Valuation of goodwill

1. Valuation of Goodwill
SAKSHAM RASTOGI
XII-E
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2. Meaning of Goodwill
 It is a good name or reputation earned by a firm.
 It is an intangible asset.
 It is the value of business over and above the value of its assets.
 It is the difference between the purchase price and the value of net assets.
 It has a positive impact on the future turnover and profits of the business.
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3. Factors Affecting Valuation of Goodwill
1. Good Public Relation
2. Regular Customers
3. Quality Product in Reasonable Price
4. Management Skills
5. Location of Business
6. Good Relation with Suppliers
7. Employees
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4. Methods of Valuation of Goodwill
1. Simple Average Profit Method
2. Super Profit Method
3. Weighted Average Method
4. Capitalization Method
a. Capitalization of Average Profit Method
b. Capitalization of Super Profit Method
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5. 1. Simple Average Profit Method
 Goodwill = Average Profit * Number of year of
purchase
 Average Profit = Total Profit / Number of Years
 Number of years of purchase means the number of
year for which the firms is likely to earn the same
amount of profit.
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6.  Things to consider before calculating the average profits :-
1. Any abnormal profit should be deducted from the net profits of that year.
2. Any abnormal loss should be added back to the net profits of that year.
3. Non-operating incomes e.g. income from investments should be deducted
from the net profits of that year.
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7. Illustration No. 1
 Following details are available about Alpha ltd.
1. Profits 2010 ₹ 100000, 2011- ₹ 125000,
2012- ₹ 140000
2. Profits of 2010 have been reduced by ₹ 15000
because goods were destroyed by fire.
3. Non-recurring income of ₹ 10000 is included in the
profit of 2011.
4. Profits of 2012 include ₹ 10000 income from
investment.
Calculate goodwill on the basis of four
years’ purchase of the average profit of last three years.
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8. Solution :-
1. Profit of 2010 ₹ 100000 add ₹ 15000 = ₹ 115000
2. Profit of 2011 ₹ 125000 less ₹ 10000 = ₹ 115000
3. Profit of 2012 ₹ 140000 less ₹ 10000 = ₹ 130000
Average Profit/ Future Maintainable Profit
= Total Profit / No. of Years Purchase
= 360000 / 3
= 120000
Goodwill = Future Maintainable Profit * No. of years purchase
= 120000 * 3
= 40000
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9. 2. Super Profits Method
 Goodwill is calculated on the basis of Super Profit i.e. the excess of actual
profits over the average profits.
 Formula:-
1. Goodwill = Super Profit * No. of years purchase
2. Super Profit = Average Profits - Normal Profits
3. Normal Profits = Capital Employed * Normal Rate of Return /
100
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10. Illustration No. 2
Average Profit is ₹. 60000, Capital employed is ₹ 500000, NRR is 10%.
Calculate goodwill on the basis of four year’s purchase of the super profit of last
four years.
Solution:
Normal Profit = Capital employed * NRR
= 500000 * 10%
= 50000
Super Profit = Average Profit – Normal Profit
= 60000 - 50000
= 10000
Goodwill = Super Profit * No. of years purchase
= 10000 * 4
= 40000
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11. 3. Weighted Average Profit
method
 This method is the modified version of the simple average profit
method. In this method, each year’s adjusted profits are multiplied
with the respective number of weights in order to calculate the total
product. The total of products is then divided by the total of weights
to calculate the weighted average profits. Thereafter, the weighted
average profits are multiplied by the number of years of purchase.
 Formula :
 Weighted Average Profits = Total Products o Profits / Total of
Weights
 Goodwill = Weighted Average Profits * No. of years of purchase
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12. 4. Capitalization of Profit Method
a. Capitalization of Average Profit Method
= Average Profit / NRR * 100
b. Capitalization of Super Profit Method
= Super Profit / NRR * 100
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13. Thank You
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