Fundamentals of Partnership and Goodwill Test - 7

Calculation of Interest on drawings:

Manik = 20,000 ×10/100 × 6/12 = 1,000 (Dr.)

Arpit = 15,000 ×10/100 × 6/12 = 750 (Dr.)

Naman = 10,000 ×10/100 × 6/12 = 500 (Dr.)

Profit = 1,000 + 750 + 500 = 2,250 (they should get this profit in 5:3:2 Ratio)

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.

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.

The concept of errors and omissions begins with:

1.When partnership deed provides for interest on capital, drawings, salary and commission etc. but not provided for.

2.When Appropriations are provied at a higher rate than the given rate.

3.When Appropriations are provided at a lower rate than the given rate.

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.

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.

Calculation of Goodwill:

1. Average Profit Rs.90,000

2. Normal Profit 4,00,000 × 15/100 = Rs.60,000

3. Super Profit = 90,000 – 60,000 = Rs.30,000

4. Goodwill = 30,000 × 100/15 = Rs.2,00,000

Profit and loss adjustment account is also known as Revaluation Account. This account is different from profit and loss appropriation account. Revaluation account is prepared when reconstitution of partnership takes place i.e. change in existing profit sharing ratio, admission of a new partner, retirement/death of a partner etc.

Calculation of Super Profit:

Actual Average profit = 68,000 – 8,000 (remuneration) = 60,000

Normal profit = 3,50,000 × 12/100 = 42,000

Super Profit = 60,000 – 42,000 = 18,000

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.

Rule: Debit the Gainer partner and credit the sacrificing partner. Whenever there is reconstitution of partnership the amount of compensation will be equal to the proportionate amount of goodwill.

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.

A firm producing qualitative products can easily have name and fame in the market. This lead to increase in the value of goodwill. The business firms which enjoys good commercial reputation for the quality of their products, they have a high value of goodwill.

Step 1. Calculate Average profit (total profits of previous years divided by No. of years)

Step 2. Find out capitalised value of average profit (Average profit × 100/Normal Rate of Return)

Step 3. Find out Goodwill = Capitalised value of average profits - Net Assets

Calculation of Goodwill by using Weighted method : Step 1 : Calculation of Total Products :

Step 2 : Calculation of weighted average profit = 3,33,000/10 = 33,300

Step 3 : Goodwill = 33,300 × 2 = 66,600

To calculate the interest on capital, we must find out the opening capital first. Sometimes opening capital is not given in the question but closing capital is given. In such a case following formula should be used to find out the opening capital:

Opening Capital = Closing Capital + Drawings - profit

Distribution of profit:

1. Actual distribution of profit in 2:3:5 Ratio = X Rs.30,000; Y Rs.45,000 and Z Rs.75,000

2. Wrongly distributed in 3:2:1 Ratio = X Rs.75,000; Y Rs.50,000 and Z Rs.25,000

3. Adjustment : X Dr.45,000; Y Dr.5,000 and Z Cr.50,000.

Purchased goodwill is recorded in the books of accounts, when a running business is purchased by another business by paying the extra amount than the actual value of the business. Purchased goodwill is the difference between the value paid for an enterprise as a going concern and the sum of its assets less the sum of its liabilities, each item of which has been separately identified and valued.

Calculation of Goodwill:

1. Average profit = Rs.65,000

2. Capital Employed = 6,80,000 – 1,80,000 = 5,00,000

3. Normal Profit = 5,00,000 × 10/100 = 50,000

4. Super Profit = 65,000 – 50,000 = 15,000

5. Goodwill = 15,000 × 100/10 = 1,50,000

Calculation of Goodwill by Super Profit Method:

1. Average profit = 36,000 + 40,000 + 44,000 = 1,20,000/3 = 40,000

2. Normal Profit = 1,20,000 × 10/100 = 12,000

3. Super Profit = 40,000 – 12,000 = 28,000

4. Goodwill = 28,000 × 3 = 84,000

Calculation of opening capital:

Formula : Closing Capital + Drawings – Profit

A = 20,000 + 3,600 – 12,000 = Rs.11,600

B = 18,000 + 4,500 – 12,000 = Rs.10,500

C = 12,000 + 2,700 – 12,000 = Rs. 2,700

To Calculate the value of goodwill following steps are required:

1. Average Profit = 40,000 + 50,000 + 60,000 + 70,000 + 80,000 = 3,00,000/5 = 60,000

2. Normal Profit = Capital Employed × Rate/100 i.e. 4,50,000 × 10/100 = 45,000

3. Super Profit = 60,000 – 45,000 = 15,000

4. Goodwill = 15,000 × 3 = 45,000

Adjustment of amounts will be done as follows:

Amount wrongly taken (2%) L Rs.30,000 M Rs.60,000 N Rs.1,20,000 = Total Rs.2,10,000

Adjust 2,10,000 in 2:3:5 ratio L Rs.42,000 M Rs.63,000 N Rs.1,05,000

L has already taken Rs.30,000 but he should get 42,000, so credit him for Rs.12,000

M has already taken Rs.60,000 but he should get 63,000, so credit him for Rs.3,000

N has already taken Rs.1,20,000 but he should get 1,05,000, so Debit him for Rs.15,000

Calculation of average profit when loss is given:

1. Calculation of total profits earned during 4 years:

27,000 + 39,000 – 16,000 + 40,000 = 90,000

2. Average profit = 90,000/4 = 22,500

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.