GAJERA INTERNATIONAL SCHOOL, SURAT

ACCOUNTANCY
STUDY MATERIAL & WORKSHEETS
Date:01-04-2020 CLASS: - XII
Chapter: 3. GOODWILL METHODS OF VALUATION OF GOODWILL

1. Goodwill A goodwill is the value of reputation, good name and wide business connections of a firm
which enables it to earn higher profits in compare to the normal profit earned by the
other firms in the same trade.

2. Features of Features of Goodwill are as under:-

Goodwill
1. It is valuable intangible Asset.

2. It helps in earning excess profit.

3. It is valuable only when entire business is sold.

3. Factors affecting The main factors affecting the value of goodwill are as follows:
the value of 1. Nature of business
Goodwill
2. Location

3. Efficiency of Management

4. Market Situations
5. Special advantages like low rate and assured supply of electricity, long term contracts for
supply of materials, well known collaborators, patents, trademarks, import, licenses etc.
enjoy higher value of goodwill.
4. Categories of 1. Purchased Goodwill

Goodwill 2. Self Generated Goodwill

6. Meaning and Goodwill for which a consideration in money or money's worth has been paid in cash is
called Purchased Goodwill.
Features of Features –
Purchased 1. It arises on purchase of business or brand.
Goodwill 2. Shown in Balance Sheet as asset.

3. It is amortized ( depreciated).
7. Meaning & It is an internally generated Goodwill which arises from a number of factors that a
running business possess.
Features of Self Features:
Generated
1. It is generated over the years.
 Goodwill
2. According to AS-26, it is not recorded in books of accounts.

3. It is also known as ''INHERENT GOODWILL''

GOODWILL needs to be valued in the following circumstances.

1. Change in Profit Sharing ratio among the existing partners

2. Admission of a New Partner

3. Retirement of a Partner

4. Death of a Partner

5. Dissolution of a firm involving Sale of business as a going Concern.

6. Amalgamation of a Partnership Firm

GOODWILL METHODS OF VALUATION OF GOODWILL

ADJUSTED/FUTURE MAINTAINABLE PROFIT

2. TOTAL OF ADJUSTED PROFIT

AVERAGE PROFIT =
No. of YEARS

3. GOODWILL = AVERAGE PROFIT X NO. OF YEAR'S OF

PURCHASE
SUPER PROFIT METHOD Under this method, the goodwill is valued at the agreed number of year's of
purchase of the super profits of the firm.

STEPS TO CALCULATE GOODWILL

opening capital employed – closing capital employed

1) Average Capital =
2
2) Calculate average maintainable profit (as above)
 3) Normal of profit = Average Capital Employed Normal rate of return
×
100

4) Super Profit = Average maintainable profits - Normal Profits

5) GOODWILL = SUPER PROFIT × NO. OF YEAR'S OF PURCHASE

Calculation of capital employed

• Assets side Approach

• Capital Employed = All Assets (except goodwill,

non-trade investments and fictitious assets) - Outside
liabilities

• Liabilities side Approach

Capital Employed = Capital + Reserves - Goodwill (if exists in books)-

Fictitious Assets - Non- trade investments

CAPITALISATION OF Under this method, the value of goodwill is calculated by deducting the actual
AVERAGE PROFITS capital employed from the capitalization value of the average profits on the
basis of the normal rate of return

STEPS TO CALCULATE GOODWILL

1. Calculate Average Normal Profit

Average profit X100

2. Capitalized value of the Business =
Normal rate of return

3. Capital Employed = All Assets (except goodwill, non-trade investment and

fictitious assets) - Outside liabilities

4. GOODWILL = Capitalized value of the Business – Net Assets

 Under this method, Goodwill is calculated by capitalizing the super profits

STEPS TO CALCULATE GOODWILL

CAPITALISATION OF
SUPER PROFITS 1. Capital Employed = All Assets (except goodwill, non-trade investments and
fictitious assets) - Outside Liabilities

