Week 3 and 4 – SS3 First Term Financial Accounting Notes

 WEEK THREE AND FOUR
ADMISSION OF PARTNERS, GOODWILL AND REVALUATION OF ASSETS
CONTENTS

1. Admission of a new partner – meaning and reason for admission
2. Goodwill admission of a new partner (a) meaning of goodwill (b) reasons for paying for goodwill (c) treatment of goodwill (d) example
3. Revaluation of asset on admission of partnership (a) introduction (b) accounting entries (c) example

 ADMISSION OF NEW PARTNERS
This occurs when a new partner is admitted into an existing partnership business. The reasons for such admission usually are: expiration of old partnership agreement, to inject in more fund, bring in a specialist, death of an old partner, etc.
However, it will be unfair to the existing partners for a new person to come in and take part in the established prosperous business without any reward to the old partners. This compensation to the old partners is goodwill.

 GOODWILL ON ADMISSION OF A PARTNER
Definition of Goodwill: Goodwill is the benefit and advantage attached to an old established business as a result of its good name, efficient management good connection, good location, etc which make it to earn more profit.

 REASONS FOR PAYMENT FOR GOODWILL
Thus, a partner of an existing business or an incoming partner will be induced to pay for goodwill because of:

1. quality of goods and services (ii) favourable business location (iii) efficient and loyal work force (iv) efficient management (v) possession of monopoly power (vi) patents and trade marks (vii) successful research and development (viii) good public image, etc.

 TREATMENT OF GOODWILL
Then goodwill will be brought into the business. This will be dealt with as follows:

1. Raising and retaining Goodwill account in the books: Here, the value of goodwill is debited to goodwill account and credited to the capital accounts in the partners old profit and loss sharing ratio.

    Accounting Entries: Dr. Goodwill A/c
           Cr. Partners capital A/c

 Any cash introduced by the new partner as capital, Dr Cash A/c; Cr. Capital A/c

1. Goodwill is written off: If the business does not desire to retain the goodwill in the books, it will be necessary to write it off to the capital account of the partners in their NEW P&L sharing ratio

Accounting Entries – goodwill written off
Dr. Capital A/c; Cr. Goodwill A/c

 EXAMPLE:    
A and B are Partners who share profit equally. They decide to admit C by agreement, goodwill valued at N60,000 is to be introduced into the books. C is required to provide capital equal to that of B after he has been credited with his share of goodwill. The new profit sharing ratio is to be 4:3:3 to A, B and C respectively.
The partner’s balance sheet before the admission of C is as follows
Balance sheet
Capital: A        80,000        Building        80,000
     B        40,000        Motor Vehicle        30,000
                        Furniture        40,000
Creditors        30,000        Cash            20,000    
Other liabilities    20,000    
            170,000                    170,000

 Prepare the following:

1. Journal and Ledger entries for the admission of C if goodwill account is to be retained.
2. The new balance sheet as a result of admission of C and the retention of goodwill account.
3. Journal and Ledger entries for the admission of C if goodwill account is not retained.
4. New balance sheet showing C admission and goodwill not retained.

 Solution

1. Journal entries – goodwill account retained
   

   JOURNAL
   

Debit            Credit
Good will Account                    60,000
Capital Account – A                                30,000
         — B                             30,000
Being goodwill introduced and shared based
on old profit sharing ratio
Cash Account                        70,000
Capital Account C                                70,000
Being capital contributed by C

 Note: Since B’s capital was N40,000 before the goodwill of N30,000, then B’s capital will now be N70,000. Hence, C must contribute same amount as stated in the question.
Ledger – goodwill account retained
Goodwill Account
            N                        N
Capital: A        30,000        
     B        30,000        Bal c/d        60,000    
            60,000                    60,000
Bal b/d        60,000                    
Capital Account

