### 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