Essential Accounting Concepts: Goodwill, Shares, Debentures, and Financial Reporting

Posted on Oct 18, 2025 in Business Administration and Innovation Management

Understanding Goodwill in Business Accounting

Meaning of Goodwill: Goodwill is defined as “the current value of expected future income in excess of the normal return on investment in net tangible assets.”

Characteristics of Goodwill

1. It is an intangible asset: Goodwill is a type of intangible asset, like patents or trademarks. The question of depreciation does not arise on it as it does not suffer wear and tear like other assets.
2. Its value tends to fluctuate: Goodwill cannot have an exact cost. Its value tends to fluctuate from time to time due to internal and external factors which ultimately affect the fortune of the company.
3. Difficulty in placing value: It is difficult to place the value of goodwill because its value fluctuates from time to time due to changing circumstances.
4. No objective valuation: There is no objective valuation of goodwill as the valuation is done in a subjective manner and differs from estimator to estimator. Therefore, the value of goodwill is based on the subjective judgment of the valuer.

Nature of Goodwill

Goodwill is nothing but the reputation of a partnership firm. It is computed on the basis of expected profits in excess of normal profits. It denotes the firm’s capacity to earn a greater profit in the future based on its track record.

1. Goodwill is an intangible fixed asset. It is intangible because it has no physical existence; it cannot be seen or touched.
2. It has a definite value depending on the profitability of the business enterprise.
3. It cannot be separated from the business.
4. It helps in earning more profit and attracts more customers.

Factors Affecting Goodwill Value

1. Location of Business: If the firm is located in a centralized place where there is more traffic, it tends to have higher sales and thus earns more goodwill. A prominent location attracts more customers and generates more goodwill.
2. Management: Good and efficient management helps the business earn more profit and goodwill. A business with efficient and experienced management will generate more goodwill.
3. Business Longevity: An older business, or one with higher longevity, is known by more customers and therefore will have more goodwill, as reputation and the number of customers increase over time.

Need for Goodwill Valuation

Goodwill arises when a company acquires another business. The amount of goodwill is the cost to purchase the business minus the fair market value of the tangible assets, intangible assets, and liabilities obtained in the purchase. The need for the valuation of goodwill arises in various situations, including:

• The difference in the profit-sharing ratio (PSR) amongst the existing partners.
• Admission of a new partner.
• Retirement of a partner.
• Death of a partner.
• Dissolution of an enterprise involving the sale of the business as a trading concern.
• Consolidation of partnership firms.

Methods of Goodwill Valuation

It is very difficult to assess the value of goodwill, as it is an intangible asset. In the case of the sale of a business, its value depends on the mutual agreement between the seller and the purchaser. Some of the important methods of valuing goodwill are:

1. Average Profit Method
2. Weighted Average Profit Method
3. Super Profit Method
4. Capitalization Method
5. Annuity Method
6. Purchase Method

Average Profit Method Formula

Goodwill = Average Profits × Number of Years’ of Purchase

Weighted Average Profit Method Formula

Weighted Average Profits = (Total of Products of Profits) / (Total of Weights)

Goodwill = Weighted Average Profits × Number of Years’ of Purchase

Debentures: Definition and Features

The issue of debentures is a method of raising a loan from the public. A debenture may be defined as an instrument acknowledging a debt by a company to some person or persons, which may or may not be secured by a charge on its assets.

According to Mr. Topham, “A debenture is a document given by a company as evidence of a debt to the holder usually arising out of a loan and most commonly secured by a charge.”

Section 2(12) of the Companies Act, 2013 states: “Debenture includes debenture stocks, bonds and any other securities of the company whether constituting a charge on the company’s assets or not.”

Main Features of Debentures

1. A debenture is in the form of a certificate, like a share certificate.
2. It is issued under the common seal of the company.
3. This certificate is an acknowledgment of debt by the company to its holder.
4. A debenture usually provides for the repayment of a specified principal sum on a specified date. However, there is no restriction on the issue of irredeemable debentures.
5. It usually provides for the payment of interest at regular intervals at fixed dates until the principal sum is completely paid back.
6. It is normally secured by a floating charge on the assets of the company.