	A	B	C		A	B	C
Bal c/d	N    110,000 110,000	N    70,000 70,000	N    70,000 70,000	Bal b/d Cash Goodwill  Bal b/d	N 80,000 – 30,000 110,000 110,000	N 40,000 – 30,000 70,000 70,000	N  70,000 – 70,000 70,000

 Cash Account
NN
Bal b/d        20,000        
capital            70,000        Bal c/d        90,000    
            90,000                    90,000
Bal b/d        90,000    
A, B and C
Balance Sheet

		N	N	N
Goodwill				60,000
Fixed Assets
Building			80,000
Furniture			40,000
Motor vehicle			30,000	150,000
				210,000
Current asset
Cash			90,000
Current liabilities
Creditors		30,000
Other liabilities		20,000	50,000
Net current asset				40,000
				250,000
Financed by
Capital account
A				110,000
B				70,000
C				70,000
				250,000

Journal entries – goodwill account not retained

 JOURNAL

 Cash Account
N                        N
Bal b/d        20,000        
C’s – Capital        70,000        Bal c/d        90,000    
            90,000                    90,000
Bal b/d        90,000    

 Goodwill Account
Capital Account – A        30,000    Capital Account – A        24,000
Capital Account – B        30,000    Capital Account – B        18,000
                        Capital Account – C        18,000
                60,000                    60,000

 Capital Account

	A	B	C		A	B	C
	N	N	N	N	N	N	N
Goodwill Bal c/d	24,000 86,000 110,000	18,000 52,000 70,000	18,000 52,000 70,000	Bal b/d Cash Goodwill  Bal b/d	80,000 – 30,000 110,000 86,000	40,000 – 30,000 70,000 52,000	– 70,000 – 70,000 52,000

A, B and C
Balance Sheet

Capital Account:		Fixed Assets
	N		N
A	86,000	Building	80,000
B	52,000	Furniture	40,000
C	52,000	Motor vehicle	30,000
	190,000		150,000
Current liabilities		Current asset
Creditors	30,000	Cash	90,000
Other liabilities	20,000
	240,000		240,000

 EVALUATION
1.    Explain the term Goodwill.
2.    List five circumstances that can give rise to the valuation of goodwill in partnership accounts.

 REVALUATION OF ASSETS ON ADMISSION OF A NEW PARTNER INTO A PARTNERSHIP
The assets of a partnership should be revalued to show their current value in any of the following circumstances: (i) admission of a partner (ii) retirement of a partner (iii) changes occur in P & L sharing ratio of partners.

 ACCOUNTING ENTRIES

1. Open a Revaluation A/c;
   

1. Dr. Assets A/c; Cr. Revaluation A/c with increase in value of asset
   

1. Cr. Assets A/c; Dr. Revaluation A/c with reduction in value of assets.
   

1. Dr. Revaluation A/c; Cr. Liabilities A/c with increase in value of liabilities
   
2. Cr. Revaluation A/c; Dr. liabilities with reduction in the value of liabilities
   
3. If Goodwill is introduced
   

   Dr. Goodwill A/c; Cr Revaluation A/c with the amount of the Goodwill

4. Transfer of profit on revaluation to the old partners capital account:
   

   Dr. Revaluation A/c in the old P & L sharing ratio
   Cr. Capital A/c in the P & L sharing ratio

1. Transfer of loss on revaluation
   

       Cr. Revaluation A./c in the P & L sharing ratio
       Dr. Capital A/c in the P & L sharing ration

2. Goodwill to be written off
   

       Cr. Goodwill A/c in the NEW P & L sharing ration
       Dr. Capital A/c in the P & L sharing ratio

In revaluation of assets, the following accounts will be prepared.

