Treatment of Goodwill in Partnership Accounts Video Lecture | Principles and Practice of Accounting - CA Foundation

here we're going to be looking at
admission of a new partner into a
partnership and we're going to be using
the goodwill method now with the good
mil method here the total capital of the
new partnership approximates the fair
value of the partnership here so let's
go down and look at our example here we
have existing partners here a and B here
and they have capital balances and their
total capital balance here is $150,000
and then they have portioned out here
their capital up ratio here and also the
profit ratio profit ratio here is 5050
here and we have this partner seed which
is going to invest $54,000 to acquire an
interest in capital of 20% and an
interest of profit of 20% so going over
here the new partner would have an
interest in the capital here of 20% and
the profit here at 20% so let's go down
and look at our calculations here so the
book value of the original partners here
we headed $150,000 and then we have the
investment of the new partners see here
they're going to pay $54,000 so adding
those together that gives us a total
capital here of the partnership of two
hundred and four thousand dollars and
then we're going to go here and we're
going to calculate what the implied fair
value of the partnership is here based
on enough this partner sees investment
so partner C invests $54,000 for a 20%
interest here so based on that you got
the 54,000 divided by 20% gives two
hundred and seventy thousand dollars as
a fair value of this partnership so
going up here to our diagram here we got
a total and fear of an implied fair
value of two hundred and seventy
thousand here and we have total capital
here invested of two hundred and four
thousand dollars so we have a difference
here so let's go and look at how what
that difference could mean to us here so
we got two hundred and seventy thousand
dollars implied fair value less than two
hundred and four thousand dollar total
capital so that gives us a difference
here of sixty six thousand dollars here
and that could be one of two things
either there is goodwill involved in
this partner C entering the partnership
or they're in or there's some unrecorded
appreciation for this partner see
entering a partnership here and in
either case here this $66,000 that must
be added to the existing book value or
in case of goodwill it has to be
allocated to the original partners here
so let's go down here and look at one
more alternative here for calculating
that goodwill or that unrealized
appreciation so taking the book value of
the new partnership here so we got 20%
here of the total book value that the
new partner would be getting that's two
hundred and four thousand times twenty
percent that gives forty thousand eight
hundred dollars book value to the new
partner here but they paid fifty four
thousand dollars so taking the
difference here to $54,000 paid less the
forty thousand eight hundred dollars
here in book value that they would have
been allocated gives us a difference
here thirteen thousand two hundred
dollars that's what they had paid extra
here so taking the thirteen thousand two
hundred dollars which it represents the
twenty percent here of the new partners
it capital amount here so you divide
that here into thirteen twenty percent
into thirteen thousand two hundred and
you get sixty six thousand dollars here
as goodwill here that would or in this
case goodwill or unrecorded appreciation
of some asset here that was the total
difference so let's go back here and
look at our diagram here once again so
this in total implied fair value here of
two hundred and seventy thousand dollars
well when we're using the goodwill
method the total capital of the new
partnership must be approximate this
fair value so the total capital in new
partnership here is two hundred and four
thousand dollars but it must approximate
it must be equal to two hundred and
seventy thousand dollars here using the
goodwill method so we have two ways of
handling handling that so we can look at
case one here which is identifiable
assets here so if the difference between
the fair value in the book value here of
the recorded assets our identify
identifiable then adjustments to the
asset balance should be considered here
and then we have case two that we can
look at now that's traceable goodwill
here so assuming there's no difference
between the book
you in the fair value of the assets the
new partners willingness to pay more
indicates that their goodwill existed
prior to the new partners partners
admission so the goodwill is recorded
and allocated to the original partners
per their profit and loss ratio so we're
going to look at both ways here looking
at case when the identifiable assets in
case to hear the traceable goodwill and
how we'd record those okay now we're
going to look at how we'd handle this
goodwill or this unrecognized
appreciation here of $66,000 so when
using the goodwill method we have to
bring this total capital amount here of
240 the 4,000 dollars up to two hundred
and seventy thousand dollars the implied
fair value here of the partnership so
let's look at case one here where we
have identifiable assets and for our
example here we're going to have a land
depreciation of eighty six thousand
dollars and then we get inventory write
down or a reduction of inventory here of
twenty thousand dollars so the net
appreciation or increase we have is
sixty six thousand dollars which
represents the sixty six thousand dollar
increase here from the total capital to
the implied fair value here so let's
look at how we'd record this for partner
C's investment here so assets from
partner C that would be the amount they
invested here that would get debited for
fifty four thousand dollars and then the
increase in the appreciation of land
would get debited here increase for
eighty six thousand dollars and then
inventory that would get credited or
reduced here by twenty thousand dollars
and then A's cap or partner ace capital
would be increase or debited here for
thirty three thousand dollars B's
capital would be debited for thirty
three thousand dollars and then see this
capital account here would be debited
for fifty four thousand dollars the
amount that they invested in the
partnership so let's look at this thirty
three thousand dollars here that was
allocated for a and B and that amounts
to the net appreciation here of sixty
six thousand dollars so how we allocate
that is based on the previous on the
partners previous or their older old
profit and loss ratios in this case that
was before they
the new partners see entered the
partnership and their profit loss ratio
here was 50% to a and 50% to be here
partner it got 50% partner B got 50% so
here's that $66,000 net appreciation
here so 50% of that would go to a for 33
thousand and then B would get 50% here
for 33 thousand so that calculates here
the capital that would be credited to
both a and B split 50-50 here between
each of them now let's go look at case 2
here where we have traceable goodwill
here and again we're dealing with this a
sixty six thousand dollar amount here so
partners see looking at their investment
here how we'd record that assets from C
again would be debited here for fifty
four thousand dollars the amount they
invested and then goodwill in this case
would get debited here for sixty six
thousand dollars or increased and then
the capital capital A's accountant would
be credited here for thirty three
thousand capital R for partner B their
capital account would get debited here
for thirty three thousand and partner C
would get debited here for fifty four
thousand dollars the investment they
made here now they a thirty three
thousand dollar amount for each partner
a and partner B here that was as we
calculated using their old profit ratios
here splitting the $66,000 goodwill that
was allocated here between the two and
then we want to denote here for partner
C there are capital account that would
be the original capital of one hundred
fifty thousand dollars plus their
investment here fifty four thousand plus
the goodwill here of sixty six thousand
gives a total amount here of two hundred
seventy thousand and partner C's
interest would be twenty percent of that
that gives them a partner C's capital
balance here of fifty four thousand
dollars okay to summarize here when
using the goodwill method here we've
taken the total capital amount here of
two hundred and four thousand dollars
now that was based on the book value
here of one hundred fifty thousand
dollars from the original partners plus
the fifty four thousand dollar
investment by partners see here so this
is sitting
that's Book value here and what you
we've done here with the goodwill method
we have adjusted it up to the fair value
of those of the partnerships capital
accounts whatever had to be adjusted
here for up to its fair value so we've
taken the Book value here and adjusted
it up to its fair value and we either
did that in this example through
identifiable assets or some traceable
goodwill here but nonetheless just
remember here when you're working with
the goodwill method you take the Book
value here of your total capital and you
adjust it up to its fair value