Indian Partnership Act-Goodwill of a Firm

Indian Partnership Act 1932

Goodwill is an asset that is impalpable, and it is associated with the procurement of a company by another. To be more specific, goodwill is a portion of the purchase price that is usually higher than the total sum of the net fair for all the assets purchased. A company’s goodwill is based on the brand name, proprietary technology, good customer base, customer relationship, and employee relationship. A detailed study can be achieved from the Indian partnership act-goodwill of a firm.

 

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The long-term asset of goodwill is categorized as an important part of the growth of business reputation. The amount of goodwill is the cost to purchase that is subtracted from the fair market value. Hence, this intangible asset can be identified based on the obtained liabilities from the purchase. Goodwill of the firm can be adjusted to a smaller amount due to an impairment of the company that has been procured. It is usually shown on the balance sheet of the company. Most of the private companies want to amortize goodwill over 10 years and thus, reduce the complexity and cost involved in the process.

 

How to Calculate Goodwill When Selling a Business?

The process of goodwill partnership is calculated based on a fairly straightforward principle. However, sometimes it can be pretty complex in practice. If you want to determine the goodwill of the firm in a simple formula, consider taking the company’s purchase price and then subtract it from the net fair market value. The formula stands:

 

Goodwill = P – (A – L).

 

P – Purchase price

 

A – Asset value of the fair market

 

L – Liabilities value of the fair market

 

What are the Features of Goodwill?

If you want to know what is goodwill in partnership, consider the following key features.

  • Goodwill is the overall position and reputation in the market a firm has, especially when it comes to monetary terms.

  • Goodwill showcases the capacity of an enterprise in terms of earning profits.

  • Goodwill cannot be seen, but certainly can be felt. 

  • Goodwill in business has no connection with the contribution of capital for establishing a reputation in the market.

  • The value of a company’s goodwill may change in the long run.

  • The value is prone to fluctuation due to factors contributed to the business environment.

 

What is Goodwill in a Partnership? 

The value of goodwill in partnership arises when there is an acquisition. It occurs when an acquirer purchases a target company. The amount that is paid by the acquirer to the target company is the value of the goodwill, the target company has. The sum is based on the target company’s net assets based on the fair value market. When the acquiring company pays less than the sum shown on the target’s book, the acquirer achieves negative goodwill. This indicates that the acquirer has purchased the company on a distress sale over a bargain. 

 

Understanding the goodwill of a partnership is crucial if you are looking for – how to calculate goodwill when selling a business? Goodwill is recorded in the company’s balance sheet long-term asset account. Under the terms of GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards), companies need to evaluate goodwill’s value based on the financial statements for at least once in a year. This is a good practice to keep track of the impairments.

 

Factors that Contribute to Goodwill of a Company

Goodwill incorporation is not an easy task for a firm. It cannot be ensured in a single day. With continued great efforts, it takes years to maintain proper goodwill. The factors that contribute to the goodwill of the firm are as follows.

  • Customer service

  • The quality offered through products and services

  • Efficiency in management

  • The Reputation of the promoters or founders

  • Goodwill in business through locational advantage

  • Monopolistic nature

  • Fair competition

  • Consistency

  • Market share

  • Coverage or reach

  • Advertising and marketing strategy

  • Customer satisfaction

  • Possession of trademark and distinctive patent

 

Goodwill Partnership with customers also means a lot when it comes to business reputation. When the customers stay loyal to the firm and keep visiting regularly, it can be said that the company has the potential of earning surplus profits.


Indian businesses are well known for their successful partnership, so to monitor and govern such partnerships The Indian Partnership Act was established on the 1st October 1932.


This partnership act provides an agreement between two or more persons who agree to do the business as one and share the profits between themselves. A partnership is classified into various types and it depends on the state and the business location. Here are some of the most common types of partnerships in a business.

  • General Partnership.

  • Limited Partnership.

  • Limited Liability Partnership.

  • Partnership at Will.


Goodwill

When a company is purchased by another company, then it is called goodwill. It is an intangible asset. In particular, In a situation where the purchase price is greater than the sum of the fair value of all solid assets and purchase of intangible assets, by acquisition and the liabilities assumed in the process.


Types of Goodwill

There are two different types of goodwill, they are

  • Purchased goodwill.

  • Inherent goodwill.


Purchased Goodwill

Purchased goodwill is the difference of the purchase value of a business as an ongoing concern and the sum of its fixed assets less the sum of its liabilities, each item of them is to be separately identified and valued.


