N24, 000, Stock: N103, 000, c. Provision for bad debts of N3, 000 is to be made d. Capital is contributed by S and O equally J is to bring N80, 000 into the business as capital. You are required to prepare: i. Revaluation account  ii. Partners capital accounts in columnar form  iii. Opening balance sheet of the new partnership of S, O and J.

 

Solution

The closing balance sheet of the partnership must be prepared to show the capital contributed by J and S.

Balance Sheet

N                                              N

Capital: S 102,590

O 102,590              205, 180           Freehold premises   75, 000

Fixtures & fittings    26, 000

Creditors                             58, 940           Stock                   105, 480

Debtors                  45, 000

Cash in hand          12, 640

264, 120                                      264, 120

Note: The question states that capital is contributed equally by S and O.

Dr.                                        Revaluation account                                  Cr

N                                                                 N

Decrease invalue of assets                        Increase in value of asset

Fixture and fittings                     2,000           Freehold premises                      25,000

Stock                                        2,480           Goodwill                                    30,000

Provision for bad debts               3,000

Share of profit:

S        23,760

O       23,760         47,520

55,000                                                         55,000

 

Dr                                   Partners’ capital accounts                                                 Cr

S                 O            J                                S               O                  J

 

 

Balance c/d   126,350       126,350   80, 000  Bal. b/f          102,590       102,590       –

Cash            –                    –             80,000

Share of profit 23,760        23,760         –

126,350       126,350     80,000                     126,350       126,350        80,000

 

 

Share of profit        S (1/2 x 47,520)=23,760          O (1/2 x 47, 520)=23,760

 

Balance Sheet as at 1st January, 1995

N N N N
Capital: Fixed Assets
S 126,350 Goodwill   30,000
O 126,350 Freehold Premises 100,000
J   80,000 332,700 Fixtures and fittings   24,000 154,000
Current Assets
Creditors   58,940 Stock 103,000
Debtors  45,000
Less Provision    3,000   42,000
Cash balance   92,640 237,640
391,640 391,640

EVALUTION

  1. What is a revaluation account?
  2. List five assets that may be revalued in partnership accounts.

 

Weekend Assignment

  1. The double entry for the N5,000 salary paid to partner A is (a) Dr. Appropriation A/c N5,000, Cr A’s current A/c N5,000 (b) Dr. A’s Capital A/c N5,000,

Cr Appropriation A/c N5,000 (c) Cr Revaluation A/c N5,000; Dr. Salary A/c N5,000

(d) None of the above

  1. Goodwill is (a) Fixed Asset (b) Current Asset (c) Current Liability (d) Intangible Asset
  2. Goodwill can be classified into (a) Liquid (b) tangible (c) intangible (d) Inherent and purchased
  3. _________ A/c is credited with increase in values of assets (a) goodwill

(b) capital (c) revaluation (d) current

  1. For a reduction in the value of an asset ___ the asset A/c and debit Revaluation A/c (a) debit (b) credit (c) deduct (d) Add

 

Theory

  1. Explain clearly but briefly the terms goodwill and revaluation of assets. Why and when are they necessary in accounting?
  2. Give the journal entries for each of the following transactions:

(a)      Goodwill A/c of N50,00 is to be retained in the books of A& B who share                     profits and losses in ratio 2:1 respectively.

(b)     A&B admitted C and the new P & L sharing ratio is 2:2:1 respectively. Write                           of the goodwill A/c in (a) above

(c)      N4,000 provision for bad debt is to be made on revaluation of assets.

(d)     Reduction in provision for bad debt of N7,000 on revaluation

 

GENERAL EVALUATION

  • List six accounts found in the nominal ledger
  • State four reasons for the need for a bank reconciliation
  • Mention six items which must be contained in a partnership agreement
  • Mention four features of not-for-profit making organizations
  • Differentiate between adjustments and closing entries

 

See also

FINAL ACCOUNTS OF A PARTNERSHIP BUSINESS

PARTNERSHIP ACCOUNTS

ACCOUNTING SSS 3 SCHEME OF WORK

SCHEME OF WORK

 

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