CAPITAL ADJUSTMENT ACCOUNT AND CALCULATION OF GOODWILL LECTURE 12 CAPITAL ADJUSTMENT ACCOUNT AND CALCULATION OF GOODWILL

LECTURE OUTLINE Recap – Previous lecture Capital Adjustment Account Definition Journal Entries Goodwill

CAPITAL ADJUSTMENT ACCOUNT The changes in the value of the items would be shown in a special account known as a capital adjustment account. Function Is to record any necessary adjustment to the capital of the existing partners, when the ownerships changes. A+E = L + P + R

Journal Entries As Follows: 1. Increase Assets Dr Assets XX Cr Capital Adjustment Account 2. Decrease Assets Dr Capital Adjustment Account Cr Assets 3. Increase Liabilities Cr Liabilities 4. Decrease Liabilities Dr Liabilities

INTRODUCTION OF ASSETS AND LIABILITIES When a partner joins a partnership business, he or she can also bring cash with other assets and liabilities. Note : Cash amount is credited to CRJ and Assets and Liabilities are taken in the General Journal.

BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS Should it be necessary to write off bad debts during capital adjustment then this can done through the capital adjustment account in the same manner as writing down any other assets

Cont… 1. DR Capital Adjustment Accounts XX CR Debtors Journal Entries: 1. DR Capital Adjustment Accounts XX CR Debtors (Bad debts written off) 2. Provision for doubtful debts (To increase the provision for doubtful debts)

GOODWILL DR Goodwill XX CR Capital Adjustment Account There are two possible alternatives for the treatment of goodwill in the books. Alternative 1 When goodwill is suppose d to appear in the books In order to increase this existing goodwill to its agreed fair value, the journal entry would be: DR Goodwill XX CR Capital Adjustment Account (Raising the amount of goodwill)

Cont… Alternative 2 No Goodwill account is to appear in the books Even though the existing owners decide not to open the goodwill account in the books, they might still expect the new partner to pay an agreed amount of goodwill. The goodwill still has a value even though there is no existing account for it. If goodwill is sold then the new partner becomes entitled to future profits during/ after the sale of goodwill.

Cont… Now the existing partners expect the share of goodwill from the new partner, which he is entitled to. That is, the new partner is expected to pay bonus to the existing partner for the share of business goodwill. Recording the BONUS (From new partner to existing partner) This is transferred to capital from the new partner’s capital accounts to the existing partners capital account.

Cont… Journal Entries The existing partners may decide themselves what they want to do with the bonus i.e either leave it in the business capital account or withdraw it. Note: in this alternative, the capital adjustment account is not affected DR Capital Account- New Partner XX CR Capital Account - Existing Partner

Measuring goodwill It is possible to measure the value of goodwill given the following: Fair value of assets and liabilities New partner contribution Profit sharing ratio Goodwill = Purchase Price +Liabilities – Assets Or Purchase Price – Fair value (where FV= A-L)

Capital Adjustment Account Definition Journal Entries Goodwill SUMMARY Capital Adjustment Account Definition Journal Entries Goodwill

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