Financial Accounting

1. Valuation of Goodwill

2. Meaning of Goodwill
An intangible asset which provides a competitive
advantage such as a strong brand , reputation or high
employee morale. In an acquisition, goodwill appears
on the balance sheet of the acquirer in the amount by
which the purchase price exceeds the net tangible assets
of the acquired company.
Goodwill is there when a business is earning over
and above the normal earnings made by other similar
firms in the same business or industry.

3. Factors Affecting Goodwill
1.Outstanding quality of products/services.
2.Locational factors
3.The period for which the business has been in
business.
4.Money market conditions, After sales service.
5.Nature of Business
6.Good relations with customers, suppliers, labour
and government.
7.Efficiency of Management
8.Capital required

4. Need for Valuation of Goodwill
(a)In the Case of a Sole-Proprietorship Firm:
If the firm is sold to another person;
If it takes any person as a partner and
If it is converted into a company
(b)In the Case of a Partnership Firm:
If any new partner is taken;
If any old partner retires from the firm;
If there is any change in profit-sharing ratio
If any firm is sold

5. Methods for valuation of Goodwill
1.Average Profit Method
2.Super Profit Method
3.Capitalisation Method
(a) Capitalisation of Average Profit method
(b) Capitalisation of Super Profit method
4. Annuity Method.

6. 1. Average Profit Method
Under this method the value of goodwill is calculated by
multiplying the average future profit by a certain no. of
years purchase.
Goodwill = Average Profits X No. of years Purchase
Average Profit = Total Profits for all the years/Number of years

7. 2. Super Profit Method
Under this method the value of goodwill is calculated by
multiplying the super profits by a certain no. of years
purchase.
Super profit is the excess of estimated future profits
over the normal profits.An enterprise may posses some
advantages which enable it to earn extra profits over and
above the normal profits that would be earned if the capital
of the business was invested in some other business with
similar risks.
Goodwill = Super Profits X No. of years Purchase
Super Profit = Actual Profits - Normal Profit

8. 3. Capitalisation Methods
(a) Capitalisation of Average Profit method:
Under this method goodwill is ascertained by deducting actual
capital employed from the capitalized value of average profits on
the basis of normal rate of return.
Goodwill = Capitalized value- Net assets of Business
Steps in calculation of Goodwill:
1. Calculate average profits
2. Calculate the capitalized value of average profits.
Capitalized Value= Average Profits x 100/ Normal rate of return
3. Calculate Net Assets = Total Assets- Outsiders Liabilities
Outsiders Liabilities = Total Liabilities- (Share Capital+ Reserves)

9. 3. Capitalisation Methods
(b).Under this method goodwill is ascertained by
capitalizing the super profits on the basis of normal rate of
return. This method assess the capital needed for earning
the super profits
Goodwill = Super Profits x 100/ Normal rate of return

10. 4. Annuity Method
Under this method goodwill is calculated by taking
average super profits as the value of annuity over a certain
no. of years. The annuity table value is computed with
discounting rate (Normal rate of return) and the certain no.
of years.
Goodwill = Average of Super Profits x Annuity table value
Average of Super Profits = Super profits/ no. of years
Annuity table value = Normal rate of return at Certain no.
of years.