Fundamentals of partnership and Goodwill Test - 9

Adjustments in accounts of the partnership firm may be needed whenever something relating to the past period has to be corrected. The main purpose of rectification of past adjustments is to communicate the correct information.

Goodwill is an intangible asset, which cannot be seen or touched but it plays important role in earning more and more profits. If a business firm is having good reputation in the market, it will enjoy more profits and goodwill in future.

Goodwill is the capitalized value of super profits. To find out the super profits, we deducted normal profits from the actual average profits (average profits – normal profits). To find out the value of goodwill, super profit should be capitalised i.e. super profits × 100/Normal Rate of Return.

Super profit is the excess of actual profit over normal profit i.e. Super Profit = Actual/Average profit – Normal Profit. Super profit is multiplied by the number of years purchase to find out the goodwill.

Note : When Super Profit shows negative figure, it should be assumed that there is no goodwill.

There are two types of goodwill (1) Purchased Goodwill (2) Self Generated Goodwill.

Only purchased goodwill is shown in the books of accounts. Purchased goodwill is the excess amount paid on the purchase of a running business. Self generated goodwill is that which is build over the year by hard work and dedication.

1. Average Profit means normal business profits (average of previsous years profits).
2. Purchased Goodwill is acquired by making extra payment on purchase of a running business.
3. Self Generated Goodwill is internally generated goodwill which is not shown in the books of accounts.