Shares: Definition and Market

Definition: Shares are the smallest unit of the company’s capital or can be said to be a unit of equity. The holder of such shares in a company is known as “Shareholders” (the owners of the company). These shares can be issued to the public for raising the funds of the company for its expansion. The market used for trading shares is known as the “Share Market,” which deals in various markets, but the most popular share markets are NSE (National Stock Exchange) and BSE (Bombay Stock Exchange).

Key Differences Between Shares and Debentures

1. A share represents a portion of the capital of a company, whereas a debenture represents a portion of the debt of a company.
2. A shareholder is a member of the company, whereas a debenture holder is a creditor of the company.
3. A shareholder enjoys the rights of proprietorship of a company, whereas a debenture holder can enjoy the rights of a lender only.
4. A shareholder has a right of control over the working of the company by attending and voting in the general meeting, whereas a debenture holder has no such right.
5. A shareholder can get dividend only when there are profits, whereas a debenture holder is entitled to interest which the company must pay whether or not there are profits.
6. A debenture holder gets a fixed rate of interest per annum payable on fixed dates, whereas a shareholder gets a dividend that can be far higher if the company earns good profits.
7. A shareholder has a claim on the accumulated profits of the company and is normally rewarded with bonus shares, whereas a debenture holder has no claims whatsoever after he has been paid the interest amount.

Types of Debentures

A company can issue various types of debentures which can be classified on the basis of security, permanence, convertibility, and records.

1. Redeemable and Irredeemable Debentures:
   • Redeemable Debentures are issued for a specified period after which the company must repay the amount on a specified date, after notice, or by periodical drawings.
   • Irredeemable Debentures are those for which no fixed date is specified for repayment, and the holders cannot demand payment as long as the company is functioning and does not default in interest payment. (Normally, companies issue redeemable debentures.)
2. Registered and Bearer Debentures:
   • Registered Debentures are registered in the name of the holder by the company in the Register of Debentureholders. They are transferable in the same manner as shares by transfer deeds. Interest is payable to the person whose name is registered.
   • Bearer Debentures are transferable by mere delivery. Interest on such debentures is payable on the basis of coupons attached to the debenture certificate.
3. Secured and Unsecured Debentures:
   • Secured Debentures (also known as Mortgaged Debentures) are secured either by the mortgage of a particular asset of the company, known as a Fixed Charge.
   • Unsecured Debentures are those which are not secured by any charge or mortgage on any property of the company.

Financial Statements: Meaning and Components

Meaning

1. An accounting process initiates with the journalizing of transactions and ends with the preparation of the Trial Balance, which comprises all the debit and credit account balances.
2. A summary of accounting data prepared by an enterprise at the end of an accounting process with the help of such a Trial Balance is known as Financial Statements.
3. As per Section 2(40) of the Companies Act, 2013, a set of Financial Statements prepared in accordance with Schedule III of this Act comprises of a Balance Sheet, Notes to Accounts, Statement of Profit and Loss, and Cash Flow Statement.

Nature and Characteristics

Nature of Financial Statements

The nature of Financial Statements is a result of a combination of the following points:

1. Recorded Facts: Refers to the recorded transactions in the books of account on the basis of evidence.
2. Conventions: All recorded transactions should follow all relevant accounting conventions, making financial statements reliable, understandable, and comparable.
3. Accounting Concepts: All recorded transactions should follow accounting concepts, which also make the financial statements reliable, understandable, and comparable.
4. Personal Judgments: Personal judgments have an important bearing on the financial statements as they facilitate the selection of methods when one alternative is chosen out of various options.
5. Source of Financial Information: Financial statements act as a source of financial information on the basis of which conclusions and interpretations can be drawn about the financial performance and position of a company.

Characteristics of Financial Statements

1. They are historical documents, as they relate to a past period.
2. They are expressed in monetary terms.
3. They show financial performance through the Statement of Profit and Loss and financial position through the Balance Sheet.

Objectives, Essentials, and Limitations

Objectives

Financial Statements are prepared with an objective to:

1. Compute profit or loss from operating activities of the business.
2. Present a true view of the financial position of the business.
3. Provide information on economic resources of the business.
4. Provide data about the inflow and outflow of cash and cash equivalents.
5. Determine the effectiveness of the management activities to ensure better performance of its business.
6. Provide necessary information to the users of such financial statements.
7. Present and disclose accounting policies and conventions used in the preparation of books of accounts of the business entity.

