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Difficulty: HardTreatment and Valuation of Goodwill

Kemi and Emeka are partners in a firm sharing profits and losses in the ratio of 3:23:2. The profits of the firm for the past four years were N180,000\text{N}180,000, N220,000\text{N}220,000, N240,000\text{N}240,000, and N200,000\text{N}200,000 respectively. The capital employed in the firm is N1,200,000\text{N}1,200,000, and the normal rate of return expected on capital employed in this industry is 12%12\%. Goodwill is valued at 33 years' purchase of the super profit. Fola is admitted as a new partner for a 16\frac{1}{6} share in profits, with the new profit-sharing ratio agreed as 3:2:13:2:1. If goodwill is adjusted through the capital accounts without opening a goodwill account, what is the net credit amount (in Naira) to Emeka's capital account for goodwill?

Answer: 13200 Naira

Answer

The net credit amount to Emeka's capital account for goodwill is 13,200 Naira.
To find the net credit to Emeka's capital account, first compute average profit (N210,000) and normal profit (12% of N1,200,000 = N144,000). The super profit is N66,000, giving a total goodwill of N198,000 (3 × N66,000). Crediting Emeka in the old ratio (2/5) gives N79,200, and debiting Emeka in the new ratio (2/6) gives N66,000. The net adjustment is a credit of N13,200.

Step-by-Step Solution

1
Calculate the average profit of the firm
N210,000
Average profit is computed by dividing the sum of profits over 4 years (N840,000) by 4.
2
Calculate the normal profit
N144,000
Normal profit is calculated as the normal rate of return (12%) multiplied by capital employed (N1,200,000).
3
Calculate super profit
N66,000
Super profit is the excess of average profit over normal profit (N210,000 - N144,000).
4
Calculate total valuation of goodwill
N198,000
Goodwill is 3 years' purchase of super profit (3 × N66,000).
5
Determine Emeka's credit share in old profit-sharing ratio
N79,200
Goodwill is credited to old partners in old ratio 3:2 (2/5 of N198,000).
6
Determine Emeka's debit share in new profit-sharing ratio
N66,000
Goodwill written off is debited to all partners in new ratio 3:2:1 (2/6 of N198,000).
7
Calculate net credit adjustment to Emeka's capital account
N13,200
Subtract debit entry from credit entry (N79,200 - N66,000 = N13,200).

Key Concept

Valuation of goodwill using super profit method and net adjustment of goodwill through capital accounts upon admission of a partner.
Estimated Time:2m 30s
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Topics

Treatment and Valuation of Goodwill

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