Valuation of Goodwill

1. Unit 2
Goodwill
Needs,
Circumstance of valuation Goodwill
Factors influencing the value of goodwill
Methods of Goodwill
Average Profit Method & Super Profit Method
Capitalization of Average Profit Method & Capitalization of
Super Profit Method
Annuity Method – Problems and solutions of the above

2. Goodwill
Goodwill- Good name, Value of Reputation (opinion)
Advantages – attract the new customers, Retain the
existing customers, helps to earning more income in
future.
“Present value of the firm’s anticipated excess earnings
in future”.
“Capacity of a business to earn super profit in future”
“Excess of Purchase Price of another company (
Difference between fair market value of assets and
Liabilities)”

3. Characteristics and merits of Goodwill
 Intangible real assets
 Easy to describe but not define
 inseparable from company
 fluctuating nature
 indefinite usage life
 Distinguish between old and new business
 Factor to earn more super profit (Avg. Profit-NRR)

4. Circumstance / need of valuation of
goodwill
1) In the case of sole trading company
a) When it is sold
b) when it is converted into joint stock
company
c) when it is amalgamated with another
company
2) In the case of partnership firm
a) on the admission of partner
b) on the retirement
c) on the death
d) on the sale of partnership or amalgamation

5. 3) In the case of joint stock company
a) on the amalgamation of the company
b) on the absorption of the company
c) external reconstruction of the company
d) Acquisition of majority of shares
e) Purpose of valuation of shares

6. Factors affecting the Goodwill
Location of the company
Quality of the goods and servics
Efficiency of the management
Technical Know-How
Business Risk
Nature of the Business and Levels of competition
Trademark and Paten
Level of Capital

7. Types of Goodwill
Dog Goodwill – Loyal and Faithful customer base ,
Attached with the owner but not location of business
Rat Goodwill – Attached with neither person nor place
of the business
Cate Goodwill – Best Goodwill, Progressively loyal to
the brand and organization or Authority

8. Methods of Valuation of Goodwill
I. Average Profit Method
A) Simple Average Profit Method
B) Weighted Average Profit Method
II. Super Profit Method
a) Simple Average or Weighted Average Method
III. Capitalization method
a) Capitalization of Simple/Weighted Average Profit
Method
b) Capitalization of Super Profit Method
IV. Annuity Profit Method

9. I. Average Profit Method
1. Simple Average Profit Method
2. Weighted Average Profit Method
Simple average Profit Method
Goodwill = Adjusted Average Profit x Number of Purchase of Years
*Adjusted Average Profit = Adjusted Profit of all years / No of Years
*Adjusted Profit = Net Profit+(Regular Incomes likely to occur +
abnormal expenses not likely to incur in Future) – (Irregular or
Capital income + regular Expenses likely to occur in future)

10. Profit Given xxxxxxx
Add : Expenses and Losses not likely to occur in future xxxxxxx
(Abnormal or irregular, loss, salary Capital exp etc)
Add : All profit likely to come in future xxxxxxx
----------
xxxxxxxx
Less : All Expenses and losses Expected to occur in future
(salary, insurance, Depreciation, Cost to Management etc) xxxxxxx
Less: Profit not likely to recur in future xxxxxxx
--------------------
Adjusted profit of the year xxxxxxx
Finding of Adjusted Profit

11. Example: G & Co. decided to purchase a business. Its profits
for the last 4 years were
 Year 1998 – Rs.40,000,
 Year 1999- Rs.50,000,
 Year 2000 – Rs.48,000,
 Year 2001 – Rs.46,000
The business was looked after by the management.
Remuneration from alternative employment if not engaged
in the business comes to Rs.6,000p.a.
Find out the amount of goodwill, if it is valued on the basis
of 3 years purchase at the average net profit for the last 4
years.
Avg Profit : Rs.40,000, Goodwill. Rs 1,20,000)

12. Problem No: 1. Mr. Amar has been doing business, intends to
sell his business on 1-12-2006.
From the following particulars ascertain the amount of
goodwill based on 3 years purchase of average profits of last 4
years. The profits during 4 years were as follows:
 a) 2003-Rs.2,00,000 ; b) 2004—Rs. 1,40,000 ; c) 2005-
Rs.3,00,000 d) 2006- Rs.3,60,000
Additional Information
1.At the time of acquisition of business, the buyer was
employed as a manager of business on a salary of Rs.6,000 per
month.
2.The profits of 2006 include income from investment of
Rs.20,000.
3.The profits of 2003 were reduced by Rs.60,000 being loss on
speculation.
4.Similarly, in 2005 profits were reduced by Rs.1,00,000 due to
loss from betting. Ans: Adj. Avg. Profit : Rs. 2,38,000
(188000+168000+328000+268000/4) , Goodwill : Rs 7,14,000

