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GOODWILL

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GOODWILL

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  1. GOODWILL Goodwill is the value of benefits / advantages ,expressed in term of returns over and above normal returns. It arise due to Advantageous location Customer loyalty Efficient management Patents / copy rights Goodwill is valued when there is a change in profit sharing ratio.

  2. METHODS OF VALUATION OF GOODWILL

  3. Average profit method • Calculate average profit by adding profots for a No. of years (subtract loss) and divide by the No of years • The following should be adjusted: add – abnormal losses minus – abnormal profits , salary of partners , income from investments

  4. Super profit method • In this method, we calculate normal profit with normal rate on investment. Then we calculate super profit with following formula. • Super profit = actual profit/avg profit – normal profit • Normal profit = capital employed *normal rate/100 • Goodwill = super profit X No. of purchase years

  5. Capitalization method • In this method, we calculate capital employed with following formula • Capital employed = average profit or normal profit X 100/ Rate • Goodwill = capital employed – Net Assets

  6. SACRIFICING RATIO It is the ratio /portion of profit which a partner gives to another partner It is calculated when • There is a change in profit sharing • A new partner is admitted to partnership. FORMULA:----- Sacrificing ratio = old ratio – new ratio

  7. GAINING RATIO • Gaining ratio indicates the amount/ratio of gain of profits • It is calculated when:- i) A partner retires or dies ii) change in profit ratio • Formula of calculating gaining ratio:- G/R = new ratio – old ratio

  8. Difference between S/R and G/R

  9. JOURNAL ENTRY When there is change in profit sharing agreement S/R or G/R is calculated Adjustment is done by passing a journal entry as follows GAINING PARTNE’S CAPITAL A/C Dr xxx TO SACRIFICING PARTNER’S CAPITAL A/C xxx

  10. PROBLEMS & SOLUTIONS • A:B::3:1. They decide to share future profits as 3:2. Goodwill of the firm is valued as Rs. 1,50,000. Pass entry to give effect to the above. S/R = OR – NR A’S Sacri. = 3/4 - 3/5 B’s Sacri. = (15-12)/20 = 1/4 – 2/5 = 3/20 = -(3/20)gain

  11. So , B will give share of goodwill to A Amt of goodwill will be calculated as G/W of firm * share of gain 1,50,000 * 3/20 = Rs. 22,500 Journal entry:----- B’s Cap a/c-------------------Dr 22,500 to A’s Cap a/c--------------- 22,500 (being credit given to capital for loss of A’s profit share.)

  12. TREATMENT OF G/W APPEARING IN BOOKS • If g/w appears in books i.e. is shown on the asset side of balance sheet it means it g/w was valued or purchased. • Such G/W must be WRITTEN OFF when ever there is a change in profit ratio. • Journal Entry :-- Partners’ Capital A/C ----------Dr To Goodwill A/C

  13. TREATMENT OF RESERVES • General reserves/Accumulated profits(losses). These are to be transferred to partners’ capital(current) account GENERAL RASERVE/PROFIT A/C ---------------Dr TO ALL PARTNERS’ CAPITAL A/C (being undistributed reserve/profit , transferred to capital a/c.) In case of losses(shown on asset side of B/S) PARTNERS’ CAPITAL A/C------------------------Dr TO PROFIT & LOSS A/C

  14. TREATMENT OF RESERVE Journal entry if reserve is not to be distributed Gaining partner capital a/c Dr to sacrificing partner capital a/c

  15. WORKMEN COMPENSTION RESERVE Workmen Compensation Reserve/Fund is a reserve created out of profits to make payment to workers for any injury/loss. Distribution of WCF • When there is no claim WORKMEN COMPENSATION FUND-----------Dr TO ALL PARTNERS CAPITAL A/C (old ratio) • When there is claim/liability against WCF It means that some payment has to be made against the fund

  16. WORKMEN COMPENSATION FUND-----------Dr TO ALL PARTNERS CAPITAL A/C (old ratio) This entry will be passed with the balance(excess) amount of fund. For e.g.:- WCF is Rs 20,000 and claim against it is Rs.8,000. A:B:: 2:1. Then journal entry will be WCF A/C ------------------------------- Dr 12,000 TO A’s CAPITAL A/C 8,000 TO B’s CAPITAL A/C 4,000 (being balance reserve distributed ) 20,000 - 8,000 = 12,000 (Total fund - claim = balance for distribution)

  17. INVESTMENT FLACTUATION FUND IFF is created out of profit to safeguard against losses due to change(fluctuation) in market price(value) of investment. • When there is no change in mkt price of investment IFFUND-------------------------Dr TO PARTNERS’ CAPITAL A/C (Full amt. of fund transferred to cap.in old ratio)

  18. When there is a change in market value of investment i.e. market value is less than book value(there is loss in investment) IFFUND-------------------------Dr TO PARTNERS’ CAPITAL A/C (balance amt. of fund transferred to cap.in old ratio) For e.g. govt bonds appear in books at Rs.45.000 and IFF is recorded in b/s at Rs.15,000. The mkt value of govt. bonds is Rs.40,000 , then the amt of IFF to be distributed in capital a/cs’ will be Rs.10,000 (15,000-5,000)(IFF value – fall/(loss) in value of investment)

  19. EMPLOYEE PROVIDENT FUND • EPF is created from the salary of employees’. • It is given/paid to employees when they leave the organization. • It will NOT BE DISTRIBUTED to PARTNERS ‘ CAPITAL as it is NOT create out of profits. • It will appear in new balance sheet at same value.

  20. Revaluation account

  21. REVALUATION ACCOUNT