Admitting Cheong: Revaluation and Goodwill in a Printing Partnership
Amir and Bala have run a printing partnership since 20X1, sharing profits 3:2. At 30 June 20X6 their capital accounts stood at RM90,000 and RM60,000, and their current accounts at RM12,000 credit and RM4,000 debit respectively. On 1 July 20X6 they admit Cheong, who pays RM65,000 cash into the business bank account for a one-quarter share of profits; Amir and Bala will share the remaining three-quarters in the ratio 3:2.
Before Cheong is admitted, the partners agree to revalue the freehold workshop upwards by RM30,000 and to write inventory down by RM8,000. An independent valuer puts the firm's goodwill at RM80,000, and the partners agree that goodwill should not remain in the books after Cheong's admission. No entries have yet been made for the revaluation, the goodwill or the admission. Bala argues that the revaluation is unnecessary because 'the building is not for sale', and Amir wants the goodwill recorded as an asset so that the statement of financial position looks stronger for the bank.
1. Show the entries for the revaluation and goodwill, and calculate each partner's opening capital on 1 July 20X6.
Read the worked answer
1. Revaluation (net gain RM30,000 − RM8,000 = RM22,000, shared 3:2):
| Dr | Cr | RM |
|---|---|---|
| Freehold workshop | Revaluation | 30,000 |
| Revaluation | Inventory | 8,000 |
| Revaluation | Capital - Amir (3/5 x 22,000) | 13,200 |
| Revaluation | Capital - Bala (2/5 x 22,000) | 8,800 |
2. Goodwill (valued at RM80,000; not to remain in the books). Cheong's share is 1/4 x RM80,000 = RM20,000, credited to the old partners in their old ratio 3:2:
| Dr | Cr | RM |
|---|---|---|
| Capital - Cheong | Capital - Amir (3/5 x 20,000) | 12,000 |
| Capital - Bala (2/5 x 20,000) | 8,000 |
No goodwill account is opened, so nothing appears in the statement of financial position.
3. Opening capitals
| Amir | Bala | Cheong | |
|---|---|---|---|
| Capital at 30 June 20X6 | 90,000 | 60,000 | - |
| Revaluation gain | 13,200 | 8,800 | - |
| Current account | 12,000 | (4,000) | - |
| Goodwill adjustment | 12,000 | 8,000 | (20,000) |
| Cash introduced | - | - | 65,000 |
| Opening capital 1 July 20X6 | 127,200 | 72,800 | 45,000 |
Total capital RM245,000, which equals the net assets after revaluation (RM180,000) plus Cheong's RM65,000 cash.
2. Cheong asks whether RM65,000 is a fair price. Show him the arithmetic behind the figure.
Read the worked answer
Value of the firm as a whole:
| RM | |
|---|---|
| Net assets of the old firm after revaluation (90,000 + 60,000 + 12,000 − 4,000 + 22,000) | 180,000 |
| Add: goodwill valued by the valuer | 80,000 |
| Value of the firm before admission | 260,000 |
| Cheong's one-quarter share: 1/4 x 260,000 | 65,000 |
So RM65,000 is internally consistent with the agreed valuation.
Why his capital account shows only RM45,000: RM20,000 of what he pays is a premium for goodwill - compensation to Amir and Bala for giving him 25% of a business they built. He pays RM65,000 cash but RM20,000 of it is credited to the old partners, leaving RM45,000 in his capital account. This is not a loss to Cheong: he now owns 25% of a firm worth RM260,000, including goodwill of RM80,000 that he did not have to create.
What he would pay without goodwill: 1/4 x net assets of RM180,000 = RM45,000. The gap between RM45,000 and RM65,000 is precisely the goodwill premium, and Cheong should understand it before signing.
3. Advise Bala and Amir on their two arguments.
Read the worked answer
To Bala - the building must be revalued. Admission is the point at which the old partners' claim is fixed. If the RM30,000 uplift is ignored, Cheong buys into the firm at book values and then shares in a gain that arose before he arrived: when the building is eventually sold, or depreciated, part of the benefit would flow to him. Conversely, the inventory write-down of RM8,000 must also be made, so the old partners absorb their own loss rather than passing it to Cheong. 'Not for sale' is irrelevant - the uplift is supported by an independent valuation, so it is reliable and relevant. Prudence also requires the inventory write-down (lower of cost and net realisable value).
To Amir - goodwill must not be recorded as an asset.
- This is internally generated goodwill, which is not a separable asset and must not be recognised; only purchased goodwill can be capitalised.
- If an RM80,000 goodwill account were opened and later written off, the write-off would be shared in the new profit ratio - Cheong would bear 25% of a cost he has already paid for in cash. He would pay twice.
- Presenting it to the bank would overstate assets and capital and mislead the lender; the bank's own valuer would strip it out.
Agreed treatment: value the goodwill, use it to compute Cheong's contribution, then remove it through the partners' capital accounts so that no goodwill balance remains.