3. Revaluation of Assets and Liabilities: Assets and liabilities are revalued to ascertain the current value of the assets and liabilities of the partnership firm. Moreover, the profit or loss due to the revaluation need to be distributed among the old partners.

4. Accumulated profits, losses and reserves are distributed among the old partners in their old ratio.

5. Adjustment of capital of the partners.

Question - 2 : -
Why i is it necessary to ascertain new profit sharing ratio even for old partners when a new partner is admitted?

Answer - 2 : -

When new partner/s is/are admitted, then the old partners in the partnership firm need to sacrifice their share of profit in favour of the new partner/s. This reduces the share of profit of the old partners ,hence, it is necessary to ascertain the new profit sharing ratio even for the old partners in the event of admission of new partner/s.

Question - 3 : -
On what occasions sacrificing ratio is used?

Answer - 3 : -

The following are the different situations when sacrificing ratio is used.

1. When the existing partners of a partnership firm agree to change the share of profit among themselves.

2. When a new partner is admitted in the partnership firm and the amount of the goodwill brought by him/her is transferred among the old partners in sacrificing ratio of the old partners.

Question - 4 : -
If some goodwill already exists in the books and the new partner brings in his share of goodwill in cash, how will you deal with existing amount of goodwill?

Answer - 4 : - If goodwill already appears in the books of old firm (before the admission of new partner), then this should be written off among the old partners in their old profit sharing ratio. The following Journal entry is passed.

Question - 5 : -
Why is there need for the revaluation of assets and liabilities on the admission of a partner?

Answer - 5 : -

At the time of admission of a new partner, it becomes very necessary to revalue the assets and liabilities of a partnership firm for ascertaining its true and fair values. This is done because the value of assets and liabilities may have increased or decreased and consequently their corresponding figures in the old balance sheet may either be understated or overstated. Moreover, it may also be possible that some of the assets and liabilities are left unrecorded. Thus, in order to record the increase and decrease in the market value of the assets and liabilities, Revaluation Account is prepared and any profits or losses associated with this increase or decrease are distributed among the old partners of the firm.

Question - 6 : -
Do you advise that assets and liabilities must be revalued at the time of admission of a partner? If so, why? Also describe how is this treated in the book of account?

Answer - 6 : -

Yes, it is advisable to revalue the assets and liabilities at the time of admission of a new partner for ascertaining the true and fair value of the assets and liabilities. This is done because the value of assets and liabilities may have increased or decreased and consequently their corresponding figures in the old balance sheet may either be understated or overstated. Moreover, it may also be possible that some of the assets and liabilities are left unrecorded. Thus, in order to record the increase and decrease in the market value of the assets and liabilities, Revaluation Account is prepared and any profits or losses associated with this increase or decrease are distributed among the old partners of the firm.

Question - 7 : -
What is goodwill? What are the factors that effect goodwill?

Answer - 7 : -

Goodwill is an intangible asset of a firm. It is the value of a firm’s reputation and its good brand name in the market. A firm earns goodwill by its hard work and thereby winning the blind trust and faith of the customers by fulfilling their demands in both qualitative and quantitative aspects. A positive goodwill helps a firm to earn supernormal profits compared to its competitors that earns normal profits (as their goodwill is zero). In other words, goodwill ensures greater future profits as there will be greater number of satisfied customers in the future. As in the words of Lord Eldon, “Goodwill is nothing more than the probability, that the old customers will resort to the old place.”

Characteristics of Goodwill

The following are the characteristics of goodwill.

1) It is an intangible asset.

2) It is not a fictitious asset.

3) It is difficult to ascertain the exact value of goodwill.

4) It enhances the future as well as the present earning capacity of a business.

5) It helps in earning supernormal profits against the normal profits.

6) It assists the business to enjoy its upper hand over its counterparts.

Factors Affecting Goodwill

The following are the important factors that affect the goodwill of a firm.

1) Quality Products: If a company produces product of the best quality and in large scale, then automatically the company earns more goodwill.

2) Location: If a business islocated at easily reachable and convenient place, then more number of consumers will be attracted again and again which will lead to increase in sales and, therefore, the firm will earn higher goodwill.