2. Normal Profit = Capital Employed × Normal rate of return

100

3. Сapital average maintainable profit (as above)

4. Super Profit = Average maintainable profits - Normal Profits

Super Profit X 100
GOODWILL =
5. Normal rate of return

Simple Average Profit Method

Illustration 1.
Shweta purchased a business on 1st April 2019. It was agreed to value goodwill at three years purchase
of average normal profits of last 4 years. The Profits are as follows:
Year Ended Profits
31st March 2016 Rs.90,000
31st March 2017 Rs.1,60,000

31st March 2018 Rs.1,80,000

31st March 2019 Rs.2,20,000

1. During the year. ended 31/march/2016, an asset was sold at a profit of Rs.10,000
2. During the year ended 31/March/2017, firm had incurred a abnormal loss of Rs.20,000
3. Repairs to car amounting to Rs.50,000 was wrongly debited to vehicles on 1st May 2017. Depreciation
charged on vehicles @ 10 % on straight line Method
4. Firm had abnormal gain of Rs.10,000 during the year. ended 31 March 2019.
5. During the year ended 31 March 2019, a machine got destroyed in accident & Rs.30,000 was
written off as loss in Profit & Loss Account.
Solution: CALCULATION OF NORMAL PROFIT

Year Ended PROFIT ADJUSTMENT (Rs.) NORMAL PROFIT (Rs.)

31/Mar/2016 90,000 (10000) Profit on sale of Asset 80,000
31/Mar/2017 1,60,000 (20,000) Abnormal loss 1, 80,000
31/Mar/2018 1,80,000 (45,000) In note (i) & (ii) 1, 35,000
31/Mar/2019 2,20,000 (5000) Depreciation 2,45,000
(10,000) Abnormal loss
30,000 Loss on sale of asset
6, 40,000
Average Profit=Total Normal Profit =6,40,000 = 1,60,000
No. of years 4

GOODWILL = AVERAGE PROFIT X NO. OF YEAR'S OF PURCHASE

=1,60,000 X 3 = 4,80,000

Working note:

I. Repair Expenditure that should have been debited to P & L A/c as expense but accounted as capital
expenditure Rs.(50,000)

Hence, Loss rises by Rs.50,000

II. Depreciation wrongly debited to P & LA/c for the year ended 31/Mar/2018 Rs.(5,000)

III. Adjustment for year ended 31/march/2018 Rs.(45,000)

IV. Adjustment of depreciation for year ended 31/March/2019 (10 % 50,000) = Rs.(5,000 )

Weighted Average Profit Method

Illustration 2.

Sunil & Anil are partners sharing profit in the ratio 3:2. They admit Deepak into partnership. It was
agreed to value goodwill at three years purchase on the basis of average profit of the past five years.

The Profits for these 5 years were-

Year Ended Profit (Rs.)

31st March 2015 1,80,000

31st March 2016 1,60,000

31st March 2017 2, 50,000

31st March 2018 3,00,000

31st March 2019 3,50,000

 Following additional Information is given:

(i) An abnormal gain of Rs.20,000 was earned in the year ended 31st March 2016

(ii) Expenses of Rs.50,000 incurred to overhaul a machine on 1st, April 2017 was debited to P&L A/ C
instead of being debited to Machinery Account. Depreciation is charged on machinery @ 20 % on written
Down value Method.

(iii) The closing stock for the year ended 31st March, 2018 was under valued by Rs.20,000

(iv) To Cover management cost an annual charge of Rs.9600 should be made for the purpose of goodwill
valuation.

Calculate the value of goodwill

Solution:
CALCULATION OF ADJUSTED PROFIT
Particulars 31st March 31st March 31st March 31st March 31st March
2015 ( Rs.) 2016 (( Rs.) 2017 ( Rs.) 2018 ( Rs.) 2019 ( Rs.)