Inherent Goodwill

It is the value of an enterprise higher than the fair value of its separable net assets. It is also known as internally generated goodwill, and it emerges for a fixed time, due to the good fame of a business. It can also be called self-generated or non-purchased goodwill.


Calculation of Goodwill

When an entire business is acquired by another company, goodwill comes into play. The amount of goodwill is defined as the cost to purchase the business minus the fair market value of the tangible assets, the identified intangible assets, and the liabilities on purchase.


The calculation of goodwill is as follows,


Goodwill = P−(A+L)

where,

P = Purchase cost of the company


A = Fair market value of assets


L = Fair market value of liabilities


For example, If you sell a remarkable product or consistently provide outstanding service, then there is a higher possibility for an increase in goodwill.

FAQs on Indian Partnership Act-Goodwill of a Firm

1. What is goodwill in a partnership?

Goodwill is associated with the purchase of one company by another company. In the business language, the company that is purchasing is called an acquirer, and the company that is being purchased is called a target company. Goodwill partnership is recorded based on the situation when a purchase is higher than the sum of the fair value market. It is based on solid visible assets as well as intangible ones in the assumed acquisition and liabilities. 

2. What is the need for valuation and how to calculate goodwill when selling a business?

The valuation and calculation of goodwill are required when there are major changes noticed in a firm, and these are as follows.

  • Economic damage analysis

  • Amalgamation

  • Business separation

  • Change in partnerships

  • Business enterprise valuation

These were some major reasons as to why companies perform valuation and calculate goodwill. However, apart from this, goodwill can also be evaluated upon insolvency test, solvency test, intercompany transfer price, bankruptcy and reorganization, and others.

3. Define goodwill impairment

Goodwill in business is crucial, especially considering the recent competitive market. Even with the best practices, some firms fail to curb away impairment. Impairment occurs when the asset’s market value drops at an alarming rate. This type of event occurs when there is a decline in cash flows, economic disruption, an increase in a competitive environment, and other factors. Companies should determine the needs of impairment by performing impairment tests on intangible assets. Some of the common methods used to test impairments are- income approach and market approach. The income approach is used for the estimation of future cash flows which are then discounted from the present value. On the other hand, the market approach is required when analyzing the liabilities and assets of similar companies under the same industry category. 

4. What is goodwill accounting treatment?

Accounting treatment of goodwill at the time of admission of a new partner is classified into five types, they are:

  • If the goodwill amount is brought is cash and note recorded in books.

  • If the new partner brings his share as goodwill in cash and gets retained in the business.

  • If the new partner does not bring the share of goodwill in cash.

  • If the goodwill already exists in the books.

  • If the full value of the goodwill is raised.

5. What are the advantages of partnership?

  • Easy Formation – An agreement can be made either orally or as a printed agreement to enter as a partner and establish a business.

  • Large Resources – Unlike, sole proprietors where every part of the business is being contributed by one person, in partnership, partners of the business can contribute more capital and other resources required for the firm.

  • Flexibility – The partners can initiate any modification if they think it is required to meet the desired standards or to change business circumstances.

  • Sharing Risk – If a loss is incurred in the firm, it is shared equally amongst the partners of the firm.

  • Combination of different skills – The advantage of a partnership firm is that partners having different knowledge, skill, experience, and talents work as a unit.

6. What is the need for the valuation of the goodwill?

The valuation of goodwill will help a business in various ways, some of them are listed below,

  • It helps to find the difference of profit share amongst the existing partners by using the profit-sharing ratio (PSR) 

  • It helps in the admission of a new partner for the business

  • It helps in the retirement of a partner on their share details

  • It helps during the dissolution of a business involving the sale of the enterprise as a trading concern

  • It helps in consolidating the partnership of the firm

7. How does location and nature of business affect goodwill?

Business Location: An enterprise that is located in a suitable place with higher market value will have a higher chance of goodwill when compared to a business placed in a remote location with a poor market opportunity.


Business Nature: It is defined as the type of products that the business is dealing with, the competition level of the market, product demand, and the impact of the business regulations. A business that has favored in all these areas will have greater goodwill.

8. How does the quality of goods, capital and trademark of a business play a major role in goodwill?

Quality of goods and services:  A business that provides quality goods and services has a higher chance of getting goodwill when compared to others who provide inferior goods and services.


Capital: A firm that has a higher return on investment along with lower capital investment is considered more profitable and has more goodwill.


Possession of trademark and patents: Firms that have patents and trademarks will have a monopoly in the market segment, which will lead to an increase in the goodwill of the firm.

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