13. Problem No: 2. Ramesh purchase business from Suresh from
1-4-2001.Profit earned by Suresh from the preceding years were
a) 1999-5,00,000 ; b) 2000-6,00,000 ; c) 2001-5,40,000
Additional Information
 It was found that the profits for the year 1999 included a non-
recurring income of Rs. 20,000
 Profits for the year 2001 was reduced by 30,000 due to an abnormal
loss due to small fire in the shop.
 The properties of the business were not insured in the past. But it
was planned to insure the property in future at a premium of
Rs.5,000 p.a .
 Ramesh at the time of purchase of business was employee as
manager of an identical business concern at a monthly salary of Rs.
10,000 per Month. He intends to replace the manager of business
who is drawing a salary of Rs.7,500 p.m .
 The goodwill is estimated at 2 years of purchase of average profits.
Calculate the value of Goodwill.
Ans: Adj. Avg.Profit – Rs.5,15,00, Goodwill Rs. 10,30,000

14. Problem No: 3. (Complete At Home)
The following particulars are available in respect of the business
carried on by Mr. Madhu.
The profits are (in Rs.) a)1999 - 50,000 b) 2000 - 48,000 c) 2001 -
52,000.
Additional Information
 Profits of 2000 is reduced by rs. 5,000 due to stock destroyed by
fire.
 Profits of 1999 included a non-recurring income of Rs. 3,000
 Profits of 2000 include Rs. 2,000 income on investment
 The stock is not insured and it is thought prudent to insure the
stock in future. The insurance premium is estimated at Rs 500
p.a
 Fair remuneration to the proprietor (not taken in the calculation
of profits) is Rs. 10,000 p.a .
 You are required to compute the value of goodwill on the basis
of 2 years purchase of average profits of the last 3 years.
Ans: Adj.Avg.Profit – Rs.39,500, Goodwill Rs. 79,000

15. Weighted Average Profit Method
Step 1 – Calculate Adjusted Profit of Each Year
Step 2 – Multiply Profit of Each Year by weightage given for
years
Step 3 – Average of Profit = Total profit of years / Total weights
Goodwill = Weighted Average Profit x Number of Years of
Purchase
Problem No : 4, Complete at Home

16. Problem 5- (Weighted Average Profit Method)
ABC Ltd purchased the business of XYZ Ltd. The appropriate weights are :
Year Profit Weights
2001 40,500 1
2002 46,500 2
2003 60,000 3
2004 75,000 4
Additional Information
a). The company purchased new furniture on 30th June 2003 which
was entered in purchase day book. The value of furniture was
Rs.10,000 .
For the purpose of goodwill the error has to be rectified and
depreciation should be provided at 10% under written down value
method.
b). The opening stock of year 2003 was undervalued by Rs.2,500
c). Anticipated additional expenses in administration is Rs.5,00
Calculate goodwill on the basis of 3 years of purchase weighted
average for 4 years.
Ans : Adjusted & Weighted Avg: 35,500*1 + 45,000x2.5 + 62,000*3.8 +
69,050*4.2 = 6,73,110/11.5 = 58,531, Goodwill = 58531*3= 1,75,593

17. Problem 5- (Weighted Average Profit Method)
Particulars 2001 2002 2003 2004
Profit Given 40,500 47,500 60,000 75,000
Expenses will not inccur
in future (Furniture –
capital exp)
- - 10,000 -
Less : Expenses occur in
future -Depreciation
- - 500 950
Administration Expenses 5000 5000 5000 5000
Less: over valuation
opening Stock
- 2500
Add: Over Valuation of
Closing Stock
- 2500
35500 45000 62000 69050

18. Step 2 - Calculation of Weighted Profit
35,500 X 1 35,500
45,000 x X 2.5 11,250
62,000 x X 3.8 2,35,600
69,050 x X 4.2 2,90,010
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Total Weighted Profit 6,73,110
--------------
Step 3 - Weighted Average Profit
Total Profit of All Year / Total Weightage
= 6,73,110 / 11.5
=58,531
Step 4 – Calculation of Goodwill
Goodwill = Weighted Average Profit x No. of Years of Purchase
= 58,531 X 3 Years
= 1,75,593

19. Note ;
1. Cost of Furniture is Incurred for business. But it is not revenue
expenditure in nature. So Deducted one should be added again.
2. Depreciation – it should be calculated to the year concerned and
next year that immediately following.
Period of the furniture usage : From July to December=6 months ;
= 10,000 x 10/100 x 6/12
= 500
3. In the following year (2004) = 9500 x 10/100
= 950
4. Adjustment of Stock (Material Consumed) = ( opening St +
Purchase - Cl.Stock )
Take Reverse Action

