topic 15 change in partnerships

• A number of things can happen that change the partnership agreement:

  • the profit sharing ratio may change
  • assets may be revalued
  • a new partner may be admitted
  • a partner may retire or die
• Goodwill is the value of the business as a going concern over and above its SOFP value. When it has been agreed between the partners that a change in the partnership agreement should take place, it is normal to use goodwill as a means of deciding any payments between the partners
• Methods of valuing goodwill:

  • average profits over the past few years
  • average weekly sales over the past financial year
  • comparing the value of similar businesses
• Reasons for goodwill:

  • good reputation due to product quality and/or customer service
  • established customer base
  • established links with suppliers
  • good location
• So someone buying into a business pays for goodwill in order to gain access to the future profits of an established business:

  • goodwill is an intangible nca and is difficult to value objectively
  • for this reason goodwill does not usually appear in the books unless it is purchased but it can serve a useful purpose in a partnership change
  • internally generated goodwill is known as inherent goodwill
• The profit share ratio may change for a number of reasons such as:

  • a partner may not work as much as before
  • a partner's skills and ability may have changed
  • a partner may be doing more than before
• If a partner leaves the partnership, the remaining partners have to pay him/her the amount due to him/her, may require:

  • revaluation of assets
  • estimate of goodwill
• There can be liquidity problems in paying off a retiring partner, which may be resolved:

  • by converting the retiring partner's capital account to a loan account
  • by arranging a bank overdraft
  • by taking out a bank loan
  • by taking out a new partner
• Explain why the profit sharing ratio of a partnership might change:

  • some partners may be contributing more than what they used to by: becoming more experienced, taking on more responsibilities, key partners are now retiring or starting to do less than what they once did and a new partner is joining
• Explain why the assets of a partnership may be revalued when a partner leaves a business - It is the old partners who have contributed towards the assets (both tangible and intangible) which currently exist in the business. Therefore any increase or decrease in assets should impact the old partners and not a new partner who is only just joining
• Explain why a business should write off goodwill on the admission of a new partner - Goodwill is an intangible non current asset which adds additional value to a business beyond its worth. The old partners should benefit from receiving a share of goodwill under the old profit sharing ratio through an increase in their existing capital in the partnership as they have contributed towards building a good reputation due to product quality and/or customer service, established customer base, established links with suppliers and/or finding a good location