Section A: Theory of Financial Accounting
Question3
a) What is Goodwill?
b) Conditions under which Goodwill is valued in a Partnership
c) Contents of a partnership agreement
Observation
Majority of the candidates attempted this question on partnership and performed fairly. Below are some of the suggested responses:
(a) Goodwill is an intangible asset which enables a business to earn returns in excess of what is expected under normal conditions.
OR
Goodwill is the excess of purchase price/consideration over the net assets value of a
business. OR
Goodwill is an intangible asset that arises as a result of the quality of a firm’s products, good reputation, location, etc, which enables it to earn extra profits.
(b) Conditions under which Goodwill is valued in a Partnership
(i) On the admission of a new partner: On the admission of a new partner, the old partner will value goodwill and share in the old profit sharing ratio before the new partner is admitted.
(ii) Change in the profit and loss sharing ratio: If there is a change in the profit and loss sharing ratio the partners will value goodwill and share in the old profit sharing ratio before the change.
(iii) On the retirement of a partner: On the retirement of a partner, goodwill will be valued and shared among the partners including the retiring partner.
(iv) On amalgamation of partnerships: On amalgamation of partnerships, the partners in each firm will value goodwill and credit their respective capital accounts before the amalgamation.
(v) On dissolution of a partnership: On dissolution of a partnership, the partners
will value goodwill and share it among the existing partners in the old profit sharing ratio.
(vi) On the death of a partner: When a partner dies, Goodwill is valued in order to
dissolve the old partnership.
(vii) Takeover of a partnership by another business/Purchase of a partnership by another business: On the purchase of a partnership by another business, goodwill is valued and shared by the partners.
(viii) On the resignation of a partner: When a partner gives notice of his resignation,
goodwill will be valued and shared by the partners.
(c) Contents of a partnership agreement
- Names of partners
- Addresses of partners
- Name and address of the firm (Business)
- Amount of capital contribution by each partner
- Interest on capital (if any)
- Interest on drawings (if any)
- Ratio of sharing profits or losses
- Duration of partnership / Provision for resignation/retirement of partners
- Salaries of partners (if any)
- Rules regarding admission of partners
- Nature of business
- How disputes are to be settled
- Effective date of commencement of business
- Procedures for dissolution
- Restrictions of partners (if any)
- Distribution of assets on dissolution
- Rights and duties of partners
- Extent of drawings (if any)
- Method for the valuation of assets
- Name and address of bankers
- Signatories to the firm’s accounts
- Types of partners