Unit 3 Chapter 4

  • Goodwill
  • Admitting a partner
  • Revaluing assets
  • Dissolution
  • Changing the profit sharing ratio
  • Partner changes in split years
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  • Created by: Melonball
  • Created on: 29-05-14 13:40


Goodwill : a business will have a value of goodwill. This is a intangible non current asset without physical form. The value of goodwill depends on factors such as; business's reputation, location, skill of workforce, trade built up etc. 

It is worked out as the difference between the value of the business as a whle and the value of its net assets and liabilities. For example if a business is bought for £500,000 and the assets nd liabilities of the business are worth £450,000 then Goodwill is £50,000.

Business owners have to be prudent when valuing their assets at the lowest value and a goodwill value cannot be made up by the owners, it has to be based on facts and figures.

When admitting a new partner, they receive some of the goodwill of the business, as with when a partner retires, they give the other partners their share of the goodwill they have helped to create.

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Goodwill- Admitting a new partner

A temporary Goodwill account needs to be created when a partner is admitted.
The account will balance after all the adustments have been made

Partners' capital accounts   l Partners' capital accounts
 (Goodwill BEFORE)           l  (Goodwill AFTER) 

When a new partner joins, they invest CAPITAL in the business. Part of this pays for the goodwill created by existing partners.
Goodwill is divided by the existing partners in the existing profit shring ratio.
The Goodwill account is debited with each partners amount (shown in the account above)

To account for the new partner's capital, we DEBIT the BANK as we are receiving money from them ,and CREDIT their capital account (capital is brought in) 

A NEW profit sharing ratio will then be given. The Goodwill account will then be CREDITED in with the new ratio, and all the partners capital accounts will be DEBITED

The goodwill account ends up balancing, but with different values for different partners as the profit sharing ratio changes and is adjusted to equal the same, but be shared out differently. 

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Goodwill - Retirement of a partner

It is similar to an admission of a new partner. The goodwill account is DEBITED with the old partners profit sharing ratio. The capital accounts of the partenrs are CREDITED in the same ratio for goodwill. This is the same as when admitting a new partner.The remaining partners have theit capital accounts DEBITED in the new profit sharing ratio where as the retiring partner has nothing debited, therefore writing off his goodwill and then adding the amount to the other partners' goodwill. Instead, their capital account is DEBITED by the bank account as the business pays them for their goodwill. Any of the capital OWED to the retired partner can be kept in the business as a LOAN. They will have to pay the partner back at some point.

               Rob          Ian         Harry                     l               Rob              Ian       Harry 
                                                                         l   bal b/f  42,000         43,000      50,000
Goodwill     18,000        -         18,000                  l Goodwill  12,000        12,000     12,000
AFTER                                                               l BEFORE
bank                        12,000                                l                                                                 loan                          40,000                               l              
current                      3000                                  l
bal c/f       36,000                    44,000                 l              -----------        -----------         ------- 
                 ---------      --------     ---------- 
                54,000       55,000    62,000                                54,000         55,000         62,000 

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The balance sheet

Both halves of the balance sheet should be equal .
Net assets should equal the partners capital accounts.

REMEMBER to adjust the bank figure for any payments to any partners that have retired.

The new balanes on both the capital and current accounts should be used. 

Any loans being taken from a retired partner need to be included aswell. 

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Revaluation of assets

A revaulation account will be used. If a non current asset is valued at £150,000 but the correct valuation is £165,000 the this double entry applies:

Dr the non current assets account - assets have increased
Cr revaluation account

If a trade receivables account was valued at £48,000 but bad debts of £2500 need to be written off then the double entry is:

Dr revaluation
Cr trade receivables -  their asset value has gone down 

The revaluation account must balance. The difference in the figures will need to be shared out in the profit sharing ratio between the partners. Whichever side the partners capital accounts fills in on the revauluation account, the opposite side is posted to in their capital accounts - If a Debit was posted in the revaluation account, then a Credit will be posted to in their capital accounts to complete the double entry.

REMEMBER - to adjust the figures is the BALANCE SHEET  

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Partnership Changes: Split years

If a change haappens part way through the year, the share of profit needs to be calculated before and after the change to calculate the total for the end of the year accounts.

Changes can include: Partners salaries, interest on capital, net profit. 

A partner may be admitted half way through the year instead of the end of the year and changes will have to be made to the appropriation of profits.
If there is a split years question, it is probably a good idea to divide the appropriation into the months before the change and after the change for example:
           9months to 30 september     3 months to 31 december       Total for the year 
                        £                                         £                                        £ 

This will be easier to calculate figures and find the totals 

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Dissolution of a partnership

Why would a business be dissolved?

  • A partner has retired/died
  • The partners don't want to carry on the business anymore
  • The partnership was formed for a specific purpose which has been achieved
  • Expansion plans means the business will change into a limited company
  • Bankrupcy/ business is failing

For a dissolution:

The accounts of the partners must be closed.
A temporary account is used - realisation. This calculates profit or loss on dissolution. This figure will be shared out  between the partners in the profit sharing ratio.

The partners capital accounts and the bank account is the last to close.

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Realisation account

All the assets get transferred into the DEBIT side of the realisation account.
The liabilities can either be moved to the CREDIT side of the realisation account, or may get paid directly from the bank account. The only asset that doesnt get moved in the realisation account is the bank account.

If an asset is sold, then the realisation entry is a CREDIT.  If a partner takes over an asset then the realisation is CREDITED, and their capital account is DEBITED.

If a liability is partially paid for then we CREDIT the realisation account with the full amount and DEBIT it with the amount being settled for. 

Any costs involved in the dissolution of the partnership, it goes on the DEBIT side of the realisation account. The profit/loss is shared between the partners in their capital accounts

Bank (cost of dissolution)       l        Bank (sale of assets)
Assets transferred                 l        Capital - partner gets asset
Bank (liabilities paid)              l        Liabilities
Profit on dissolution               l         Loss on dissolution

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Other transactions

If a partner has made a loan to the business, they need to repay them. The doubke entry is:

DR the partners loan account
CR Bank

The partners' current accounts are transferred to their capital accounts to balance the capital accounts.

IF there is a DEBIT balance on the capital account, the partner must pay money into the business's bank account to clear the balance.

IF there is a CREDIT balance ont he capital account, the balance is repaid using the remaining bank balance. 

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Partner's debit balance in the capital account

This means they owe money to the business. They must use their own money to pay the business back. If they cannot afford this then the Garner v Murray rule 1904 applies.

Garner v Murray rule: States that if a partner cannot afford to pay the business back, the other partners have to share this loss between them using their capital balances before the dissolution began. This is different to the profit sharing ratio. 

Bill owes the business 10,000 but cannot pay. If Karen had 60,000 capital and Lucy had 20,000 capital at the start then this is how they would pay for the loss.

Karen: 60,000/80,000 x 10,000  = 7,500
Lucy:  20,000/80,000 x 10,000   = 2,500

Their individual capital is divided between the combined capital in this case 20,000 + 60,000 = 80,000. This is then multiplied by the amount owed to give an amount each of the partners will pay. 

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