Accounting for Goodwill

Juma Bananuka

Department Of AccountingMakerere University Business School

jbananuka@mubs.ac.ug

Makerere University

Makerere University Business School

The President of Uganda

The Former FDC President

Prof Wasswa Balunywa & Prof Venacious Baryamureeba

Definition Of GoodwillGoodwill is defined as the amount by which the fair

value of the net assets of the business exceeds the book value of the net assets. Goodwill is an intangible asset representing the existence of the value of the business over and above its fair value.

Goodwill is the difference between the value of a business as a whole and the aggregate of the fair value of its separable net assets. It’s the excess of the purchase consideration of the business sold as a going concern above the fair value / market price of that business.

Definition Cont……. It arises due to factors such as the reputation,

location, customer base, expertise or market position of the business.

Goodwill = Selling price as a going concern – Fair value of separable net assets = Selling price – ( Assets – Liabilities)

A business may be valued higher as a going concern, or a buyer may be willing to pay more for a business as a going concern than the total value of net assets because of the favourable attributes a firm owns.

Characteristics Of GoodwillIs intrinsic to the business. Its existence depends

on the continuance of the business. It cannot be realized separately from the business as a whole.

Is self-developedThe value of goodwill may fluctuate widely

according to internal and external circumstancesThe value of goodwill is subjective according to

different valuers.

Factors Affecting Goodwill (Reasons For The Arise Of Goodwill)

Efficient Management – Perhaps this is the most important thing as far as goodwill of a partnership / company is concerned, because if management is capable, it will naturally reflect on the business of the company which in turn will increase profits and goodwill of the company.

Location – This also has a bearing on the goodwill of the company / partnership, a company which is located at such place where it attracts more customers will have higher value of goodwill attached to it than other companies.

Customer Base – A partnership / company having good customer base and also whose customers are likely to return back to the company for future purchases because of higher quality provided by the company will have higher goodwill than other companies in the same industry.

Factors Cont…… Relationship with suppliers – If partnership / company has

access to such suppliers of raw material which are reliable as well as economical than it will be an added advantage to the company as far as goodwill is considered.

Monopoly powers – The business may have enjoyed some form of monopoly either nationally or locally for example Makerere University (non profit making public institution) existed as the only university in Uganda for quite a long time to the extent that every university is regarded to be Makerere University among people living in rural areas. A typical business that enjoyed monopoly powers in Uganda include Shell, Colgate, Omo among others.

Factors Cont…………….. Research and development – The cost of research and

development, which might have brought about cheaper manufacturing methods or cheaper products, may be charged to the current buyer. The amount which the buyer is prepared to pay will depend on his view of the future profits which will accrue to the business due to factors mentioned.

Trademarks and patent rights – The possession of trademarks and patent rights may account for goodwill. These may have cost the original owner little or nothing and they could be shown in the statement of financial position. They are normally unsellable unless the business is sold as a going concern.

Types Of GoodwillThe goodwill is generally of two types i.e.,

purchased goodwill or non-purchased (raised) goodwill. Purchased goodwill arises only when a business enterprise is acquired by another business enterprise and the price paid is more than the net assets acquired.

Such goodwill is recognized by the accounting profession and is also shown in the Balance Sheet (Statement of financial position). The main features of such goodwill are;

Types cont…….It arises only on purchase of business

It is reflected by a purchase transaction

Its cost could depend upon the future maintainable profits

It can be shown in the Balance Sheet.

Types cont.…… Non purchased (or raised) goodwill arises only when a

business generates its own goodwill over a period of time due to various factors such as location, good management, good quality products etc.

The main features of such goodwill are; It is internally generated, No cost can be placed on it, Value of goodwill is based on the subjective judgment of the

valuer, It is not reflected by a purchase consideration, and It is not shown in the Balance Sheet.

Types cont.……However, there is also another type of goodwill called Negative goodwill which arises when the realizable value of the business sold as a going concern (as a whole) is exceeded by the fair market value realized from individual assets.

Features of goodwill Goodwill can be sold only with the entire business or it cannot be sold in

part or in isolation except on admission or retirement of a partner when new partner .compensate the old partners or the retiring partner gives up his rights in favor of remaining partners.

Goodwill is valuable only if it is capable of being transferred from one person to another. If it cannot be transferred then there will be no value of goodwill.

Goodwill represents a non-physical value over and above the physical assets.

Goodwill cannot have an exact cost as its value fluctuates from time to time due to internal or external factors which ultimately affect the fortune of the Company.

The value of goodwill is based on subjective judgement of the valuer.

Ascertainment of goodwillDissolution /selling of partnership business

On admission of a new partnershipOn retirement or death of a new partner

New profit sharing ratios

Methods of accounting for goodwillThey are three methods PremiumRevaluation Memorandum revaluation

REVALUATION OF ASSETS AND LIABILITIESThe actual value of the assets and liabilities may be different from their book value as shown by the balance sheet. So Revaluation account is prepared at the time of admission of a new partner to record any increase/decrease in the value of assets and liabilities. The value of some assets may increase with time and some may show a decrease.

REVALUATION CONT……..Similarly some liabilities may also show a

increase/decrease in the value. The Revaluation account is credited if there is an increase in the value of assets or decrease in the value of liabilities. On the other hand it is debited if there is any decrease in the value of assets or an increase in the value of liabilities. This account is a nominal account and is sometimes also called Profit and Loss adjustment account.

REVALUATION CONT……The profit or Loss arising due to revaluation is

divided among the old partners in their old ratio.

Assets should be revalued when there is a change in the partnership, such as:Admission of new partnerRetirement/ withdrawal of partnersChange in the profit sharing ratioDeath of a partner

JOURNAL ENTRIES/DOUBLE ENTRYIncrease in the value of assets

Dr Individual asset A/CCr revaluation A/C

Decrease in the value of assetDr revaluation A/CCr individual asset A/C

JOURNAL ENTRIES CONT…….Increase in the value of the liabilityDr revaluation A/CCr individual Liability A/C

Decrease in the value of liabilityDr individual liability A/CCr revaluation A/C

DOUBLE ENTRY CONT…..Share of profit / loss on revaluationIn case of a profit on revaluationDr revaluation A/CCr partner’s current A/C /Capital A/C

In case of a loss on revaluationDr Partner’s current / Capital A/CCr Revaluation A/C

How do I leave ……………………when I am a successful human being?

The End

Bye