Given Profits 1,80,000 1,60,000 2,50,000 3,00,000 3,50,000

Less Abnormal
(20,000)
Gain

Add: ----------- ----------- ----------- 50,000 -----------

Capital Expenditure
on Machinery
Less: ----------- ----------- ----------- (10,000) (8,000)
Depreciation on
Machinery @ 20 %
W.D.V
Add - - - 20, 000 -
Undervaluation of
closing stock
Less undervaluation - - - - (20,000)
of opening stock
1,80,000 1,40,000 2,50,000 3, 60,000
3,22,000

Calculation of Goodwill

Average Profit = Total Normal Profit

No. of years
 = 180, 000 + 1,40000 + 250,000 + 3,60,000+ 3,22,000
5
= 12, 52,000 = 2,50, 400/-
5
Value of Goodwill = Average Profit x No. of years Purchase = Rs.2,50,400 X 3= Rs.7,51,200

Super Profit Method

Illustration: 3
The average net profits expected of a firm is future are Rs.68000 per years and capital invested in the
business by the firm is Rs.3,50,000. The rate of interest expected from capital invested in this class of
business is 12%. The remuneration of the partners is estimated to be Rs.8000 for the year. Calculate the
value of goodwill on the basis of two years purchase of super profit.

Solution

Average Profit = Average net Profit - Partner's Remuneration

(Adjusted) =Rs.68000 - Rs.8000
= Rs.60,000
Normal Profit =Capital employed X Normal Rate of Return
100
=3,50,000 X 12
100
=42,000
Super Profit = Average profit – Normal Profit
=62,000 – 42,000
=18,000
Goodwill = Super Profit x No. of years purchase
= 18,000 X 2
=36,000
 Illustration 4.

Average profit earned by a firm is Rs.75,000 which includes undervaluation of stock of Rs.5000 on
average basis. The capital invested in the business is Rs.8,00,000 & the normal rate of return is 8 %.
Calculate goodwill of the firm on the basis of 5 times the Super Profit.

Solution:

= Average Profit + Undervaluation of stock

Adjusted Average Profit
=75,000 + 5,000

= 80,000
=Capital employed X Normal Rate of Return
Normal Profit
100
=8,00,000 X 8
100
=64,000

Super Profit
= Adjusted Average Profit - Normal Profit

= Rs.80,000 – Rs.64,000
= Rs.16000

Goodwill = Rs.16000 × 5 = Rs.80,000

Capitalization of Average Profit Method

Illustration 5.
Bharat and Bhusan are partners in a retail business. Balances in Capital & Current Accounts as
on 31st March 2019 were

Capital Account Current Account

Bharat Rs.4,00,000 Rs.1,00,000

Bhusan Rs.4,80,000 Rs.20,000 (Dr)

The firm earned an average profit of Rs.97000. If the normal rate of return is 8%, find the value of goodwill.
Solution:
Capital Employed =Rs.400,000 + Rs.4,80, 000 + Rs.1,00,000 -20,000

= Rs.9,60,000

Capitalized value of the =Average Profit X 100

Business Normal Rate of Return
=97,000 X 100
8
= Rs.12, 12, 500
Goodwill = Rs.12, 12, 500 - Rs.9,60,000
=Rs.2, 52, 500

Capitalization of Super Profit Method

Illustration 6. Average Profit of the firm is Rs.1, 50, 000. Total tangible assets in the firm are
Rs.12,00,000 & outside liabilities are Rs.7,00,000. In the same type of business, the normal rate of
return is 20 %. Calculate the value of goodwill of the firm by Capitalization of Super Profit method
if the goodwill is valued at 2 years. Purchase of Super Profit.

