People who are not related to accounting or do not have a deep knowledge of the subject may wonder how goodwill term is used in accounting. Let us tell you what goodwill accounting is and what does the term mean.
What is Goodwill Accounting?
Goodwill value arises when a company purchases business for a higher price than the fair value or the book value of the assets. In other words we can say Goodwill is a premium paid by a company to another for buying its business. Amount which is paid by a buying company is called Purchase price. Seller Company deducts the premium amount in company’s book value. The difference of both the values is called Goodwill. Treatment of goodwill in accounts for any extra amount paid for buying a business is called ‘Goodwill Accounting”.
Example: Suppose a company named A wants to buy all the stock of company B. The book value of the shares of company B is $100 per share; however the trade value is $260 per share. Now Company A will pay $260 for each share it purchases. In accounting for company B, the book value is still $100. So the extra amount paid by company A for each share will go in the balance sheet of company B as Goodwill.
Formula to Calculate Goodwill:
Goodwill Value = Purchase price of the business – Market/Book value of the assets
Accounting Treatment of Goodwill in a Partnership Firm:
When any firm which is in partnership, sells its shares to a new partner, old partners of the firm need to sacrifice their share for the new partner. Thus, they must be compensated for the same in the form of Goodwill. There are following seven methods to share the goodwill with old partners. There are different types of entries for each method.
- Method #1: Private sharing
- Method #2: Cash sharing
- Method #3: Adjustment of Goodwill in debit
- Method #4: Partial cash and partial debit
- Method #5: Depositing in capital account of the old partners
- Method #6: When the goodwill is already deposited in old partners account, it will be distributed in old ratio
- Method #7: Sharing goodwill in form of other assets
Goodwill accounting and its methods may take hundreds of words to be explained. This is just the basic of goodwill accounting to give you a better idea about goodwill and its treatments.
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