Partnership Goodwill Notes2

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:

  1. Abnormal losses (e.g., loss by fire, theft etc.)
  2. Loss on sale of fixed assets
  3. Overvaluation of Opening stock or Undervaluation of Closing Stock
  4. Non-recurring expenses
  5. Assets treated as expense less depreciation

Less:

  1. Abnormal gains
  2. Profit on sale of fixed assets
  3. Overvaluation of Closing stock or Undervaluation of Opening Stock
  4. Non-recurring incomes
  5. Expenses treated as assets less depreciation
  6. 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:

      1. Reserves

Less:

      1. Non-trade Investments
      2. Goodwill
      3. Advertisement Suspense

Assets Side Approach

All Assets (excluding goodwill, fictitious assets, Non-trade Investments)

Less:

    1. 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

 

Average Capital Employed =