Solution
=Capital employed X Normal Rate of Return
Normal Profit
100
=5,00,000 X 20
100
=1,00,000
Capital Employed
=Total tangible Assets - Outside liabilities
= Rs.12, 00, 000 - Rs.7,00,000
= Rs.5,00,000

Average Profit Rs.1, 50,000 (given)

Super Profit =Average profit – Normal Profit

=1,50,000 – 1,00,000
=50,000
Goodwill =Super Profit X 100
Normal Rate of Return
= 50,000 X 100
20
=2,50,000
 Practice Exercise

1. On 1st April 2018, a firm had assets of Rs.3,00,000 including Cash of Rs.5,000. The Partner's Capital A/c
showed a balance of Rs.2, 00, 000 & the Reserve Constituted the rest. If the normal rate of return of is 10
% & the goodwill of the firm is valued at Rs.200,000 at four years purchase of Super Profit. Find the
average Profit of the firm.

[Hint:- Average Profit = Super Profit + Normal Profit]

2. Balance Sheet of M/s Laxmi Stores as at 31/3/2019 was as follows:

Liabilities Amount Assets Amount
Capital A/cs Land & Building 400,000

A 1,50,000 Computers 70,000

B 1,50,000 Furniture 30,000

C 1,50,000 Investments 1,00,000

4,50,000

Stock 2,00,000
2,50,000
Reserves

Sundry Debtors 1,50,000

3,00,000 Bill Receivable 50,000

Sundry Creditors

Cash in Hand 50,000

Outstanding Expenses 10,000

Advertisement Suspense 50,000

Bank Overdraft 90,000

11,00,000 11,00,000
Average Profit was Rs.125000. Calculate goodwill at 3 year's purchase of Super Profit given NRR = 15
% if ---
(a) Investment is treated as Trade Investment

(b) Investment is taken as Non- Trade Investment

[Hint;- Non Trade Investment are deducted to calculate Capital Employed]

3. Calculate value of goodwill of the firm -
(a) At 3 years purchase of Average Profit
(b) At 3 year's purchase of Super Profit
(c) On the basis of Capitalization of Super Profit
(d) On the basis of Capitalization of Average Profit
Following Information is given -
(i) Average capital Employed is Rs.6,00,000
(ii) Net Profit/(Loss) of the firm for the last 3 years ending are :
31st March 2019 2,00,000

31st March 2018 1,80,000

31st March 2017 1,60,000

(iii) Normal Rate of return in similar business is 10 %

(iv) Remuneration of Rs.1,00,000 to partners is to be taken as charge against profit.
(v) Assets of the firm (excluding goodwill) fictitious assets and Non-trade investments) is Rs.7,00,000
whereas Partner's Capital is Rs.6,00,000 & outside liabilities Rs.1,00,000.

4. The Capital Employed in a firm is Rs.10,00,000 & the market rate of interest is 15 %. Annual
Salary of the partners is Rs.80,000. the profit of the last 3 years were Rs.3,00,000. Rs.4,00,000
& Rs.5,00,000 respectively. Calculate value of goodwill on the basis of 2 years purchase of
average super profit of last 3 years.

5. Average profit earned be a firm is Rs.2,50,00 which includes overvaluation of stock of

Rs.10,000 on an average basis. Capital invested in the business is Rs.14,00,000 & the normal
rate of return is 15 %. Calculate goodwill of the firm on the basis of 4 times the Super Profit.
 6. On April 1, 2018, a firm has assets of Rs.1,00,000 excluding stock of Rs.20,000 . The current
liabilities were Rs.10,000 and the balance constituted partner's capital Accounts. If the normal
rate of return is 8 %, the Goodwill of the firm is valued at Rs.60.000 at four years purchase of
super profit, find the actual profits of the firm.

Solution: Total Assets = Rs.1,20,000

• Capital Employed = Total Assets - Current Liabilities
= 1, 20,000- 10,000
= Rs.1,10,000

• Normal Profits = 8 % of 1, 10,000

= Rs.8.800
• Goodwill = Super Profits X No. of Years Purchase
• Super Profits = Actual Average Profits – Normal Profits
• Given Goodwill = Rs.60, 000
• 60,000 = 4 (Average Actual Profits - Normal Profits)
• 15000 = Average Actual Profits - 8,000
• Average Actual Profits = 15, 000 + 8,800 = Rs.23, 800