distinguish between purchase goodwill and non purchase goodwill
Answers
(i) Purchased goodwill and non purchased goodwill
Goodwill is the term used by an accountant to describe the difference between the
value added/placed upon a firm and the sum of the values of identifiable net assets
of that firm. Goodwill is said to exist when a firm is earning profits over and above
normal earnings of other similar enterprises in the same industry. It is an intangible
asset.
Goodwill is the excess amount that has to be paid to acquire part or the whole
of a business as a going concern over and above the value of the net assets owned
by the business.
Purchased goodwill is the difference between the amount paid to acquire a part
or the whole of a business as a going concern and the value of the net assets owned
by the business.
Purchased goodwill = Total price – Value of net identifiable assets
Non purchased goodwill is inherently generated and not a subject of
acquisition. It arises out of a subjective valuation but not through a market
transaction. It should not be recognised in the financial statements.
(ii) Amortisation and depreciation of fixed assets
Amortisation refers to the loss of value of a fixed asset due to passing of time. For
example a business buys a patent for ten years. At the end of the ten years the asset
is said to have been fully amortised. Examples of fixed assets that an amortised
include leases, patents and goodwill.
Depreciation is the part of the cost of a fixed asset consumed during it?s
period of use by the firm. Assets depreciate because of various reasons such as
physical deterioration, depletion, obsolescence etc.,
Both amortisation and depreciation are treated as expense in the income statement.
(iii) Provisions and reserves
Provision
This is the money set aside for payment of foreseen expenses. For example in
companies the profit earned may be set aside for payment of dividends,
corporation tax.
A provision is charged against revenue as an expense. Its related either to the
dimunition in the value of an asset e.g. doubtful debts or a liability e.g. audit fees,
director?s fees, proposed dividend, taxation
Reserves
This is an appropriation of distributable profits. A company may decide not to
distribute part of the profits and during a financial year to the shareholders as
dividends. Profits not distributed are revenue reserves. E.g general reserve,
revaluation reserve, share premium
Capital reserves arise from causes other than those of normal trading e.g. share
premium, capital redemption reserve.
(iv) Compensating errors and errors of principle
A compensating error will arise where two errors of equal amounts but on opposite
sides of the accounts cancel each other out. For example, if the sales account has
added up to be Sh 10 too much and the purchases account was also added up to Sh
10 too much, then these two errors would cancel out in the trial balance.
An error of principle will arise when an item is entered in the wrong class of
account for example of a fixed asset such as a motor van is debited to an expenses
account such as motor expenses account.