Study Material & Notes
Goodwill is the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force which brings in customers. It is one factor which distinguishes an old established business from a new business at its first start.
Important to Note: As per AS-26 Goodwill should not be recorded in books unless it is purchased
Study Material & Notes
Goodwill = Simple Average Profit X Number of years purchased
Where:
Simple Average profit = Simple Average of pure profit of last few years
Computation of Pure Profits
Profit or Loss of past year (before adjustments)
Add:
Less:
Number of years purchased = For how many years firm will earn same profits (this is given in the question)
Goodwill = Weighted Average Profit X Number of years purchased
Where:
Weighted Average profit = Weighted Average of pure profit of last few years
Number of years purchased = For how many years firm will earn same profits (this is given in the question)
Goodwill = Super Profit X Number of years purchased
Where:
Super Profit = Average Profit – Normal profit
Average profit = Simple Average of pure profit of last few years
Normal Profit = Normal Profit is the Profit earned by similar firms in similar businesses and can be computed with the formula
Average Capital Employed X Normal Rate of Return
Average Capital Employed =
(Capital Employed at beginning of year + Capital Employed at end of year) / 2
Normal Rate of Return = Rate of return earned by the similar firms in the market. This rate is already given in the question
Number of years purchased = For how many years firm will earn same profits (this is given in the question)
Computation of Capital Employed
Liabilities Side Approach
Capital
Add:
Less:
Assets Side Approach
All Assets (excluding goodwill, fictitious assets, Non-trade Investments)
Less:
Goodwill = Super Profit X
Where:
Super Profit = Average Profit – Normal profit
Average profit = Simple Average of pure profit of last few years
Normal Profit = Profit earned by similar firms in similar businesses and can be computed with the formula:
Average Capital Employed X Normal Rate of Return
Normal Rate of Return = Rate of return earned by the similar firms in the market. This rate is already given in the question
Goodwill Employed = Average Profits X
– Net Assets or Average Capital
Where:
Average Profits = Simple Average of pure profit of last few years
Normal Rate of Return = Rate of return earned by the similar firms in the market. This rate is already given in the question