Goodwill represents the reputation of a firm. Which provides some extra benefits/profits in the future in comparison to other firms. It builds up when the business has continued for some time. This is treated as intangible assets in accounts. It is not a fictitious asset. Hidden Goodwill may be defined as the value of a firm. Its effect is extra profit which firms earn over the normal rate of profit in the future.
Hidden Goodwill means the value of goodwill that is not specified at the time of admission of a partner. If the new partner requires to bring the share of goodwill, then, in this case, we have to calculate the value of the firm’s goodwill.
Difference between the capitalized value of the firm and the net worth of the firm is treated as the value of Hidden Goodwill. In other words, we can say hidden Goodwill is the Inferred Goodwill. This is not given in question but is implied from brought in capital by the new partner for his share in the firm.
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Learn more about Revaluation Account here in detail.
Example: M and N are two partners in a firm with the capital balances of ₹ 1,60,000 and ₹ 2,20,000 respectively. The firm had a general reserve of ₹ 40,000. They admitted P into the firm for the 1/4th share of profits. He brings capital of ₹ 1,80,000. Calculate the firm’s goodwill and P’s share of goodwill.
Value of Goodwill = Capitalised Value of Firm – Net Worth
Capitalised Value of Firm = P’s Capital × Reciprocal of his Share
Net Worth = Total Capital (including P’s Capital) + Reserve
Net Worth = (1,60,000 + 2,20,000 + 1,80,000) + 40,000 = 6,00,000
Value of Goodwill = 7,20,000 – 6,00,000 = 1,20,000
Now we are going to discuss accounting treatment of Hidden Goodwill.
Accounting treatment of Hidden Goodwill
When the value of Goodwill of a firm is not specified, the value of Goodwill has to be calculated and adjusted as follows:
|New partner capital *Reciprocal of new partner share||XXX|
|Less: Total capital (including new partner capital)||XXX|
|Value of Goodwill||XXX|
Following is the Journal Entry
|Date||Particular||Amount (Dr.)||Amount (Cr.)|
|New Partner’s capital A/c||Dr.||XXX|
|To Old Partner’s capital A/c||Cr.||XXX|
|(Being new partner’s share of hidden Goodwill adjusted through old partner’s capital account)|
Solved Question on Hidden Goodwill
Amar and Akbar are in partnership sharing profits and losses equally. The Balance sheet of M/s. Amar and Akbar as on 31.12.2016 is:
|Capital A/c:||Sunday fixed Assets||30000|
On 1.1.2017 they agree to take Anthony as a 1/3rd partner to increase the capital base to ₹67500. Anthony agrees to pay ₹ 30000. Show the necessary journal entries and prepare the partner’s capital accounts.
In the Books of M/s. Amar Akbar and Anthony
|To Anthony capital A/c||Cr||30000|
|(cash brought in by Anthony for 1/3rd share)|
|2.||Anthony capital A/c||Dr.||7500|
|To Amar capital A/c||Cr.||3750|
|To Akbar capital A/c||Cr.||3750|
|(Being amount adjusted through partner’s capital accounts)|
|3||Amar capital A/c||Dr.||3750|
|Akbar capital A/c||Dr.||3750|
|To Bank A/c||Cr.||7500|
|(Amount of Goodwill will due to Amar and Akbar withdrawn)|
Partner’s capital A/c
|To Amar||3750||By Balance b/d||22500||22500||–|
|To Akbar||3750||By Bank||–||–||30000|
|To Bank||3750||3750||–||By Anthony||3750||3750||–|
|To Balance c/d||22500||22500||22500|
- Old profit sharing Ratio 1:1
- New profit sharing Ratio 1:1:1
- Anthony share of capital ₹67500×1/3=22500
- Goodwill ₹30000 -22500=7500 for 1/3rd share
Total Goodwill is 7500×3=22500