CORPORATE

ACCOUNTING
B.COM II
 VALUATION
OF GOODWILL
 A software company may have net
assets (consisting primarily of
miscellaneous equipment, and
assuming no debt) valued at Rs 1crore,
but the company's overall value
(including brand, customers, intellectual
capital) is valued at Rs 4 crore.
Anybody buying that company would
book Rs 4 crore in total assets
acquired, comprising Rs1 crore physical
assets, and Rs 3 crore in goodwill.
 GOODWILL
“Goodwill is nothing more
than the probability that the
old customer will resort to
the old place.”
-lord Eldon
When a man pays for goodwill, he
pays for something which places
him in the position of being able to
earn more than he would be able to
do by his own unaided efforts.
Goodwill is, thus, present value of
a firm’s anticipated super normal
earnings.
 FEATURES OF GOODWILL
• It is an intangible asset.
• It may be purchased or inherent in the
business.
• It is capable of transfer from one
person to another.
• Value of goodwill generally fluctuates
from time to time.
• It can be sold only with entire business
and not separately.
 Elements of Goodwill
• Patents
• Franchises
• Customer lists
• Copyrights
• Organisation cost
• Special location advantage
FACTORS DETERMINING THE
VALUE OF GOODWILL
• LOCATION ADVANTAGE
• CAPITAL REQUIRED
• SKILL OF MANAGEMENT
• TRADE NAME
• PROFIT TREND
• QUALITY
• SPECIAL CONTRACT
 METHOD OF VALUING
GOODWILL
• Arbitrary Assessment
• Capitalisation Method
• Purchase of Past Average Profit
• Super profit-
(i)Purchase of Super Profit
(ii)Annuity Method
(iii)Capitalisation of Super Profit
Method
ARBITRARY ASSESSMENT
The valuation of goodwill is arrived at by
making a valuation by one of the parties,
vendor or purchaser to which the other
agrees. If a company decide to purchase the
business of another concern and it mutually
agreed upon that the purchasing company
will pay a specific amount for goodwill in
lump sum. The amount so agreed upon is
called an arbitrary assessment.
Example:-
X ltd. Purchases the business of
Y ltd. And it is mutually agreed
upon that X ltd. Will pay to Y ltd. a
sum of Rs. 1 lac on account of
goodwill. This is the case of
arbitrary assessment of valuation
of goodwill.
CAPITALISATION METHOD
Following are the main steps to be taken in
computing by this method –
a. ascertain the average net profit which it is
expected will be earned in future.
b. capitalize this net profit at the rate which is
considered a suitable return on capital invested in a
business of the type under consideration
c. find the value of the net tangible assets used in
the business (assets less outside liabilities)
d. deduct the net tangible assets from the
capitalized profit obtained and the difference is
goodwill
Example;
If the company desirous of selling its business has
earned average profits of Rs. 1,80,000 and the net
tangible assets of the vendor company was Rs.
15,00,000 and it was considered that a reasonable
return on capital invested was 10%

Capitalised Profits= 1,80,000 x 100

10
= 18,00,000
Net Tangible Assets = 15,00,000
Goodwill = Capitalised profit- Net Tangible Assets
= Rs.3,00,000
 Purchase of Past Average
Profit
This method of valuing goodwill is commonly met with in
practice and probably is the on most generally understood. it is
calculated on the following basis:
1.profit for an agreed number of year preceding valuation are
averaged so as to arrive at the average annual profit earned
during that period
(average may be simple or weighted).
2. The goodwill is then estimated to be worth so many year
purchase of such average profit .The number of year selected is
presumed to bear relation to the number of years benefit to be
derived from past association.
The value of goodwill is calculated by multiplying the adjusted
annual purchase profit by the number of year of purchase.
Goodwill = Average profits x Number of
years purchase

Example:-
Average profit =
45000+ 40000+50000+ 47000+58000 = 48000
5
Goodwill = Average profits x No. of years
purchase = Rs. 48000x3 =Rs. 144000
 WEIGHTED AVERAGE
PROFITS METHOD

Goodwill = Weighted Average

Profits x Number of Years Of
Purchase
 SUPER PROFIT
It is the excess of the average profit over the normal profit
based on normal rate of return for representative firm in the
industry for computation of super profit , the following three
factor are required:
Normal rate of return-This is the rate of profit or return
which an investor expects on his investment.
Capital employed –it may be calculated on the basis
of assets side items or liabilities side items.
capital employed=fixed assets +trade investment + current
assets – debenture – current liabilities
Normal profit – it is calculated by multiplying the
normal rate of return with capital employed as the
case may be.
 PURCHASE OF SUPER
PROFIT
Super Profit = Average Profit
- Normal Profit

Goodwill = Super profit x

No. Of Years Of Purchase
• Goodwill=Super Profits x Number
of Years Purchase.

• Super profits=Average Profits –

Normal Profits.

• Normal profits=Capital Employed-

Normal rate of return/100
EXAMPLE;
X Ltd. is running its business with a capital of Rs.
20,00,000.on the basis of previous records , it is
expected that the company will earn Rs. 5,00,000 in
future. The normal rate of return is 15%. The super
normal profits of X Ltd. Will be calculated as;
Profits expected in future
RS.5,00,000
LESS: Normal profits = [20,00,00 x15%]
= Rs.3,00,000
Super profits = Rs.2,00,000
Goodwill= 2,00,000 x 5 =Rs.10,00,000
CAPITALISATION OF SUPER
PROFIT METHOD
Under this method, the value of
goodwill is calculated by capitalizing
the super profit at a normal rate of
return. This method attempts to
determine the amount of capital needed
for earning super profit.
Goodwill= Average Super Profit x 100
Normal Rate Of Return
EXAMPLE: If super profit is Rs. 45,000,
the normal rate of profit is 15%, the
value of goodwill as per capitalisation
of super profit will be-

Goodwill= Super profit x 100

Normal rate of return
= 45000 x100
15
 ANNUITY METHOD
Under this method, the value of goodwill
is calculated by finding the present
worth of an annuity paying the super
profit (per year) over the estimated
period discounted at the appropriate
rate of interest. The annuity method of
calculation of goodwill is based on the
present worth of an annuity of Re 1 for
n years at r percent.
GOODWILL =
SUPER Profit X ANNUITY
VALUE
EXAMPLE;
The amount of super profits amounts to
Rs. 2,00,000.A reference to annuity
table shows that Re.1 paid annually for
5 years at 10% rate of interest is equal
to Rs.3.78 immediately. Hence
Goodwill=Super profits x value of an
annuity
=2,00,000 x 3.78 =Rs. 7,56,000
 CONCLUSION
“Just as cement binds together the
bricks and other building material
into walls, similarly goodwill binds
together or unites the other assets
and aspects of the business into
cohesive whole.”