Prof.
Viswanatha S R
M.Com,MPhil, B.Ed,UGC NET, (Phd)
MODEL NO 3: VALUATION OF GOODWILL
Meaning of Goodwill
Goodwill means the value of Reputation or Good Name of the business. It is an Intangible
Assets of the business Concern.
Definition
According to Professor Dicksee "when a man pays for Goodwill, he pays for something which
puts him in a position of being able to earn more than he would be able to do by his own
unaided efforts".
Types of goodwill
1) Purchase goodwill
2) Inherent goodwill (Non purchase Goodwill)
1) Purchase Goodwill
It is the difference between the value paid for an enterprise as a going concern and the sum of
its assets less the sum of its liabilities, each item of which has been separately identified and
valued.
2) Inherent Goodwill
It is the value of business in excess of the fare value of its separable net assets. it is referred
as internally generated goodwill and it arises over a period of time due to the good reputation
of business. It is also called as self-generated or Non-purchased goodwill.
Features of Goodwill
1. It is an intangible asset
2. It is a real asset but not a fictitious asset
3. It always exists in the business but it cannot exist by itself
4. It is subjected to fluctuations
5. It helps in earning excess profit
6. It is difficult to estimate the exact value of goodwill
Factors determining the value of goodwill
1. Location factor
2. Time factor
3. Nature of business
4. Efficiency of management
5. Past profits of a business
6. Stability of a business
7. Future prospects of business
Circumstances of Valuation of Goodwill
The following are the circumstances it may be necessary to value goodwill.
1. In case of soul trading concern
1. when a sole trading concern is sold.
2. When a sole trading concern is converted into partnership firm or a joint stock company.
3. when a sole trading concern is amalgamated with other sole trading concern.
2. In case of partnership firm
1. On admission of a new partner.
2. On retirement of a partner.
3. On death of a partner.
4. On the amalgamation of partnership firm.
5. Sale of partnership firm to limited company.
3.In case of joint stock company
1. On the Amalgamation of two or more company.
2. On the absorption of one company by another company.
3. On the external reconstruction of a company.
4. For the purpose of valuation of shares.
Methods of Valuation of Goodwill
1. Average Profit Method
2. Capitalisation Method
3. Super profit Method
4. Annuity Method
1.AVERAGE PROFIT METHOD
Steps for Valuation of Goodwill under Average Profit Method
Step 1. Calculation of Adjusted profit ( 5marks )
Particulars Amount
Rs
Profit Xxx
Add All Expenses and Losses not likely incur in future:
1. Loss from fire/theft
(Abnormal loss) Xxx
2. Capital Expenses
Xxx
3. Extraordinary salary of a person
4. Profit likely comes in future (profit of new line
business) Xxx
5. Loss due to speculation
6. Non incurring loss
Xxx
Xxx
xxx
Xxxx
Less Expenses /losses expected to occur in future
1. Non-recurring Income Xxx
2. Insurance on stock in future Xxx
3. Directors’ salary Xxx
4. Staff to be appointed Xxx
5. Depreciation in future. Xxx
6. Cost of management Xxx
7. Profits not likely arise in future Xxx
8. Interest on Investment xxx
Adjusted profit Xxx
Step 2: Calculation of Adjusted Average profit
There are two methods (Any one method will be followed)
A. Simple average method (When there is fluctuation in profits)
Adjusted average profit = Total adjusted profits of all the given years / Number of years
B. Weighted average method (when the weights for each year is given or when profits
are increasing or decreasing trend)
Adjusted Average Profit = Total Product/ Total Weight
Note : Students can use any one method depends on information given in the problem.
Step 3 Calculation of Goodwill
Goodwill =Adjusted Average Profit x Number of years of Purchase
2. CAPITALIASTION METHOD
This method can be divided in to two methods
A. Capitaliasation Avearge profits
B. Capitaliastion of Super profits.
A. Valuation of Goodwill under capitalisation of Average Profits Method
Step 1: Calculation of Adjusted average Profits ( same as under Avg profit
method).
Step 2: Calculation of Total Value of the Business.
Total value of the Business= Adjusted Avg Profits x 100
Normal Rate of Return
Step 3: Calculation of Goodwill
Goodwill= Total Value of the Business-Capital Employed
Where, Capital Employed =Assets- Liabilities
B. Capitalisation of super profits
Goodwill = Super Profit x100
Normal rate of Return
3.SUPER PROFIT METHOD
Super Profit is the difference between the average profit earned by the business and the
normal profit based on the normal rate of return.
Normal Rate of Return: The rate of earnings which investor in general expect on their
Investment.
STEPS TO BE FOLLOWED FOR VALUATION OF GOODWILL UNDER SUPER
PROFIT METHOD.
Step 1: Calculation of Adjusted Average Profit (Same as Avg profit method)
Step2: Calculation of Average Capital Employed ( There are TWO ways)
A. Assets Basis
B. Liabilities Basis
Assets Basis Approach
Particulars Amount
Rs
Trade Assets Xxxx
(Other than Non trading Assets, Goodwill, Past Deffered Expenses
and Losses such as preliminary Exp, Discount on Issue of shares and
Debenture etc)
Less: liabilities to outsiders Xxxx
Capital Employed Xxxx
Less: Half of the Profit earned during the Year xxxx
Average Capital employed Xxxx
Note 1: Let us do problems on Assets Basis so ignore Liability based*
Note 2: if capital employed is given in the problem, need not to calculate Avg capital
employed.
Note 3: Non Trading assets means assets purchased because of spare funds such as
investments in Govt securities, preliminary expense, past losses etc.
Step3: Calculation of Normal Profits
Normal profit= Average Capital Employed x Normal rate of Return
Step4: Calculation of Super profit
Super Profit= Adjusted Profit- Normal Profits
Step5: Calculation of Goodwill
Goodwill=Super Profits x No of Year’s of Purchase
4.ANNUITY METHOD
The goodwill of a concern is calculated by taking into the present value of an annuity for a
certain number of years at a certain rate of Interest.
Goodwill = Super Profit x Annuity Value
