Intermediate Financial

Accounting 1
 Changes in partnership’s structures
Typical events that requires special
treatment and may change the partnership
structures:
1. Change in profit sharing ratio
2. Admission of new partners
3. Death or retirement of existing partner

• Eventually 2 and 3 will lead to 1

 Basic
If partners decided that the value of the
partnership is equal to the book value, thus simple
accounting treatment
The only thing that changes is the profit and loss
ratio, which affect the allocation of future profits
or losses
Therefore changes will only appear at the end of
the next accounting period (the amount of profits
shared).
 Example
Sam, Sim and Soon are partners with profit
sharing ratio of 3:2:1. The capital and current a/c
as at 31 Dec 20-X shows:
Capital Sam shs30000
Sim shs20000
Soon shs15000
Total shs65000

Current Sam shs1500 (dt.)

Sim shs2000 (cr.)
Soon shs300 (cr.)
Total shs800 (cr.) shs65800
 At that date, there are 3 possibilities:
a) Change the profit sharing ratio to 3:3:1 as Sim
will manage the new outlet
b) Admit a new partner Shak who will
contribute shs5000
c) Sam died of heart attack

What would the treatment be for all of the

above possibilities if they value the
partnership as what is in the book (B/S)?
 Discussion
No changes in the value of business
The only thing that changes is the profit
sharing ratio
Assets – Liabilities = Equity (capital a/c +
current a/c)  shs65800
Thus;
a) No special entries needed.
b) Shak contribute shs5000  dt. Bank, cr.
Shak’s capital (current a/c 0 balance).
c) Sam’s balance will be withdrawn from the
business  closed a/c, give cash!
When does it needs special treatment?
Only when the partners believe that the
value of the business is greater than what is
in the book.
Previous example Sam, Sim and Soon
partnership valued at shs65800 but current
value / market value of the business is
shs70000 (could be sold shs70000).
The treatment of the extra value – goodwill
and revaluation
 Revaluation
Why do we revalue
Amount charged as depreciation every year
can only be an approximation
If no changes in composition of partnership,
this basis of revaluing assets is satisfactory
When changes occur, it becomes necessary to
revalue the assets
Circumstances that necessitates revaluation:
1. Admission of new partner
2. Death or retirement of existing partner
 Illustration
Consider A and B as partners and has been
since 10 years ago. Bought a building when
they first started at the cost of shs4000, but its
present value is shs10000 (diff. shs6000).
Say they agree to admit C, thus necessary to
revalue the building to shs10000.
 Dt Buildings shs6000, profit credited to A
and B a/cs, NOT C since C does not deserve
it (he was not yet a member when the value
increase).
 Goodwill
What is
Ability to earn profits in the future
Difference between the value of the business as
a whole and the sum of the values of the
identifiable assets less the sum of its liabilities
Value of business 50000
Assets 34000
Liabilities 12000
(Net assets) 22000
Goodwill 28000
 Usually when the business is sold, partnership
– same circumstances for revaluation
Factors that may bring about the existence
of goodwill
Personal characteristics of the owner (chashs,
relationship with customers, tact etc.)
Quality of goods
Location of premises
The possession of near-monopoly rights
Value of labour force, management skills
Cost of the research and development that make
it more efficient to run the business
Badwill – negative goodwill
 Valuation of Goodwill
1. Average profits
- Base calculation on past profits with weight
given to more recent years (practically 5 yrs)
- Goodwill = X times the weighted average of the
last Y years.
- 19x1: shs600, 19x2 : shs900, 19x3 : shs1200
and Goodwill should be taken as 2 (x) years
purchase of the weighted average of the last 3
years. Weighting, 3:2:1.
 1x 500 = 600
2x 900 = 1800
3x 1200 = 3600
6 6000
Weighted average = shs6000 / 6 = shs1000
Goodwill = 2 x shs1000 = shs2000

Note :
- it uses past result while goodwill is concern about
future prospect , assume past result would affect future
result
- trend of the past result may foretell future expected
profits
2. Average revenue
- just substitute profits with revenue

3. Future profits
- estimate future cash flows generated
- value the stream of cash (value of the PS)
- goodwill = value of the PS – ( A – L )
-
 Illustration for Future Profits

Expected profits shs25000 per annum

Fair charge for service of partners shs11000
10% return expected from investment in such
business
Net assets (A – L) is shs23000

Estimated annual return 25000

Less : Charge for partners’ services 11000
Return 14000
Say V is the value of the partnership, thus
V = 14000 = 140000
0.10

Value of P/S 140000

Less : Net assets 23000
Goodwill 127000