1. Revaluation b. Capital accounts of partners c. Balance sheet

 Example
S & O are in partnership, sharing profits and losses equally. On 1/1/1995 they decided to admit J, who would be entitled to one quarter of any future profits, the balance being shared equally between S and O.
The financial position of the business before the admission of J was a follows:-
Freehold premises: N75, 000, Fixtures and fittings: N26, 000, Stock in trade: N105, 000 Debtors: N45, 000, Cash in hand: N12, 640, Creditors: N58, 940.
Additional information:

1. It is agreed to value and retain goodwill at N30,000, b. Revalue the other assets as follows: Freehold premise: N100,000, Fixtures and fittings: N24, 000, Stock: N103, 000, c. Provision for bad debts of N3, 000 is to be made d. Capital is contributed by S and O equally e. J is to bring N80, 000 into the business as capital. You are required to prepare: i. Revaluation account ii. Partners capital accounts in columnar form iii. Opening balance sheet of the new partnership of S, O and J.

 Solution
The closing balance sheet of the partnership must be prepared to show the capital contributed by J and S.
Balance Sheet
                    N                    N
Capital: S 102,590
     O 102,590     205, 180        Freehold premises    75, 000
                            Fixtures & fittings 26, 000
Creditors              58, 940        Stock         105, 480
                            Debtors        45, 000
                            Cash in hand        12, 640
                 264, 120                 264, 120
Note: The question states that capital is contributed equally by S and O.
Dr.                    Revaluation account             Cr
                    N                            N
Decrease invalue of assets            Increase in value of asset
Fixture and fittings             2,000        Freehold premises            25,000
Stock                    2,480        Goodwill                30,000
Provision for bad debts        3,000
Share of profit:
        S    23,760
        O    23,760    47,520                
55,000                        55,000

 Dr                Partners’ capital accounts                 Cr
         S         O        J             S         O         J

Balance c/d    126,350    126,350 80, 000 Bal. b/f        102,590    102,590    –
                             Cash      –         –        80,000
                         Share of profit 23,760    23,760    –
        126,350    126,350 80,000            126,350    126,350 80,000     
        

 Share of profit S (1/2 x 47,520)=23,760 O (1/2 x 47, 520)=23,760

EVALUTION
1.    What is a revaluation account?
2.    List five assets that may be revalued in partnership accounts.

 READING ASSIGNMENT
Essential Financial Accounting by O.A. Longe, Pages 278-281
Financial Accounting with Ease by OnafowokanYombo, Pages 247-251
Simplified Bookkeeping & Accounting by F.L. Olatunji, Pages 303-307

 Weekend Assignment
1.    The double entry for the N5,000 salary paid to partner A is (a) Dr. Appropriation     A/c N5,000, Cr A’s current A/c N5,000 (b) Dr. A’s Capital A/c N5,000,
    Cr Appropriation A/c N5,000 (c) Cr Revaluation A/c N5,000; Dr. Salary A/c N5,000
    (d) None of the above
2.    Goodwill is (a) Fixed Asset (b) Current Asset (c) Current Liability (d) Intangible     Asset
3.    Goodwill can be classified into (a) Liquid (b) tangible (c) intangible (d) Inherent     and purchased
4.    _________ A/c is credited with increase in values of assets (a) goodwill
     (b) capital (c) revaluation (d) current
5.    For a reduction in the value of an asset ___ the asset A/c and debit Revaluation     A/c (a) debit (b) credit (c) deduct (d) Add

 Theory
1.    Explain clearly but briefly the terms goodwill and revaluation of assets. Why and     when are they necessary in accounting?
2.    Give the journal entries for each of the following transactions:
    (a)    Goodwill A/c of N50,00 is to be retained in the books of A& B who share             profits and losses in ratio 2:1 respectively.
    (b)    A&B admitted C and the new P & L sharing ratio is 2:2:1 respectively. Write             of the goodwill A/c in (a) above
    (c)    N4,000 provision for bad debt is to be made on revaluation of assets.
    (d)    Reduction in provision for bad debt of N7,000 on revaluation

 GENERAL EVALUATION

1. List six accounts found in the nominal ledger
2. State four reasons for the need for a bank reconciliation
3. Mention six items which must be contained in a partnership agreement
4. Mention four features of not-for-profit making organizations
5. Differentiate between adjustments and closing entries