Death of a Partner including Treatment of Goodwill

Introduction:

Goodwill is an intangible asset that represents the value created by an entity in accounting terms. The term “goodwill” has a broad definition and is frequently used when one entity has  acquired another.

The price that entities are ready to pay for acquiring another company at a price that is higher than its actual market value is known as goodwill. 

Concept of Goodwill

When partners stay with their firm for a long period, they develop a reputation. This reputation translates in monetary terms into expected future profits above-normal profits. This surplus profit is frequently referred to as the company’s goodwill. 

Goodwill is nothing but the reputation of the partnership firm. It is computed based on expected profit more than normal profits. It indicates the company’s ability to produce a higher profit in the future based on its past performance.

For example, since 2010, two partners have owned a popular restaurant. The total value (assets-liabilities) is Rs. 60 lakhs. In 2015, the partners decided to sell their restaurant. A potential buyer has made an offer of Rs. 64 lakhs for the company. The excess of Rs. 4 lakhs represents the goodwill they have built up over the last 5 years.

Nature of Goodwill

Goodwill is an asset both in terms of the books of accounts as well as literally. It is a form of intangible asset that provides monetary benefits and profits to a business. 

An intangible asset must have the following characteristics, according to accounting standards. We may conclude that goodwill is an intangible asset since it possesses all of these properties.

• It must-have characteristics of assets. This means that it must have some identifiable value.
• The asset must have future economic benefits. The company must be able to anticipate and forecast the value it will derive from it.

• Its value must be measurable. If we can’t put a monetary value on anything, it’s not an asset.

Principles of Treatment of Goodwill

Let’s look at how goodwill is treated now that we have a better understanding of the notion. These essential rules must be followed when dealing with goodwill, according to accounting standards.

 To begin with, goodwill can only be recorded when money or money’s worth is exchanged. As a result, we can only record acquired goodwill.

Second, internal goodwill is prohibited by accounting standards in the death of a partner. To put it another way, we can’t record goodwill for which money hasn’t been paid. Partners, for example, may elect to keep track of goodwill for no apparent reason. This is impossible for them to accomplish.

Finally, goodwill must be written down over some time. In the event of a firm’s reorganisation, they must first write off all goodwill and then proceed.

The goodwill of the partners is evaluated when the profit-sharing ratio of the partners changes. One partner may benefit from the profits while the others make sacrifices.

As a result, the goodwill is adjusted through the capital accounts of the partners. The capital account of the gaining partner is debited, and the capital account of the sacrificial partner is credited. The profit-sharing ratio is used to make this accounting change. Furthermore, if the partners decide to change the profit-sharing ratio in the future, the gaining partner compensates the losing partner according to the agreed-upon ratio. The value of goodwill reflected by the gain will then be used to determine compensation. The change in the profit-sharing ratio indicates that one partner is buying the profit share of another partner.

Accounting Treatment in the Event of Death of a Partner

Because the firm’s goodwill was built via the work of all partners in the past, the departing or deceased partner is entitled to his share when he retires or passes away. Because of the current goodwill, revenues will be created in the future.

The retiring or deceased partner will not be entitled to future gains. As a result, all surviving partners in the gaining ratio pay the retiring partner’s Goodwill share. It’s only fair that the retired or deceased partner be compensated. We evaluate goodwill based on agreement among partners at the time of a partner’s retirement or death.

The partner’s goodwill adjustment will be made after the goodwill valuation.

Note: In the event of the death of a partner in a partnership, the money due to him must be paid to his legal representatives.