Essentials

Following are the Essentials of Financial Statements:

1. Factual Information: Financial Statements should disclose the factual information about the financial position of the company.
2. Understandability: Financial Statements should be prepared following accepted accounting principles for the better understanding of the users.
3. Comparable: Financial Statements should disclose the information in a manner that the user can compare the information of the same entity over years and also compare the reporting company’s financial information with that of others.
4. Verifiable: Financial Statements of the company should disclose such information which is verifiable from the records of the company.
5. Relevant: Financial Statements should disclose the financial information which is in accordance with the legal requirements.
6. Timeliness: After the end of the accounting period, financial statements should be prepared and presented within a reasonable period to avoid any undue effect on the relevance of these statements.

Limitations

Following are the limitations of the financial statements:

1. Historical Records: Financial Statements provide information which is historical in nature and, therefore, are not useful for potential investors or lenders as they do not provide any information about the future business or its future financial position.
2. Affected by Estimates: Financial Statements are the outcome of accounting concepts and conventions combined with estimates and are, therefore, not free from bias.
3. Different Accounting Practices: Financial Statements can be drawn up on the basis of different accounting practices. Profitability determined by each of these practices will be different, and hence, there is no standard practice which can be followed by all.

Users of Financial Statements

Following are the categories of Users of Financial Statements:

1. Internal Users:
   1. Shareholders: Provide funds and are exposed to risks. They are interested in profitability, returns, financial, and cash position.
   2. Management: Responsible for safeguarding investment and maximizing profits. They use financial information to make informed decisions.
   3. Employees: Work for salary and benefits (like bonus) which are often linked directly to the profits of the business.
2. External Users:
   1. Banks and Financial Institutions: Provide loans and are concerned about the company’s performance to ensure repayment of the loan along with interest due.
   2. Investors and Potential Investors: Wish to know how safe their investments are and judge profitability and growth status.
   3. Creditors: Suppliers who provide goods and services on credit and are concerned about the financial stability of the company to ensure that dues are cleared on time.

Provisions and Reserves

Provisions and reserves are two important accounting concepts:

• Provisions are amounts set aside to cover known liabilities or expenses that have already been incurred but are not yet paid. They are recognized in the financial statements as a charge against profit.
• Reserves, on the other hand, are appropriations of profit set aside for specific future purposes, such as covering potential losses or contingencies. They are not recognized as expenses until they are utilized.

In summary, provisions are for known expenses, while reserves are for future uncertainties.

Format of Comparative Statements

Procedure for Issue of Shares

The procedure followed for the issue of shares is as follows:

1. Issue of Prospectus: First of all, the company issues a prospectus which provides complete information about the company to the prospective investors. It also mentions the manner in which the amount on shares is to be collected.
2. Receipt of Applications: The Company makes its application forms available to the public through its brokers and banks. Applications are received through a Scheduled bank for at least four days from the date of opening the subscription to the issue.
3. Allotment of Shares: After the closure of the subscription list, the shares have to be allotted within 120 days of the issue of the prospectus, provided ‘minimum subscription’ has been received. Minimum subscription is the amount which, in the opinion of directors, must be raised to meet the basic needs of the business operations of the company. If the same is not received, the company cannot proceed with the allotment of shares, and the application money must be refunded to the applicants within 130 days of the issue of the prospectus.

Calls in Advance

When a company accepts money paid by some allottee in respect of calls not yet due, such amount is known as ‘Calls in Advance’. It may also happen in case of partial allotment of shares when the full amount of application money paid by an applicant is not adjusted to allotment, and if the company decides to retain such excess amount, it is called ‘Calls in Advance’. It is a liability of the company and should be transferred to the ‘Calls in Advance’ Account. It will be adjusted when the respective call is made.

Types of Shares

The following are the two types of shares:

• Preference Shares: Preference shares define preferential rights over other shares and get claims before ordinary or equity shares. Preference shareholders get a dividend in priority at the time of dividend distribution. Even at the time of liquidation of the company, they have the preferential right over capital repayment.
• Equity Shares: Equity shares are one of the most significant sources of long-term financing. They are also known as owner’s equity or ordinary shares. The shareholders of such shares are the company’s absolute owners, but these shareholders get the dividend paid only after the payment of the dividends to the preference shareholders. Equity shareholders do not have the right to claim dividends on income or assets at the time of the company’s liquidation.