Treatment of Goodwill in Accounting
What is Goodwill?
Goodwill is an intangible asset gained when a company acquires another business entirely. Specifically, goodwill is registered in a situation where the acquisition value is higher than the market cost of the tangible and intangible assets and liabilities achieved in the purchase.
In the balance sheet, goodwill is recorded under long-term or noncurrent asset category. And as per the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), businesses once a year are required to estimate the goodwill value and report on their financial statement.
In some situations, goodwill is referred to a firm’s brand name, trustworthy consumer base, delivering good customer service, good employee associations and management, and any patents or proprietary technology. However, these instances of goodwill are not recorded on the firm’s balance sheet.
Let us now understand when the treatment of goodwill is accounted.
Accounting Treatment of Goodwill
- When their is a change in profit-sharing ratio (PSR) of partners – Apart from death, retirement, and admission of a partner, there are few times where partners decide to adjust their current profit sharing ratio. One such case can be when one partner gain a share of profit and others may sacrifice. So, Whenever the profit-sharing ratio of partners is changed, their goodwill is valued.
- Admission of a new partner – The newly admitted partner contributes some amount as his part of goodwill share to the existing partners as compensate for the loss suffered by them. There are two ways to treat goodwill at the admission of new partners
(a) Premium method
(b) Revaluation method.
- In partners death or retirement – The deceased or retiring partner is entitled to a goodwill share because the goodwill gained by a business is the outcome of their struggle and efforts in the past. Therefore in future, the profits the company will gain is because of the firm’s past and present goodwill. However, the deceased and retiring partner will not share future profits. Therefore, the continuing partners give the retired partner the goodwill share in gaining ratio.
- When the entire company is sold – In accounting aspect, a firm should value the goodwill and recorded it in the balance sheet once a year and see if an adjustment is needed. If the value of the goodwill decreases, then the fair market, then the differences must be registered to make the value of the goodwill equal to the fair market value.
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