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Factor Valuation
Its
Goodwill affecting of
features
goodwill goodwill
Goodwill
Goodwill is an intangible assets linked to
an established business built over time, as
business gains favorable reputation for
maintaining good customers-suppliers
relationship and effective branding as it is
expected to make profit year to year
Goodwill
Intangible asset
It is valuable only entire business is sold
It is difficult to place an exact value
It may be purchased or non- purchased.
Factor affecting goodwill
Average Profit
Method
Super Profit
Method
Capitalization
Method
Average Profit Method
Goodwill=Average profit * no. of years
of purchase
Where,
Super profit=
Normal profit
Actual profit- Normal
profit
Normal Profit=
Capital Employed Normal Rate Of Return Capital employed*
Normal rate of
return
Example
The capital employed as shown by the books of ABC
Ltd is $ 50,000,000. And the normal rate of return is
10 %. Goodwill is to be calculated on the basis of 3
years purchase of super profits of the last four years.
Profits for the last four years are:
2005 10,000,000
2006 12,250,000
2007 7,450,000
2008 5,400,000
Solution
Total profits for the last four years =
10,000,000 + 12,250,000 + 7,450,000 +
5,400,000 = $35,100,000
Average Profits = 35,100,000 / 4 = $ 8,775,000
Normal Profits = 50,000,000 X 10/100
= $ 5,000,000
Super Profits
= Average/ Actual Profits − Normal Profits
= 8,775,000 − 5,000,000 = $ 3,775,000
Capitalization
method
Example
ABC Ltd earns a profit of $ 50,000 by employing a
capital of $ 200,000, The normal rate of return of a
firm is 20%.To calculate Goodwill:
Normal Profits = 200,000 * 20/100 =$ 40,000
Super profits = 50,000 − 40,000 = $10,000
Goodwill = 10,000 × 100 / 20 = $50,000
Need for valuation of goodwill
In case of sole trade:
When the business is to be disposed off
When someone is to be admitted as a partner
For accessing the wealth tax on the death.
In case of Partnership:
When a new partner is admitted
When a partner retires or dies
When there is change in the profit sharing ratio
When there is dissolution.
In case of a company:
When one company takes over another
When two or more companies amalgamate
When government take over the business