20. Problem No: 4. G Ltd proposed to purchase the business carried on by Mr. S . Goodwill for this purpose
is agreed to be valued at 3 years purchase of the weighted average profits of the past 4 years ,
The appropriate weights to be used are:
Year Profit Weightage Additional Information.
1. On 1st January ,2000 a major repair was made in respect of
the plant incurring Rs. 30,000 which amount was charged to
revenue .
1998 1,01,000 1
1999 1,24,000 2
2000 1,00,000 3
2001 1,50,000 4
2. The said sum is agreed to be capitalized for goodwill calculation subject to adjustment of
depreciation of 10% p.a on reducing balance method.
3. The closing stock for the year 1999 was over valued by Rs.12,000
4. To cover management cost an annual charge of Rs.24,000 should be made for the purpose of
goodwill valuation. Compute the value of goodwill
Ans: Rs.77,000*1 + 88,000*2 + 1,15,000*3 + 1,23,500*4 = 10,91,200 / 10 = 1,09,120 Goodwill=3,27,360

21. Super Profit Method
A)Super Profit Under Simple or Weighted Average Profit Method
Super Profit Under Simple Average Method
Step 1: Calculation of Adj.Average Profit ( Total Profit / Total no of
years)
Step 2: Normal Profit = Avg.Capital Employed in Business x
Normal Rate of Return ( Avg.Capital Employed =Closing Capital –
½ of Current year Profit)
Step 3 : Calculation of Super Profit = Average Profit – Normal
Profit
Step 4 : Calculation of Goodwill = Super Profit X No. of years of
Purchase.

22. 2.1 Super Profit Under Simple Average Method
Problem No: 6.
From the following particulars ,compute the value of Goodwilll on the
basis of 3 years purchase of super profit taking advantage of last 4
years.
Fixed assets-Rs.8,00,000 Current assets- Rs.80,000
Current liabilities- Rs.1,60,000 Normal rate of return-15% Managerial
remuneration if employed elsewhere-Rs.10,000 P.a
Profits for the last 4 years were Rs. 1,20,000 , Rs. 1,40,000, Rs.
1,30,000 and Rs. 1,50,000 respectively.
Ans : - Average Profit = 1,35,000 – 10,000 = 1,25,000
Average Capital Employed = 8,80,000 – 1,60,000 – 70,000 (1,50,000 –
10,000)
Normal Profit = Capital Employed * NRR = 97,500
Super Profit = Adj.Avg.Profit – Normal Profit = 1,25,000 -, 97,500=27,500
Value of Goodwill = Super Profit x No. of Years of Purchase =82,500

23. 2.1 Super Profit Under Weighted Average Method
Problem No: 7 .
From the following balance sheet of S Ltd as on 31-03-2010, calculate
the goodwill at 3 years purchase of super profits.
Liabilities Assets
Share capital 30,00,000 Fixed assets 20,00,000
Reserves & surplus 7,50,000 Current Assets 25,00,000
Creditors 12,50,000 Investment 5,00,000
The investments are 8% Government Bonds.
The net profit after taxation for the past 4 years were Rs.7,85,00, Rs.
8,45,000, Rs. 8,50,000, Rs. 8,60,000 respectively. Normal rate of return
on the average capital employed is 20%
Ans : Profit of 4 years / Taken Weights = Weighted Average Profit = 84,65,000/ 10 =,8,46,500
Adjusted Weighted Average Profit = Avg Profit – Interest on Investment = 8,46,500-40,000 =
8,06,500, Capital Employed = Fixed + Current - Creditors
:Average Capital employed = Closing capital Employed – ½ of Current year Profit
32,50,000 -, 4,10,000
Normal Profit = 28,40,000 * 20% = 5,68,000
Super Profit = Average Profit – Normal Profit = 2,38,500
Goodwill = Super Profit X No of Years of Purchase = 7,15,500

24. 2.1 Super Profit Under Weighted Average Method
Problem No: 7 .
From the following balance sheet of S Ltd as on 31-03-2010, calculate
the goodwill at 3 years purchase of super profits.
Liabilities Assets
Share capital 30,00,000 Fixed assets 20,00,000
Reserves & surplus 7,50,000 Current Assets 25,00,000
Creditors 12,50,000 Investment 5,00,000
The investments are 8% Government Bonds.
The net profit after taxation for the past 4 years were Rs.7,85,00, Rs.
8,45,000, Rs. 8,50,000, Rs. 8,60,000 respectively. Normal rate of return
on the average capital employed is 20%
Ans : Profit of 4 years / Taken Weights = Weighted Average Profit = 84,65,000/ 10 =,8,46,500
Adjusted Weighted Average Profit = Avg Profit – Interest on Investment = 8,46,500-40,000 =
8,06,500, Capital Employed = Fixed + Current - Creditors
:Average Capital employed = Closing capital Employed – ½ of Current year Profit
32,50,000 -, 4,10,000
Normal Profit = 28,40,000 * 20% = 5,68,000
Super Profit = Average Profit – Normal Profit = 2,38,500
Goodwill = Super Profit X No of Years of Purchase = 7,15,500