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Difficulty: HardTreatment and Valuation of Goodwill

Kemi and Tunde are partners in a firm sharing profits and losses in the ratio of 3:23:2. On 1st January 2025, they admit Bisi into the partnership, and the new profit-sharing ratio among Kemi, Tunde, and Bisi is agreed at 5:3:25:3:2. Goodwill is to be valued at 33 years' purchase of the super profit of the firm. The average annual profit of the firm for the past four years is N45,000\mathcal{N}45,000, while the normal annual profit expected on capital employed is N25,000\mathcal{N}25,000. If goodwill is raised in the books and immediately written off, what is the net adjustment to Tunde's Capital Account?

  1. Credited with N6,000\mathcal{N}6,000Answer
  2. B
    Debited with N6,000\mathcal{N}6,000
  3. C
    Credited with N13,500\mathcal{N}13,500
  4. D
    Debited with N18,000\mathcal{N}18,000

Answer

Credited with N6,000\mathcal{N}6,000
Super profit is calculated as N45,000−N25,000=N20,000\mathcal{N}45,000 - \mathcal{N}25,000 = \mathcal{N}20,000. Total goodwill equals 3×N20,000=N60,0003 \times \mathcal{N}20,000 = \mathcal{N}60,000. Raising goodwill credits Tunde's Capital Account with 25×N60,000=N24,000\frac{2}{5} \times \mathcal{N}60,000 = \mathcal{N}24,000, while writing off goodwill debits Tunde's Capital Account with 310×N60,000=N18,000\frac{3}{10} \times \mathcal{N}60,000 = \mathcal{N}18,000. The net difference is a credit adjustment of N6,000\mathcal{N}6,000.

Step-by-Step Solution

1
Calculate the super profit of the firm
Super Profit = Average Profit - Normal Profit = N45,000−N25,000=N20,000\mathcal{N}45,000 - \mathcal{N}25,000 = \mathcal{N}20,000
Super profit is the excess of average profit over expected normal profit.
2
Calculate total valuation of goodwill
Firm Goodwill = 3×N20,000=N60,0003 \times \mathcal{N}20,000 = \mathcal{N}60,000
Goodwill is calculated at 3 years' purchase of super profit.
3
Determine Tunde's credit share when raising goodwill in the old ratio (3:23:2)
Tunde's Credit Share = 25×N60,000=N24,000\frac{2}{5} \times \mathcal{N}60,000 = \mathcal{N}24,000
Goodwill existing prior to admission is credited to old partners in their old profit-sharing ratio.
4
Determine Tunde's debit share when writing off goodwill in the new ratio (5:3:25:3:2)
Tunde's Debit Share = 310×N60,000=N18,000\frac{3}{10} \times \mathcal{N}60,000 = \mathcal{N}18,000
Goodwill written off is debited to all partners in the new profit-sharing ratio.
5
Compute the net adjustment to Tunde's Capital Account
Net Adjustment = Credit of N24,000−Debit of N18,000=Credit of N6,000\mathcal{N}24,000 - \text{Debit of } \mathcal{N}18,000 = \text{Credit of } \mathcal{N}6,000
Comparing total credit and debit entries gives a net credit adjustment of N6,000\mathcal{N}6,000.

Key Concept

Valuation of Goodwill via Super Profit Method and Accounting Treatment on Admission of a Partner
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Topics

Treatment and Valuation of Goodwill

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