3) Management: Efficient management leads to cost efficiency and increases productivity. If a firm’s management is efficient, then superior quality products can be produced at lower cost .These can be sold at lesser price. Superior quality at lower price enables a firm to earn higher goodwill.

4) Market Structure: If a firm is operating in a monopoly market with no close substitutes, then there will be more goodwill of the firm.

5) Economies of Scale: If a firm enjoys special advantages like, continuous supply of power, fuel and raw materials at a low price and produces quality product at a large scale, then the firm enjoys higher value of goodwill.

Question - 8 : -
Explain various methods of valuation of goodwill.

Answer - 8 : -

The following are the various methods of valuation of goodwill.

1. Average Profit Method: Under this method, goodwill is calculated on the average basis of the profits of past few years. The formula for calculating goodwill is:

Goodwill = Average Profit × No. of Years Purchase

Number of Years Purchase implies number of years for which the firm expects to earn the same amount of profits.

Steps to Calculate Goodwill by Average Profit Method:

Step 1: Ascertain the total profit of past given years.

Step 2: Add all abnormal losses like, loss by fire, theft etc.

Step 3: Add all normal income, if not added previously.

Step 4: Less all non-business incomes and all abnormal gains and incomes like, speculation, lottery etc.

Step 5: Less all normal expenses, if not deducted previously.

Step 6: Calculate Average Profit, by dividing the total profit ascertained in Step 5 by number of years.

Step 7: Multiply the Average Profit to the Number of Year’s Purchases to calculate the value of goodwill.

Example:

The profits for last 5 years are 1,00,000, 3,00,000, (2,00,000), 5,00,000, 8,00,000.

Calculate goodwill on the basis of 4 years purchase

2. Weight Average Method: It is modified version of the Average Profit Method. Under this method, the weights are assigned for each year’s profit. Highest weights are assigned to the recent year’s profit and lower weights are assigned to the past year’s profits. The products of the profits and the weights are added and divided by the total weights to calculate Weighted Average Profits. The formula for calculating goodwill by this method is:

Steps to Calculate Goodwill by Weight Average Method:

Step 1: Assign highest weights to the recent year’s profit and lower weights to the past year’s profits, like 4,3,2,1.

Step 2: Multiply the weights with its corresponding year’s profits.

Step 3: Calculate the total of the products

Step 4: Divide the total of the product by the total of the eights in order to calculate Weighted Average Profit.

Step 5: Multiply the Weighted Average Profit by the number of years purchase.

For example:

The profits for the last 5 years are Rs 1,00,000, Rs 3,00,000, Rs (2,00,000), Rs 5,00,000, Rs 8,00,000.

Calculate goodwill onthe basis of 4 yearspurchase

Profit/Loss Rs	Weights	Product Rs
1,00,000	1	1,00,000 × 1 = 1,00,000
3,00,000	2	3,00,000 × 2 = 6,00,000
(2,00,000)	3	(2,00,000) × 3 = (6,00,000)
5,00,000	4	5,00,000 × 4 = 20,00,000
8,00,000	5	8,00,000× 5 = 40,00,000
Total	15	Rs 61,00,000

3. Super Profit Method: Under this method, goodwill is calculated on the basis of excess profit earned by a firm over the normal profit earned by its counterparts in the same industry. The excess profit over the normal profit is termed as Super Normal Profit.

Steps to Calculate Goodwill by Super Profit Method:

Step 1: Calculate Average Profit

Step 2: Calculate Average Capital Employed as:

Step 3: Calculate Normal Profit by the formula:

Step 4: Calculate Super Normal Profit by the formula:

Super Normal Profit = Average Profit – Normal Profit

Step 5: Multiply the Super Normal Profit by the Number of Years Purchase to calculate goodwill.

4. Capitalisation Method: Under this method, goodwill is calculated by the following two methods :

a) By capitalisation of Average Profit.

b) By capitalisation of Super Profit.

a) Capitalisation of Average Profit

Step 1: Calculate Average Profit

Step 2: Calculate Capitalised value of Average Profit by the following formula:

Step 3: Ascertain Actual Capital Employed

Step 4: Deduct Actual Capital Employed from Capitalised Average Profit to calculate goodwill.

