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.
Good will = Good name or Reputation
Is an Intangible asset…cannot be seen or touched
Places an enterprise at an advantageous position due to efforts made in the past
Enterprise is able to earn higher profits without extra efforts
B. Factors affecting valuation of Goodwill
C. Need for valuation of Goodwill
At the time of admission, retirement or death of a partner.
Change in the profit-sharing ratio amongst the existing partners.
When the partnership firm is sold out.
When the firms amalgamate (merge)
When the firm is converted into Company
D. Classification of Goodwill
1) Purchased (Acquired) Goodwill
It is the goodwill that is acquired by a business after paying consideration in cash or in kind.
For example, consideration paid Rs. 10 lacs for purchase of a business wherein Assets acquired valued Rs. 20 lacs & Liabilities taken over for Rs. 12 lacs. Extra Rs. 2 Lacs is paid here for Goodwill.
2) Self Generated Goodwill
It is internally generated or hard-earned goodwill which arises due to continued hard work of the organization, its better-quality products and better customer services.
Self-generated goodwill is not recorded in the books because no consideration in money or money’s worth is paid for it.
Important to Note:As per AS-26 Goodwill should not be recorded in books unless it is purchased
Quiz [2]
Topic - 2 | METHODS OF VALUATION OF GOODWILL:
Video Lectures [3]
Study Material & Notes
Study Material & Notes for the Chapter 2
Partnership – Goodwill
II. METHODS OF VALUATION OF GOODWILL
A. Simple Average Profit
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:
Abnormal losses (e.g., loss by fire, theft etc.)
Loss on sale of fixed assets
Overvaluation of Opening stock or Undervaluation of Closing Stock
Non-recurring expenses
Assets treated as expense less depreciation
Less:
Abnormal gains
Profit on sale of fixed assets
Overvaluation of Closing stock or Undervaluation of Opening Stock
Non-recurring incomes
Expenses treated as assets less depreciation
Partners Salary
Number of years purchased = For how many years firm will earn same profits (this is given in the question)
B. Weighted Average Profit
Goodwill = Weighted Average Profit X Number of years purchased
Where:
Weighted Average profit = Weighted Average of pure profit of last few years
Weights for each year Profit is given in the question
Pure Profit is multiplied by weight of respective year and ‘Product’ is obtained
Weighted Average Profit = Total Product / Total Weights
Number of years purchased = For how many years firm will earn same profits (this is given in the question)
C. Super Profit Method
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:
Reserves
Less:
Non-trade Investments
Goodwill
Advertisement Suspense
Assets Side Approach
All Assets (excluding goodwill, fictitious assets, Non-trade Investments)
Less:
Outside Liabilities
D. Capitalization of Super Profit Method
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
E. Capitalization of Average Profits
Goodwill Employed = Average Profits X
– Net Assets or Average Capital
As per the profit earned by firm, how much capital is required for the same (using normal rate)
How much Capital Firm has put in the business (Capital Employed)
If the Firm is able to earn more profits even by putting lesser capital, it is because of Firm’s Goodwill
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