Goodwill = Capitalised Average Profit – Actual Capital Employed

b) Capitalisation of Super Profit

Step 1: Calculate the Capital Employed

Step 2: Calculate Normal Profit by the following formula:

Step 3: Calculate Average Profit.

Step 4: Calculate Super Normal Profit by the following formula:

Super Normal Profit = Average Profit – Normal Profit

Step 5: Calculate goodwill by the following formula:

Question - 9 : - If it is agreed that the capital of all the partners be proportionate to the new profit sharing ratio, how will you work out the new capital of each partner? Give examples and state how necessary adjustments will be made.

Answer - 9 : -

When a new partner is admitted, sometimes it is agreed that the capital of all the partners should be proportionate to the new profit sharing ratio. The calculation of the new capital of each partner depends on the following situations:

1) When the capital of the new partner is given

2) When the total capital of the firm is given.

1) When the capital of the new partner is given

In this situation, the calculation of the new capital of all the partners involves the following steps:

Step 1: The total capital of the new firm is calculated on the basis of new partner’s capital.

Step 2: The new capital of each partner is calculated by dividing the total capital of the firm by their individual new profit share.

Step 3: After posting all adjustments and items in the Partners’ Capital Account, calculate credit minus debit side of the old Partners’ Capital Account.

Step 4: The new capital ascertained in the Step 2 is written as ‘Balance c/d’ on the credit side of the Partner’s Capital Account.

Step 5: If the amount ascertained in Step 2 (New capital) exceeds the capital amount ascertained in Step 3 (Old Capital), then it is termed as ‘Deficit’ and the difference amount is to be brought in by the old partners. On the contrast, if the amount ascertained in the Step 2 (New Capital) is lesser than the capital amount ascertained in the Step 3 (old Capital), then it is termed as ‘Surplus’ and the difference amount is returned to the old partners.

Let us understand the above steps with the help of an example.

A and B are partners sharing profit and loss equally. They agree to admit C for

share in profit. C brings Rs 50,000 as capital. The old capitals of A and B are Rs 60,000 and Rs 40,000 respectively, at the time admission of C.

Step 1: The total capital of the new firm on the basis of C =

Step 2: A’s new capital =

B’s share in new firm =

Step 3:

	A	B
New Capital	50,000	50,000
Less: Existing Capital	(60,000)	(40,000)
Withdrawal (deposit)	10,000	(10,000)

2) When the total capital of the new firm is given:

When the capital of new partner is not mentioned then his/her capital is ascertained on the proportionate basis of total capital of the firm. The amount ascertained is to be brought in by the new partner in the form of his/her portion of capital. In order to ascertain the proportionate capital of the new partner, the following steps are to be followed.

Step 1: Ascertain the total old capital of the old partners (after making all adjustments)

Step 2: Ascertain the total capital of the new firm by multiplying the total of old capitals of the old partners (ascertained in the Step 1) with reciprocal of total share of old partners. That is,

Step 3: Calculate New Capital of each partner on the basis of Total Capital ascertained in Step 2. That is, multiplying the Total Capital by the new profit sharing ratio individually for all the partners (including the new partner).

Let us understand the above steps with the help of an example.

X and Y are partners in a firm sharing profit and loss equally. They agree to admit Z for

share in profit and decided to share future profit and loss equally. X’s capital is Rs 2,00,000 and Y’s capital is Rs 1,50,000. Z brings sufficient capital for his share in profit.

Step 1: Calculation of Total Capital of Old Partners (after all adjustments)

The total capital of the old partners = Rs 2,00,000 + Rs 1,50,000 = Rs 3,50,000

Step 2: Calculation of Total Capital of New Firm

Step 3: Calculation of New Capital of Each Partner

Question - 10 : -
Explain how will you deal with goodwill when new partner is not in a position to bring his share of goodwill in cash.?

Answer - 10 : - When the new partner is not in a position to bring his share of goodwill in cash, then goodwill account is adjusted through the old Partners’ Capital Account. New Partner’s Capital Account or Current Account is debited with his/her share of goodwill and the partners who sacrifice their share in favour of the new partner are credited in their sacrificing ratio. The following Journal entry is passed in the books of accounts.

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